Eckhard Platen

University of Technology Sydney

Targeted Pensions: Minimising the Cost of Securing our Social Future

Abstract: This paper provides an innovative approach to the design of sustainable pension schemes. It proposes the introduction of a new generation of pensions, called targeted pensions. These can secure a decent standard of living in retirement and are cheaper to create than is possible under current paradigms and methodologies. Most existing schemes suffer from severe shortcomings. It is practically impossible to completely control all risks associated with the delivery of a fully guaranteed stream of pension payouts, as has been historically attempted by many pension schemes. Risks that cannot be hedged will have to be accepted by the beneficiaries. Therefore, payouts can only be targeted and not guaranteed. Financial market risk and mortality risk can be mitigated by hedging and diversification. Based on new theoretical insights, this paper will exploit a new level of sophisticated asset management that produces portfolios with outstanding performance. These portfolios, used in combination with new valuation and hedging methods, target the payouts of interest indexed life annuities with minimal cost. By regularly adjusting entitlements in targeted pension schemes total assets match total fair values of targeted payouts. Model risk, longevity risk and other unknowable risks are jointly shared by the beneficiaries, which makes these schemes sustainable in perpetuity.