Risk-Sharing and Benefit Smoothing in A Hybrid Pension Plan

Abstract

A hybrid pension plan with an explicit formula for sharing risk between the plan sponsor and the members is proposed. The performance of this plan is analyzed using a modified version of the model used by Dufresne (1988). Formulas for the variance of the contribution income and benefit outgo are derived, assuming investment returns are independent and identically distributed. The performance of the hybrid plan is compared with a defined contribution (DC) plan providing the same expected retirement benefit. It is shown that the hybrid plan is more efficient in the control of investment risk, and that this gain in efficiency is greater when “lifestyle” investment strategies are adopted in the DC plan. Modifications to the proposed hybrid benefit structure that might be required for a real plan are suggested.