Stability of participation in collective pension schemes: An option pricing approach

This paper contributes to the discussion about mandatory participation in collective funded pension schemes. It explores under what circumstances individual participants exercise the option to exit such scheme if participation is voluntary. First, we show how the willingness to participate increases when there are more future exercise dates. Then, we show how the pension fund’s set of policy instruments can be designed to minimise the likelihood that cohorts exit the pension scheme. The instruments consist of contribution and indexation policies. Recovery of the funding ratio (ratio of assets over liabilities) to its regulatory target level may be based on uniform contributions or age-dependent contributions which are actuarially fair in expectation. Specifically, while the value of the exit-option deters younger workers from exiting the pension fund, a uniform contribution policy encourages older workers to stay in the pension scheme.
 
Keywords: defined-benefit and collective defined-contribution pension funds; participation decision; actuarially fair, uniform and age-dependent contribution; European, Bermuda and American option; Least Squares Monte Carlo simulations; stability.
JEL classifications: C61, G23, J32.

Working paper no. 484.