Abstract
Nowadays pension funds are actors of the financial market that cannot be ignored; for example, the asset traded by these funds represented $29.5 trillion in 2009 and moreover, as stated by David Dodge , "pension funds have already become the largest institutional investors among G-10 countries". However, despite the expansion of these institutional investors, we can ask ourselves a set of questions concerning these financial actors and regarding the services they provide: What is the aim of pension funds? What are the different forms of pension schemes? Who is responsible for the risk in these schemes?
In order to address these questions, we will focus more precisely on the two main types of schemes offered by pension funds: the defined-benefit and the defined-contribution pension scheme. Moreover, in the recent years, an important shift from defined-benefit to defined-contribution plans has emerged. This transfer can be explained by several factors that will be discussed in the third part of this paper.
The first section of this essay highlights the main characteristics of a defined benefit-pension scheme. The subsequent section focuses on another type of pension plan, the defined-contribution pension. The final section copes with the reasons leading to the increasing importance of defined-contribution pension schemes in the last decade.
Extract
[...] What are the different forms of pension schemes? Who is responsible for the risk in these schemes? In order to address these questions, we will focus more precisely on the 2 main types of schemes offered by pension funds: the defined-benefit and the defined-contribution pension scheme. Moreover, in the recent years appears an important shift from defined-benefit to defined-contribution plans. This transfer can be explained by several factors that will be discussed in the third part of this paper. The first part of this essay highlights the main characteristics of a defined benefit-pension scheme. [...]
[...] Conclusion: As we have seen in this essay, several factors have conducted the shift toward defined-contribution schemes. This change offers different advantages for both employers and employees such as flexibility and cost reduction for the employer or better control on the futures incomes and freedom for the employee. However, a defined-contribution scheme exposes individuals to greater risks than the defined-benefit schemes by shifting the risk from the employer to the employee and integrating more uncertainty on the amount of the final income. [...]
[...] Along this transfer from defined-benefit to defined-contribution schemes, some other options are available. Plans combining the ability to weight contributions to age and a profit-sharing design such as Hybrid plans or cash balance plans are alternatives options for companies. Indeed, Hybrid plans are a mix between defined-benefit and defined-contribution schemes in grouping the advantages of both plans in one. For example, according to Clark R. L. and al.9, the main characteristics of hybrids plans are an automatic contribution level from the employer, a shared market risk, an absence of departure penalty and a portability of the benefices. [...]
[...] Since 1999, many defined-benefit plans have closed and have been replaced by defined-contributions plans for new employees. This recent shift toward defined-contribution schemes will be explained in this part, by focusing on the internal characteristics of the two schemes and the external economical factors leading to this change. One of the main reasons of this shift is related to the risks of the defined-benefits plans that is borne mainly by employers and can be explained by the willingness from employers to transfer the risk to employees. [...]
[...] The second part of this paper focus on another type of pension plan, the defined-contribution pension. Finally, the third part cope with the reasons leading to the increasing importance of defined-contribution pension schemes in the last decade. 1. Defined-benefit pension schemes The aim of pension funds is to provide incomes to employee when they want to retire by investing a defined amount of money each year in the financial market (principally in the stock market) during the working life of the employee. [...]
