Efficient life cycle investment strategies in defined contribution pension plans in Israel
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2017-12-30
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Rzecznik Finansowy, Fundacja Edukacji Ubezpieczeniowej
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Abstract
Pension systems, both in Israel and worldwide, have been through major reforms during the last 30 years, expanding the defined contribution (DC) pension arrangements that invest their assets in the capital market. There is an increasing consensus that the risk of a pension plan’s investment portfolio should be decreased towards the retirement age, but the strategies to implement this are still under debate. Research regarding efficient strategies has been carried out around the world, but in Israel, it is being done for the first time. Therefore, the purpose of this paper is to present the results and conclusions of research that is focused on finding the most efficient strategies for implementation in Israel's pension system, according to mean vs. risk of returns and net replacement rates. Risk measurement was carried out using CVaR, which is superior for the measurement of extreme risk, while most of the former research has used VaR for this purpose. In order to answer the research questions, Monte Carlo simulations were run 10,000 times, and efficiency frontiers for 15 investment strategies and for each of six representative agents. Based on the data of different growth rates for the salaries of males and females, and the higher salaries of males, the research also examines the influence of these factors on the gender gap, by examining whether the pension system is reducing or expanding the gender gap. The first conclusion derived from the study is that a life cycle of dynamic strategies with a high portion of equities, switching gradually to a full bonds portfolio at retirement, produced the highest returns and replacement rates for a given risk. Withdrawals of parts of severance pays significantly reduced the replacement rates. The second conclusion is that the gap between genders during the working period expands during the retirement period. Reducing the gap requires dealing with the salary gap created during the working period and raising the retirement age of females. Another redistributive act can be a raise of the flat rate old age pension (the first pillar) and financing it by reducing contribution rates of the second pillar that were found to be too high.
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Manor M., 2017, Efficient life cycle investment strategies in defined contribution pension plans in Israel, "Journal of Insurance, Financial Markets and Consumer Protection", 26(4), pp. 47-66.