The Future of Pension Plan Design

In the thirty years since the introduction of the Employee Retirement Income Security Act, tremendous changes have taken place in the US private pension environment. Traditional defined benefit pension plans have been replaced with newer defined contribution-type arrangements. As the change matures, it is becoming clear that the problem of optimal pension scheme design has not been solved. On the contrary, much work remains to ensure that occupational pension schemes meet the needs of both employers and employees. Traditionally, it has been difficult to evaluate different pension scheme designs from an economic point of view. This is because there was no theory which modeled how firms and workers actually valued their pensions: realistic pension contracts were too complex for traditional theoretical economic models. The massive reduction in the cost of computing power has changed this, so it is now possible to assess alternative pension designs using a coherent theoretical framework. This chapter develops such a framework and presents some illustrative results.