Quantitative regulations may help to limit the retirement income risk in defined contribution (DC) pension systems in countries where payments from DC are the most prevalent source of income in old age, says Allianz Global Investors AG (AllianzGI) and the Organisation for Economic Cooperation and Development (OECD).

The working paper from the asset management company and the OECD shows that a default option should be integrated to a DC system that includes investment choice to protect future retirement income, and a risk-return trade-off of different investment portfolios and strategies should be assessed by examining projected retirement benefits.

A ceiling on risky assets should be introduced in a move towards quantitative regulations, which should vary depending on risk-aversion, contribution length and accumulation period. Country-specific factors should also be considered when it comes to the design of DC investment regulations.

Those countries with mandatory DC pension systems saw losses of 20 to 25 per cent in 2008, with portfolios with
high equity exposures unsurprisingly experiencing the highest investment losses.

"Despite their many advantages, DC systems subject retirement benefits to a great deal of uncertainty," commented Brigitte Miksa, head of international pensions at AllianzGI. "While regulations can limit some of these risks and prevent older and retired workers from suffering major losses to their retirement income, it is a complex task to design these regulations and it requires careful consideration of a number of factors which are explored in this paper."

More careful analysis is also, the paper recommends, needed on the design of suitable life-cycle investment strategies.
Juan Yermo, OECD, added: "The analysis corroborates that an investment portfolio may be mean-variance efficient in the short-term but inefficient when looked at through the lens of a pension plan member. Both very low allocations to equities (below 20 per cent) and very high ones (above 80 per cent) look unattractive in terms of the trade-off between replacement rate expectations and risk."

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