Financial risks and Benefits associated with Private pensions contributions and Investment returns in Nigerian Corporate Organisations

Methodology

Introduction

Before evaluating risk sharing through occupational pension plans one may wonder whether such contracts can always be successfully replicated by the market, specifically when intergenerational risks are involved. Two general approaches or solutions to intergenerational risk sharing can in principle be distinguished. The first approach is based on the principle that pension funds collectively bear intergenerational risks. More precisely, pension funds collectively organise risk sharing by redistributing the risks between various stakeholders including future generations. This implies that these risks are in the end borne by these stakeholders (pension funds act only an (organising) agent and not as a principal; they do not own funds or reserves like insurers do). Given the large population of (future) stakeholders, the price of intergenerational risk sharing is lower when organised via pension funds. The first solution implies that pension funds make markets more complete, meaning that pension funds improve social welfare.

The second approach is based on hedging solutions via financial markets (e.g. they buy hedges in the market or they reinsure these risks). The remainder of this section discusses the limits of intergenerational risk-sharing via the market. To illustrate the issues and policy decisions at stake, we will refer to longevity risk as a clear case of an intergenerational risk that poses a great challenge for pension funds to incorporate in pension arrangements. Idiosyncratic or micro longevity risk (survival risk) can in principle be tackled in an efficient risk sharing fashion via annuities markets. Unfortunately, private annuity markets are affected by adverse selection. Government action (in the form of e.g. mandatory participation rules) can in principle address this type of market failure. Aggregate or macro longevity risk affects current cohorts in roughly the same way.

Sample: Methods of Data Collection

Positive correlations across individuals mean that private market solutions cannot be used to share this risk efficiently. Common tools to minimise exposure to this macro risk (diversification across cohorts, international diversification via cross-border investments, risk sharing with annuitants, or hedging of insurance companies by selling both annuities and life-insurance) cannot completely eliminate it. Financial markets (including insurance) work efficiently for sharing short-term risks between cohorts (with largely overlapping lifetimes) but not, for example, for the long-term life risks of older cohorts that are largely known when the younger cohorts arrive. Ex ante efficient intergenerational risk sharing via private markets is therefore not possible as future generations cannot be included. The government, on the other hand, can use fiscal policy (taxes, social insurance, transfers and public debt) as a vehicle to spread risk across generations, thereby (in theory) improving social welfare.

Description of Research Instrument

To put it differently, governments have in principle the ability to make markets more complete by providing longevity insurance backed by future generations. This conclusion can be generalised by introducing a social security system in an overlapping-generation economy so as to achieve an optimal intergenerational risk sharing arrangement. However, government interventions need to take the following considerations ...