How Much Can Collective Defined Contribution Plans Improve Risk-Sharing?

Vol. 18, No. 3, 2020

Deborah Lucas and Daniel Smith

Collective Defined Contribution (CDC) plans have been suggested as an attractive and sustainable alternative to public sector DB plans. A CDC plan is a hybrid structure, designed to provide more predictable retirement benefits than a traditional DC plan while operating at the lower cost of a DB plan. It does this by sharing investment risk across worker cohorts and centralizing asset management. We develop a model of an unsubsidized CDC plan, and use it to characterize the risk-sharing rules and investment policies that maximize a “scheduled benefit” for retirees that is almost always achieved or exceeded. We compare the outcomes under the CDC system with those from an otherwise similar options-augmented DC model, where participants have access to self-financing strategies that involve trading in one-year put and call options. The ability to effectively trade long-dated options in the CDC framework delivers a somewhat higher scheduled benefit than can be achieved by self-insuring in an options-augmented DC plan. However under current contribution policies, the scheduled benefit in the CDC plan falls short of what most would consider an adequate retirement income.