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Pension Schemes as Options on Pension Fund Assets:
Implications for Pension Fund Management

David Blake


This paper investigates the relationship between the three most important
types of funded pension scheme: the defined benefit, the defined contribution,
and the targeted money purchase schemes. While, on the surface, there
appears to be substantial differences between these schemes, we show
that they are related in a very simple way that is equivalent to different
combinations of options on the underlying assets in the pension fund.
Once this recognised, it is relatively straightforward for scheme members,
sponsers and the financial markets to value the different pension schemes
and to make choices between them. There are also important implications for
pension fund management. We propose a dynamic asset allocation strategy
over the lifetime of a pension scheme which involves switching, according to
pre-set criteria, between equities, index bonds and conventional bonds. Our
approach contrasts markedly with the prevailing theoretical framework for
analysing pension fund investment decision-making which emphasizes 100%
bond dedication, but it does correspond more closely with the conventional
practice of pension fund managers.