The Relative Risk Characteristics of Defined-Benefit and Defined-Contribution Pensions and the Implications for Public Policy

This paper shows that an uninsured fully-funded defined-benefit (DL) pension is effectively a defined-contribution (DC) pension invested in a special type of fixed-income security, one that imposes a large amount of diversifiable inflation risk on plan participants and that is apparently dominated by other market securities. It is also demonstrated that DL pensions are not an effective means of sharing income risk between employees and employers, or of sharing income risk between generations of workers. In light of these findings, it is suggested that a public policy of encouraging the substitution of DC pensions for DL pensions might be preferable to the current policy of mandating taxpayer-backed DL pension insurance