Individual pension risk preference elicitation and collective asset allocation with heterogeneity

Collectively organized pension plans must increasingly demonstrate that the risk preferences of their members are adequately reflected in the plans’ asset allocations. However, whether funds should elicit individual members’ risk preferences to achieve this goal, or whether they can rely on other indicators, such as socio-demographics, remains unclear. To address this question, we apply a tailored augmented lottery choice method to elicit individual pension income risk preferences from 7,894 members from five different pension plans. The results show that member risk preferences are strongly heterogeneous and can only partially be predicted from individual and plan characteristics. Differences in risk preference imply different optimal asset allocations. We find large welfare losses for heterogeneous members in pension plans with their current asset allocation because these allocations are safer than implied by members’ preferences. We provide a framework for pension plans to gauge the need to elicit risk preferences among their members.