Which statement correctly describes risk allocation in defined benefit versus defined contribution schemes?

• A. In a defined benefit scheme, members bear investment risk.
• B. In a defined contribution scheme, the employer bears longevity risk.
• C. In a defined benefit scheme, the member bears longevity risk.
• D. In a defined benefit scheme, the employer bears investment and longevity risk.

Answer: (D)

Risk allocation here is about who carries the investment risk and the longevity risk. In a defined benefit scheme, the employer promises a specific pension, calculated by a formula. That means the fund’s ability to meet those promised benefits depends on investment performance and on how long members live. The sponsor must cover shortfalls if investments underperform or if lifespans extend, so both investment risk and longevity risk lie with the employer.

In a defined contribution scheme, the retirement amount depends on contributions and how the investments perform, with no guaranteed benefit. The member bears the investment risk because the fund’s value determines retirement income, and they typically also bear longevity risk unless there’s a guaranteed lifetime income from an insurer or annuity.

So the statement that in a defined benefit scheme the employer bears both investment and longevity risk correctly describes the risk allocation. The other choices misstate who bears those risks: investment risk and longevity risk do not rest with the member in a defined benefit plan, and longevity risk is not the employer’s burden in a defined contribution plan.