Pension Benefit Security: A Comparison of Solvency Requirements, a Pension Guarantee Fund and Sponsor Support

48 Pages Posted: 27 Oct 2011

See all articles by Dirk Broeders

Dirk Broeders

De Nederlandsche Bank; Maastricht University

An Chen

Ulm University - Institute of Insurance Science

Multiple version iconThere are 2 versions of this paper

Date Written: December 1, 2010

Abstract

Developed countries apply different security mechanisms in regulation to protect defined pension benefits: solvency requirements, a pension guarantee fund, and sponsor support. We test the performance of these mechanisms in terms of the protection offered to pension benefits in relation to the costs. For this, we calculate the expected log-return for the beneficiaries and the shortfall probability, i.e. the likelihood of the pension payment falling below the promised level. We show that it is possible to compare different pension security mechanisms using appropriate finance tools. Compared to a system based on solvency requirements alone, support by a pension guarantee fund or by the sponsor offers better downside protection for pension funds pursuing an aggressive investment policy. However, this comes at an additional cost. Beneficiaries of pension funds with conservative investment policies are better off under solvency requirements.

Keywords: Pension plans, regulation, barrier options, rainbow barrier options, guarantee systems

JEL Classification: G11, G23

Suggested Citation

Broeders, Dirk and Chen, An, Pension Benefit Security: A Comparison of Solvency Requirements, a Pension Guarantee Fund and Sponsor Support (December 1, 2010). De Nederlandsche Bank Working Paper No. 268, Available at SSRN: https://ssrn.com/abstract=1950111 or http://dx.doi.org/10.2139/ssrn.1950111

Dirk Broeders (Contact Author)

De Nederlandsche Bank ( email )

P.O. Box 98
Amsterdam, 1000 AB
Netherlands

HOME PAGE: http://www.dnb.nl/en/research/personal-pages/dirk-broeders/

Maastricht University ( email )

P.O. Box 616
Maastricht, Limburg 6200MD
Netherlands

HOME PAGE: http://www.maastrichtuniversity.nl/about-um/faculties/school-business-and-economics

An Chen

Ulm University - Institute of Insurance Science ( email )

Ulm, 89081
Germany

HOME PAGE: http://www.uni-ulm.de/mawi/ivw/team

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