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The Financial Theory of Defined Benefit Pension Schemes

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  • Exley, C.J.
  • Mehta, S.J.B.
  • Smith, A.D.

Abstract

Increasingly, modern business and investment management techniques are founded on approaches to measurement of profit and risk developed by financial economists. This paper begins by analysing corporate pension provision from the perspective of such financial theory. The results of this analysis are then reconciled with the sometimes contradictory messages from traditional actuarial valuation approaches and the alternative market-based valuation paradigm is introduced. The paper then proposes a successful blueprint for this mark-to-market valuation discipline and considers whether and how it can be applied to pension schemes both in theory and in practice. It is asserted that adoption of this market based approach appears now to be essential in many of the most critical areas of actuarial advice in the field of defined benefit corporate pension provision and that the principles can in addition be used to establish more efficient and transparent methodologies in areas which have traditionally relied on subjective or arbitrary methods. We extend the hope that the insights gained from financial theory can be used to level the playing field between defined benefit and defined contribution arrangements from both corporate and member perspectives.

Suggested Citation

  • Exley, C.J. & Mehta, S.J.B. & Smith, A.D., 1997. "The Financial Theory of Defined Benefit Pension Schemes," British Actuarial Journal, Cambridge University Press, vol. 3(4), pages 835-966, October.
    • Handle: RePEc:cup:bracjl:v:3:y:1997:i:04:p:835-966_00
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    Citations

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    Cited by:

    1. Colombo, Luigi & Haberman, Steven, 2005. "Optimal contributions in a defined benefit pension scheme with stochastic new entrants," Insurance: Mathematics and Economics, Elsevier, vol. 37(2), pages 335-354, October.
    2. Dirk Broeders & An Chen & David Rijsbergen, 2013. "Valuation of liabilities in hybrid pension plans," Applied Financial Economics, Taylor & Francis Journals, vol. 23(15), pages 1215-1229, August.
    3. Nick Silver, 2006. "The Trouble With Final Salary Pension Schemes," Economic Affairs, Wiley Blackwell, vol. 26(4), pages 53-60, December.
    4. Wang, Lijian & Béland, Daniel & Zhang, Sifeng, 2014. "Pension fairness in China," China Economic Review, Elsevier, vol. 28(C), pages 25-36.
    5. Ponds, E.H.M. & Severinson, C. & Yermo, J., 2012. "Implicit debt in public sector plans : An international comparison," Other publications TiSEM 8263bb65-8b50-4890-9252-0, Tilburg University, School of Economics and Management.
    6. Dirk Broeders & An Chen & Birgit Koos, 2009. "An institutional evaluation of pension funds and life insurance companies," DNB Working Papers 227, Netherlands Central Bank, Research Department.
    7. Rama Malladi, 2022. "HARI: Characteristics of a new defined lifestyle (DL) retirement planning product," Journal of Financial Services Marketing, Palgrave Macmillan, vol. 27(2), pages 147-163, June.
    8. Haberman, Steven & Butt, Zoltan & Megaloudi, Chryssoula, 2000. "Contribution and solvency risk in a defined benefit pension scheme," Insurance: Mathematics and Economics, Elsevier, vol. 27(2), pages 237-259, October.
    9. David McCarthy & David Miles, 2013. "Optimal Portfolio Allocation for Corporate Pension Funds," European Financial Management, European Financial Management Association, vol. 19(3), pages 599-629, June.
    10. John Board & Charles Sutcliffe, 2007. "Joined-Up Pensions Policy in the UK: An Asset-Liability Model for Simultaneously Determining the Asset Allocation and Contribution Rate," Economic Analysis, Institute of Economic Sciences, vol. 40(3-4), pages 87-118.
    11. Inkmann, Joachim & Blake, David, 2004. "Liability valuation and optimal asset allocation," LSE Research Online Documents on Economics 24754, London School of Economics and Political Science, LSE Library.
    12. Ashby H. B. Monk, 2008. "The Knot of Contracts: The Corporate Geography of Legacy Costs," Economic Geography, Clark University, vol. 84(2), pages 211-235, April.
    13. Anna Zalewska, 2006. "Is Locking Domestic Funds into the Local Market Beneficial? Evidence from the Polish Pension Reforms," The Centre for Market and Public Organisation 06/153, The Centre for Market and Public Organisation, University of Bristol, UK.
    14. Broeders, Dirk & Chen, An & Koos, Birgit, 2011. "A utility-based comparison of pension funds and life insurance companies under regulatory constraints," Insurance: Mathematics and Economics, Elsevier, vol. 49(1), pages 1-10, July.
    15. Anna Zalewska, 2005. "Home bias and stock market development. The Polish experience," The Centre for Market and Public Organisation 05/136, The Centre for Market and Public Organisation, University of Bristol, UK.
    16. Chen, Zhiqiang & Pelsser, Antoon & Ponds, Eduard, 2014. "Evaluating the UK and Dutch defined-benefit pension policies using the holistic balance sheet framework," Insurance: Mathematics and Economics, Elsevier, vol. 58(C), pages 89-102.
    17. Kamakshya Trivedi & Garry Young, 2006. "Defined benefit company pensions and corporate valuations: simulation and empirical evidence from the United Kingdom," Bank of England working papers 289, Bank of England.

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