An institutional evaluation of pension funds and life insurance companies
This paper compares two different types of annuity providers, i.e. defined benefit pension funds and life insurance companies. One of the key differences is that the residual risk in pension funds is collectively borne by the beneficiaries and the sponsor while in the case of life insurers, it is borne by the external shareholders. This paper employs a contingent claim approach to evaluate the risk return trade-off for annuitants.For that, we take into account the differences in contract specifications and in regulatory regimes. Mean-variance analysis is conducted to determine annuity choices of consumers with different preferences. Using realistic parameters we find that under linear and quadratic utility, life insurance companies always dominate pension funds, while under other utility specifications this is only true for low default probabilities. Furthermore, we find that power utility consumers are indifferent if the long term default probability of pension funds exceeds that of life insurers by 2 to 4%.ÂÂÂ
|Date of creation:||Nov 2009|
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- Zvi Bodie, 1989.
"Pensions as Retirement Income Insurance,"
NBER Working Papers
2917, National Bureau of Economic Research, Inc.
- An Chen & Michael Suchanecki, 2006.
"Default Risk, Bankruptcy Procedures and the Market Value of Life Insurance Liabilities,"
Bonn Econ Discussion Papers
bgse8_2006, University of Bonn, Germany.
- Chen, An & Suchanecki, Michael, 2007. "Default risk, bankruptcy procedures and the market value of life insurance liabilities," Insurance: Mathematics and Economics, Elsevier, vol. 40(2), pages 231-255, March.
- Broeders, Dirk & Chen, An, 2010.
"Pension regulation and the market value of pension liabilities: A contingent claims analysis using Parisian options,"
Journal of Banking & Finance,
Elsevier, vol. 34(6), pages 1201-1214, June.
- Dirk Broeders & An Chen, 2008. "Pension regulation and the market value of pension liabilities - a contingent claims analysis using Parisian options," DNB Working Papers 183, Netherlands Central Bank, Research Department.
- Jeffrey R. Brown & Peter R. Orszag, 2006. "The Political Economy of Government-Issued Longevity Bonds," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 73(4), pages 611-631.
- David Blake, 1999. "Portfolio Choice Models of Pension Funds and Life Assurance Companies: Similarities and Differences," The Geneva Papers on Risk and Insurance - Issues and Practice, Palgrave Macmillan;The Geneva Association, vol. 24(3), pages 327-357, July.
- Jacob A. Bikker & Peter J.G. Vlaar, 2006. "Conditional Indexation in Defined Benefit Pension Plans," DNB Working Papers 086, Netherlands Central Bank, Research Department.
- 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(04), pages 835-966, October.
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