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Pension benefit security: a comparison of solvency requirements, a pension guarantee fund and sponsor support

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Listed:
  • Dirk Broeders
  • An Chen

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.

Suggested Citation

  • Dirk Broeders & An Chen, 2010. "Pension benefit security: a comparison of solvency requirements, a pension guarantee fund and sponsor support," DNB Working Papers 268, Netherlands Central Bank, Research Department.
  • Handle: RePEc:dnb:dnbwpp:268
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    References listed on IDEAS

    as
    1. 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.
    2. Jacob A. Bikker & Dirk W.G.A. Broeders & Dirk Jan de Dreu, 2010. "Stock Market Performance and Pension Fund Investment Policy: Rebalancing, Free Float, or Market Timing?," International Journal of Central Banking, International Journal of Central Banking, vol. 6(2), pages 53-79, June.
    3. 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.
    4. Zvi Bodie & John B. Shoven & David A. Wise, 1987. "Issues in Pension Economics," NBER Books, National Bureau of Economic Research, Inc, number bodi87-1, January.
    5. Sharpe, William F., 1976. "Corporate pension funding policy," Journal of Financial Economics, Elsevier, vol. 3(3), pages 183-193, June.
    6. Alan Marcus, 1987. "Corporate Pension Policy and the Value of PBGC Insurance," NBER Chapters,in: Issues in Pension Economics, pages 49-80 National Bureau of Economic Research, Inc.
    7. Feldstein, Martin & Seligman, Stephanie, 1981. "Pension Funding, Share Prices, and National Savings," Journal of Finance, American Finance Association, vol. 36(4), pages 801-824, September.
    8. Olivieri, Annamaria & Pitacco, Ermanno, 2003. "Solvency requirements for pension annuities," Journal of Pension Economics and Finance, Cambridge University Press, vol. 2(02), pages 127-157, July.
    9. Dirk Broeders, 2010. "Valuation of Contingent Pension Liabilities and Guarantees Under Sponsor Default Risk," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 77(4), pages 911-934.
    10. Robert C. Merton & Zvi Bodie, 1992. "On the Management of Financial Guarantees," Financial Management, Financial Management Association, vol. 21(4), Winter.
    11. Joshua D. Rauh, 2006. "Investment and Financing Constraints: Evidence from the Funding of Corporate Pension Plans," Journal of Finance, American Finance Association, vol. 61(1), pages 33-71, February.
    12. Hsieh, Su-Jane & Chen, Andrew H. & Ferris, Kenneth R., 1994. "The Valuation of PBGC Insurance Premiums Using an Option Pricing Model," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 29(01), pages 89-99, March.
    13. Blake, David, 1998. "Pension schemes as options on pension fund assets: implications for pension fund management," Insurance: Mathematics and Economics, Elsevier, vol. 23(3), pages 263-286, December.
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    Cited by:

    1. Dirk Broeders & An Chen & Birgit Koos, 2014. "Utility-equivalence of pension security mechanisms," DNB Working Papers 414, Netherlands Central Bank, Research Department.
    2. repec:eee:jimfin:v:84:y:2018:i:c:p:23-41 is not listed on IDEAS
    3. repec:bla:jrinsu:v:84:y:2017:i:2:p:539-565 is not listed on IDEAS

    More about this item

    Keywords

    Pension plans; regulation; barrier options; rainbow barrier options; guarantee systems;

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors

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