Economic capital for defined benefit pension schemes: An application to the UK Universities Superannuation Scheme

Abstract

This article considers the amount of economic capital that defined benefit pension schemes potentially need to cover the risks they are running. A real open scheme, the Universities Superannuation Scheme, is modelled and used to illustrate our results and, as expected, economic capital requirements are large. We discuss the appropriateness of these results and what they mean for the defined benefit pension scheme industry and their sponsors. The article is particularly pertinent following the recent European Commission Green Paper on the future of European pensions systems, its call for advice on reviewing the Institutions for Occupational Retirement Provision Directive and the introduction of the Basel 2 and Solvency 2 risk-based regulatory regimes for banking and insurance respectively. keywordsDefined benefit pension scheme, Economic capital, Solvency, Stochastic modelling, Asset-liability management.

Role of the Pension Protection Fund in financial risk management of UK defined benefit pension sector: a multi-period economic capital study

“…The authors found that on a run-off basis 97.5th percentile economic capital for joint life annuities can range from 20% to 88% of best-estimate liabilities depending on the underlying investment strategy. Porteous et al (2012) proposed a comprehensive approach towards quantifying economic capital for a real DB pension scheme using a high-level model of UK's Universities Superannuation Scheme (USS). The authors found that the amount of capital needed to ensure solvency of USS on a run-off basis at a 99.5th percentile level is about 60% of best-estimate liabilities.…”

“…In our paper, we will adopt this approach to quantify economic capital for a representative sample of DB pension schemes in the United Kingdom. However, for quantifying the economic capital of PPF, we needed to adapt and extend the approach of Porteous et al (2012), as discussed in section 3.…”

“…In particular, in the context of capital requirement for DB pension schemes, the concept is still in its infancy. For the purposes of this paper, we will adapt the definition of economic capital for DB pension schemes proposed by Porteous et al (2012), as outlined below:…”

“…For a detailed discussion of the different aspects of the definition of economic capital for DB pension schemes, please refer to Porteous et al (2012). The main issues pertinent to this paper are as follows:…”

“…(c) The s179 valuation used in this paper differs from the best-estimate liability valuation used in Porteous et al (2012), Boerger (2010), Olivieri & Pitacco (2008) and Stevens et al (2009), and the market consistent valuation used in Hari et al (2008). We specifically chose the s179 valuation approach in order to maintain consistency with the data and results published by the PPF and The Pensions Regulator.…”