Impact of the choice of risk assessment time horizons on defined benefit pension schemes

Abstract

We examine the impact of asset allocation and contribution rates on the risk of defined benefit (DB) pension schemes, using both a run-off and a shorter 3-year time horizon. Using the 3-year horizon, which is typically preferred by regulators, a high bond allocation reduces the spread of the distribution of surplus. However, this result is reversed when examined on a run-off basis. Furthermore, under both the 3-year horizon and the run-off, the higher bond allocation reduces the median level of surplus. Pressure on the affordability of DB schemes has led to widespread implementation of the so-called de-risking strategies, such as moving away from predominantly equity investments to greater bond investments. If the incentives produced by shorter term risk assessments are contributing to this shift, they might be harming the long-term financial health of the schemes. Contribution rates have relatively lower impact on the risk.

On the benefits of pension plan consolidation: Understanding the impact of full plan mergers

“…The notion of economic capital has been extensively used for the purpose of risk quantification in the financial and insurance sectors. More recently, a few studies considered its application in the pension context (see, e.g., Porteous et al 2012;Yang & Tapadar, 2015;Tapadar et al, 2019;Andrews et al, 2021). Similar to these studies, we adopt the following definition of economic capital.…”

“…A pension scheme's net benefit obligations are all obligations in respect of plan members, including future service and net of future contributions to the plan. (Andrews et al, 2021).…”

“…Second, we focus on a going-concern valuation, which assumes that the pension plan continues into the future indefinitely. This strategy is different than that used by Porteous et al (2012), Yang & Tapadar (2015), Tapadar et al (2019), and Andrews et al (2021); the latter authors use a solvency basis and assume that no new members join the plan.…”