Valuation of Intergenerational Transfers in Funded Collective Pension Schemes

Abstract

This paper applies contingent claim analysis to value pension contracts for real-life collective pension plans with intergenerational risk sharing and offering DB-like benefits.We rewrite the balance sheet of such a pension fund as an aggregate of embedded generational options. This implies that a pension fund is a zero-sum game in value terms, so any policy change inevitably leads to value transfers between generations. We explore intergenerational value transfers that may arise from a plan redesign or from changes in funding policy and risk sharing rules. We develop a stochastic framework which accounts for time-varying investment opportunities and computes the embedded generational options. Changes in the values of the generational options enable us to evaluate the impact of policy modifications in the pension contract with respect to intergenerational transfers and redistribution. We find that a switch to a less risky asset mix is beneficial to elderly members at the expense of younger members who lose value. A reallocation of risk bearing from a plan with flexible contributions and fixed benefits to a plan with fixed contributions and flexible benefits leads to value redistribution from older plan members to younger ones.

Pension scheme redesign and wealth redistribution between the members and sponsor: The USS rule change in October 2011

“…We use a VAR(1) model to generate the future scenarios, as have Hoevenaars and Ponds (2008), Hoevenaars et al (2009), 8 The data we use to estimate the VAR(1) model starts in 1993. This is because earlier data is not available for some of the maturities involved in the estimation of the three Nelson-Siegel yield curve factors: β 1 , β 2 and β 3 .…”

“…Following Hoevenaars and Ponds (2008), Hoevenaars et al (2009Hoevenaars et al ( , 2010 and Hoevenaars (2011), we forward iterate this model for the out-of-sample period to produce 5000 sets of forecasts (i.e. scenarios) of asset returns, inflation rates, and the yield curve until the horizon date.…”

“…This is the fundamental theorem of asset pricing (see, for instance, Cochrane, 2001), and no knowledge of individual preferences is required to compute the state prices. Following Ang et al (2008) and Cochrane and Piazzesi (2005); as well as Nijman and Koijen (2006), Hoevenaars and Ponds (2008), Hoevenaars et al (2009), Hoevenaars et al (2010) and Hoevenaars (2011 from the pensions literature, we define SDFs (m t+1 ) as:-…”

Measuring Lifetime Redistribution in Dutch Occupational Pensions

“…Occupational pension schemes often also contain ex post (or reciprocal) redistribution that relates to risk sharing and occurs after the pension fund experiences a financial loss or gain. This form of redistribution, as for example analysed in Gollier (2008), Hoevenaars and Ponds (2006) and Cui et al (2006), will not be considered because sharing of reciprocal risks does not lead to structural transfers from one group to another.…”

“…5Hoevenaars and Ponds (2006) show that changes in risk allocation rules, like for example a switch to a more risky asset mix, involve large intergenerational transfers.…”