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.

The Holistic Balance Sheet as the New Framework for European Pension Supervision - Evaluation from a Dutch Perspective

“…Since the classic paper of Sharpe (1976), there has been a large number of applications of contingent claim analysis to real-life problems in the fields of pensions and insurance (Blake 1998;Chapman, Gordon and Speed 2001;Guillén, Jørgensen, and Nielsen 2006;Kortleve and Ponds 2006;Kocken 2006, Hoevenaars and Ponds 2008, Lekniute 2011, Lever, Mehlkopf and van Ewijk 2012. It should be emphasized that an analysis with the help of embedded options, also called value-based ALM, is complementary to classical ALM analysis.…”

Guaranteeing Benefits in Generational Pension Plans

“…The value at this moment is derived from the economic value of the items at the time of fund closure. We apply the value-based ALM in Hoevenaars & Ponds (2008) that the value of assets and liabilities of a pension fund should account for their respective risks.…”

Developments in pension reform: the case of Dutch stand-alone collective pension schemes

“…The policy ladders are also incomplete in the sense that they do not specify investment decisions. By changing investment decisions, governing boards can redistribute resources among the various stakeholders of the fund, depending on the various options that are written by the stakeholders of the fund (see Hoevenaars and Ponds 2006). Finally, policy ladders are at present not more than guidelines for the governing board.…”