De-risking defined benefit plans

Yijia Lin, Richard D. MacMinn and Ruilin Tian

Insurance: Mathematics and Economics, 2015, vol. 63, issue C, 52-65

Abstract: To identify an appropriate pension de-risking method, this paper proposes an optimization model that minimizes the expected total pension cost subject to a conditional value at risk (CVaR) constraint on pension funding level. Using this model, we examine three pension hedging strategies, i.e., longevity hedge, buy-in and buy-out; each strategy is examined with hedging costs that include a risk premium, search and information cost, underfunding cost, and counter-party risk cost. The numerical examples demonstrate that these hedging costs have a significant impact on the hedging decision. The hedge ratio (total pension cost) decreases (increases) with the transaction cost, the counter-party default probability and the underfunding ratio. In addition, the buy-out underperforms the longevity hedge and the buy-in for underfunded plans and the longevity hedge is less sensitive to the default risk than the buy-in.

Keywords: Defined benefit pension plan; Longevity hedge; Buy-in; Buy-out; Hedging costs (search for similar items in EconPapers)
Date: 2015
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Citations: View citations in EconPapers (20)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:insuma:v:63:y:2015:i:c:p:52-65

DOI: 10.1016/j.insmatheco.2015.03.028

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