Valuation and risk analysis for Dutch pension schemes

This paper examines fair value liabilities and derives the implied indexation rate as the measure of the benefits provided by the conditional indexation mechanism. Further, it assesses the sensitivity of the fair value liabilities to real and nominal curves and discusses immunisation techniques derived from this framework

There have been significant developments in the life and pensions industry over the last few years. In countries such as the UK, Denmark and the Netherlands, the regulatory framework has shifted from book valuation towards fair valuation of both assets and liabilities. Traditionally, asset management solutions for pension schemes were targeting long-term objectives such as full or partial indexation of liabilities and reduction of the contribution rate for the sponsor. Simultaneously, short-term mark-to-market exposure of a pension plan was smoothed out over time. The smoothing technique was promoted by regulators as well as by accounting standards of that period. Recent advances in the regulatory framework forced pension schemes to start developing LDI strategies that satisfy regulatory constraints and meet the long-term objectives of pension schemes. An overview of the conditional indexation methodology and market strategies can be found in Kocken et al. (2005).

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References

Grosen, A. and Jorgensen, P.L., Fair valuation of life insurance liabilities: the impact of interest rate guarantees, surrender options and bonus policies, Insurance: Mathematics and Economics, 26, 37-57 (2000)

Kocken, T., J. van der Hoek, A. Michaels and D. Bieber, From Conditional to Full Indexation: A Discussion of Liability Solutions Used in Dutch and UK Pension Funds, in: Inflation-linked Products, Opportunities for Portfolio, Asset & Liability Managers, RISK Publications (2005)

Prieul D., Putyatin V., Nassar, T., On Pricing and Reserving With-Profits Life Insurance Contracts, Applied Mathematical Finance 8, 145-166 (2001)

Klein Haneveld, W., Streutker, M., Van der Vlerk, M., ALM Modelling for Dutch Pension Funds in an Era of Pension Reform, Operations Research Proceedings 2006, Springer Berlin Heidelberg (2006)

Leland, H. and Toft, K., Optimal Capital Structure, Endogenous Bankruptcy, and the Term Structure of Credit Spreads, Journal of Finance, v51(3 Jul), 987-1019 (1996)

Merton, R., On the Pricing of Corporate Debt: The Risk Structure of Interest Rates, Journal of Finance v 29(2), 449-470 (1974)

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