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Role of the Pension Protection Fund in financial risk management of UK defined benefit pension sector: a multi-period economic capital study

Published online by Cambridge University Press:  09 December 2014

Wei Yang  and
Pradip Tapadar
Wei Yang
Affiliation:
School of Insurance and Collaborative Innovation Center of Financial Security, Southwestern University of Finance and Economics, Chengdu, Sichuan 611130, China
Pradip Tapadar*
Affiliation:
School of Mathematics, Statistics and Actuarial Science, University of Kent, Canterbury CT2 7NF, UK
*
*Correspondence to: Pradip Tapadar, School of Mathematics, Statistics and Actuarial Science, University of Kent, Canterbury, CT2 7NF, UK. Tel: +44 (0)1227 470219; Fax: +44 (0)1227 827932; E-mail: [email protected]
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Abstract

With the advent of formal regulatory requirements for rigorous risk-based, or economic, capital quantification for the financial risk management of banking and insurance sectors, regulators and policy-makers are turning their attention to the pension sector, the other integral player in the financial markets. In this paper, we analyse the impact of applying economic capital techniques to defined benefit pension schemes in the United Kingdom. We propose two alternative economic capital quantification approaches, first, for individual defined benefit pension schemes on a stand-alone basis and then for the pension sector as a whole by quantifying economic capital of the UK’s Pension Protection Fund, which takes over eligible schemes with deficit, in the event of sponsor insolvency. We find that economic capital requirements for individual schemes are significantly high. However, we show that sharing risks through the Pension Protection Fund reduces the aggregate economic capital requirement of the entire sector.

Keywords

Pension Protection FundDefined benefit pension schemeEconomic capitalSolvencyFinancial risk management
Type
Papers
Information
Annals of Actuarial Science , Volume 9 , Issue 1 , March 2015 , pp. 134 - 166
Copyright
© Institute and Faculty of Actuaries 2014 

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