Hostname: page-component-78c5997874-v9fdk Total loading time: 0 Render date: 2024-11-05T10:30:29.144Z Has data issue: false hasContentIssue false

Integrated risk management for defined benefit pensions: models and metrics*

Published online by Cambridge University Press:  22 December 2014

RAIMOND MAURER*
Affiliation:
Chair of Investment, Portfolio Management and Pension Finance, Goethe University Frankfurt, Germany Gruneburgplatz 1, 60323 Frankfurt am Main, Germany. (e-mail: [email protected])

Abstract

The Pension Benefit Guaranty Corporation (PBGC) insures private sector defined benefit (DB) pension plans, when an employer becomes insolvent and is unable to pay the pension liabilities. In principle, the insurance premiums collected by PBGC should be sufficient to cover potential losses; this would ensure that PBGC could pay the insured benefits of terminated pension plan without additional external funding (e.g., from taxpayers). Therefore, the risk exposure of the PBGC from insuring DB pension plans arises from the probability of the employer insolvencies; and the terminating plans’ funding status (the excess of the value of the insured plan liabilities over the plan assets). Here we explore only the second component, namely the impact of plan underfunding for the operation of the PBGC. When a DB plan is fully funded, the PBGC's risk exposure for an ongoing plan is low even if the plan sponsor becomes insolvent. Thus the questions most pertinent to the PBGC are: what key risk factors can produce underfunding in a DB plan, and how can these risk factors be quantified? We discuss the key risk factors that produce DB pension underfunding, namely, investment risk and liability risk. These are interrelated and must be considered simultaneously in order to quantify the risk exposure of a DB pension plan. We propose that an integrated risk management model (an Integrated Asset/Liability Model) can help better understand DB pension plan funding risk. We also examine the Pension Insurance Modeling System developed by the PBGC in terms of its own use of some of the building blocks of an integrated risk management model.

Type
Articles
Copyright
Copyright © Cambridge University Press 2014 

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

Footnotes

*

The research reported herein was pursuant to a grant from the U.S. Social Security Administration (SSA) funded as part of the Retirement Research Consortium (RRC); the author also acknowledges support from The Pension Research Council at The Wharton School and helpful comments from Olivia S. Mitchell. All findings and conclusions expressed are solely those of the author and do not represent the views of the SSA or any agency of the federal government, the MRRC, the PRC, or The Wharton School at the University of Pennsylvania.

References

Artzner, P., Delbaen, F., Eber, J. and Heath, D. (1999) Coherent measures of risk. Mathematical Finance, 9: 203228.CrossRefGoogle Scholar
Balduzzi, P., Ranjan Das, S., Foresi, S. and Sundraram, R. (1996) A simple approach to three-factor affine term structure models. Journal of Fixed Income, December: 4352.Google Scholar
Blake, D. (2006) Pension Finance. West Sussex, p. 77.Google Scholar
Cairns, A. (2004) Interest Rate Models: An Introduction. Princeton, NJ: Princeton University Press.Google Scholar
Cairns, A., Blake, D. and Dowd, K. (2006 a) Pricing death: frameworks for the valuation and securitization of mortality risk. ASTIN Bulletin, 36: 79120.Google Scholar
Cairns, A., Blake, D. and Dowd, K. (2006 b) A two-factor model for stochastic mortality with parameter uncertainty: theory and calibration. Journal of Risk and Insurance, 73: 687718.Google Scholar
Cairns, A., Blake, D., Dowd, K., Coughlan, G., Epstein, D. and Khalaf-Allah, M. (2010) A Framework for Forecasting Mortality Rates with an Application to Six Stochastic Mortality Models, Pensions Institute Discussion Paper PI-0801. London, U.K.: The Pensions Institute.Google Scholar
Campbell, J. Y.; Chan, Y. L. and Viceira, L. M. (2003) A multivariate model of strategic asset allocation. Journal of Financial Economics, 67: 4180.Google Scholar
Fisher, J. D., Geltner, D. M. and Webb, R. B. (1994) Value indices of commercial real estate: a comparison of index construction methods. Journal of Real Estate Finance and Economics, 9: 137164.CrossRefGoogle Scholar
Guidolin, M. and Timmermann, A. (2007) Asset allocation under multivariate regime switching. Journal of Economic Dynamics and Control, 31(11): 35033544.Google Scholar
Hoesli, M. and MacGregor, B. D. (2000) Property Investment: Principles and Practice of Portfolio Management. Harlow: Pearson.Google Scholar
Hoevenaars, R. P., Molenaar, R. D., Schotman, P. C. and Steenkamp, T. B. (2008) Strategic asset allocation with liabilities: beyond stocks and bonds. Journal of Economic Dynamics and Control, 32: 29382970.Google Scholar
Hustead, E. C. and Mitchell, O. S. (2001) Public sector pension plans. In Mitchell, O. S. and Hustead, E. C.(eds), Pensions in the Public Sector. Philadelphia, PA: University of Pennsylvania Press, pp. 310.Google Scholar
Lee, R. and Carter, L. (1992) Modeling and forecasting U.S. mortality. Journal of the American Statistical Association, 87: 659671.Google Scholar
Maurer, R., Mitchell, O. S. and Rogalla, R. (2009) Reforming German civil servant pensions. In Mitchell, O. S. and Anderson, G. W.(eds), The Future of Public Employee Retirement Systems. Oxford: Oxford University Press, pp. 3250.Google Scholar
Maurer, R., Mitchell, O. S., Rogalla, R. and Kartashov, V. (2013) Lifecycle portfolio choice with systematic longevity risk and variable investment-linked deferred annuities. The Journal of Risk and Insurance, 80: 649676.Google Scholar
Pension Benefit Guaranty Corporation (PBGC) (2010) PIMS System Description, Version 1.0. Washington, DC: PBGC.Google Scholar
Pitacco, E., Denuit, M., Haberman, S. and Olivieri, A. (2009) Modeling Longevity Dynamics for Pensions and Annuity Business. Oxford: Oxford University Press.Google Scholar
Renshaw, A. and Haberman, S. (2003) Lee-Carter mortality forecasting with age-specific Enhancement. Insurance: Mathematics and Economics, 33: 255272.Google Scholar