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

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

Longevity, Life-Cycle Behavior and Pension Reform

How can public pension systems be reformed to ensure fiscal stability in the face of increasing life expectancy? To address this pressing open question in public finance, we estimate a life-cycle model in which the optimal employment, retirement and consumption decisions of forward-looking individuals depend, inter alia, on life expectancy and the design of the public pension system. We calculate that, in the case of Germany, the fiscal consequences of the 6.4 year increase in age 65 life expectancy anticipated to occur over the 40 years that separate the 1942 and 1982 birth cohorts can be offset by either an increase of 4.34 years in the full pensionable age or a cut of 37.7% in the per-year value of public pension benefits. Of these two distinct policy approaches to coping with the fiscal consequences of improving longevity, increasing the full pensionable age generates the largest responses in labor supply and retirement behavior.life expectancy, public pension reform, retirement, employment, life-cycle models, consumption, tax and transfer system

Longevity, Life-Cycle Behavior and Pension Reform

How can public pension systems be reformed to ensure fiscal stability in the face of increasing life expectancy? To address this pressing open question in public finance, we estimate a life-cycle model in which the optimal employment, retirement and consumption decisions of forward-looking individuals depend, inter alia, on life expectancy and the design of the public pension system. We calculate that, in the case of Germany, the fiscal consequences of the 6.4 year increase in age 65 life expectancy anticipated to occur over the 40 years that separate the 1942 and 1982 birth cohorts can be offset by either an increase of 4.34 years in the full pensionable age or a cut of 37.7% in the per-year value of public pension benefits. Of these two distinct policy approaches to coping with the fiscal consequences of improving longevity, increasing the full pensionable age generates the largest responses in labor supply and retirement behavior.Life expectancy, public pension reform, retirement, employment, life-cycle models, consumption, tax and transfer system

Longevity, Life-Cycle Behavior and Pension Reform

How can public pension systems be reformed to ensure fiscal stability in the face of increasing life expectancy? To address this pressing open question in public finance, we estimate a life-cycle model in which the optimal employment, retirement and consumption decisions of forward-looking individuals depend, inter alia, on life expectancy and the design of the public pension system. We calculate that, in the case of Germany, the fiscal consequences of the 6.4 year increase in age 65 life expectancy anticipated to occur over the 40 years that separate the 1942 and 1982 birth cohorts can be offset by either an increase of 4.34 years in the full pensionable age or a cut of 37.7% in the per-year value of public pension benefits. Of these two distinct policy approaches to coping with the fiscal consequences of improving longevity, increasing the full pensionable age generates the largest responses in labor supply and retirement behavior.Life expectancy, public pension reform, retirement, employment, life-cycle models, consumption, tax and transfer system

Measuring Longevity Risk for a Canadian Pension Fund

In this paper we consider two particular Canadian defined benefit pension plans to illustrate the importance of adequate mortality forecasting on actuarial liabilities. An employer who sets up an employee defined benefit pension plan promises to periodically pay a certain sum to the participant until death. Both the employee and the employer finance these periodical payments during the beneficiary’s career. Any shortcoming of funds in the future is, however, the employer’s responsibility. It is therefore essential for the employer to be able to predict with a high degree of confidence the total amount that will be required to cover its obligations to the future retiree. If increases in life expectancy were predictable and taken into consideration when establishing retirement funds, assessing future liabilities would be riskless in that respect. Unfortunately, future survival rates are uncertain. On that account, pensioners may outlive their life expectancies and expose pension funds to longevity risk. We present different tools to hedge this risk and the potential cost for two Canadian public pension plans.Cairns-Blake-Dowd model, Lee-Carter model, Pension Funds.,

Long Term Modelling of Economic and Demographic Variables for Risk Assessment of Defined Benefit Pension Schemes

In this thesis, we ascertain the amount of economic capital which Defined Benefit (DB) pension schemes should potentially hold to cover their economic and mortality risks exposures. Recent financial crisis such as the dot com bubble and the 2008 financial crisis has led to funding levels of many DB pension schemes to worsen. Moreover, increasing longevity of pensioners raises further questions on the sustainability of DB pension schemes. Unlike insurance companies or banks, there is no formal regulatory requirement to quantify the risks of DB pension schemes. Given the increasing uncertainty around the solvency of DB pension schemes, there is an urgent need for such a framework. In this respect, we propose a framework for risk quantification of individual DB schemes across different countries. For our analysis, we focus on three countries; UK, US and Canada. We implement economic and mortality models to quantify financial risks underlying large DB pension schemes. In particular, we develop an Economic Scenario Generator (ESG) using a graphical modelling approach. We focus on economic variables relevant to pension schemes e.g. price inflation, wage inflation, dividend yield, dividend growth and long term bond yield. The dependence between variables is represented by "edges" in a graph connecting the variables or "nodes". The graphical model approach is fairly easy to implement, is flexible and transparent when incorporating new variables, and thus easy to apply across different datasets (e.g. countries). We also show that the results are consistent with well-established ESGs such as the Wilkie Model in the UK context. We also compare quantitatively seven stochastic models explaining improvements in mortality rates. In particular, we use the Bayes Information Criteria to choose a model which provides a good fit to mortality data from UK, US and Canada. We use the graphical model alongside the mortality model to examine the risks of UK, US and Canadian pension schemes. Although the modelling methodology remains the same, we fit the economic and demographic models to data from all three countries. We then implement our framework to calculate the economic capital for existing and ``stylised" pension schemes.For the UK, we carry out risk assessment of the Universities Superannuation Scheme (USS). For the US, we use a US stylised scheme for our analysis. The US stylised scheme is based on the membership profile and benefits of the USS but adapted to be representative of a US pension scheme. For Canada, we carry out risk assessment of the Ontario Teachers' Pension Plan (OTPP). Both the USS and the OTPP are very large pension schemes with over 300,000 members. We further carry out sensitivity analysis by varying the mortality assumptions and the asset allocations of the pension schemes. The overall aim of the exercise is to determine and compare the long-term sustainability of pension schemes in different countries. The interaction between population structure, investments and asset returns will be of interest to pension funds, actuaries and policy-makers, all of whom are interested in the overall health of both public and private pension schemes

Introducing a new retirement savings scheme in the UK

Mestrado em Actuarial ScienceNos últimos tempos, as empresas patrocinadoras de pensões do RU têm mostrado preocupações acrescidas com o passivo cada vez mais elevado dos esquemas de benefícios definidos (BD), e com o baixo nível de aceitação dos membros em suportar o risco associado aos esquemas de contribuição definida (CD). Para lidar com esta situação, um fundo de pensões britânico de grande dimensão, em colaboração com o sindicato dos trabalhadores e o departamento do trabalho e pensões britânico sugeriram a implementação de um novo tipo de esquema de risco compartilhado, já que este conceito é um tópico importante no mundo das pensões, pois pretende ser uma solução intermédia entre ambos os esquemas. A principal razão para a escolha deste tópico surgiu durante o meu estágio na Willis Towers Watson, onde trabalhei com diferentes esquemas de BD. Ao realizar a avaliação atuarial nesses diferentes planos, percebi que o número de membros ativos estava em declínio, quando comparado com avaliações anteriores, e que até em alguns deles não havia membros ativos, pois tinham sido fechados à entrada de novos membros, o que potencia os problemas com estes esquemas. Usando o caso do Royal Mail como exemplo, pude entender a necessidade de um novo esquema e legislação para fundos de pensões, apresentando um modelo que visa testar o funcionamento dos esquemas/planos de pensão propostos, face a pressupostos económicos e demográficos desfavoráveis. Este relatório procura contribuir para uma melhor compreensão do mercado de pensões, especialmente no RU, e para uma melhor perceção do esquema de benefícios proposto.During recent times, sponsors of the UK pension scheme have been more concerned with the ever-increasing liabilities of Defined Benefit (DB) schemes and low level of acceptance from members with bearing the risk associated with the Defined Contribution (DC) schemes. To deal with this, one large UK pension scheme, in collaboration with their Workers Union and the Department of Works and Pension, suggested the implementation of a new type of risk?sharing scheme. The concept of risk- sharing is a hot topic in the world of pensions, as it aims to be the midpoint between DC and DB schemes. The main idea for this topic came about during my internship at Willis Towers Watson, where I got the opportunity to work directly with different DB schemes. While carrying out actuarial valuation on various schemes, I realized that the number of active members were on a decline when compared to previous valuations, and in some cases there were no active members in the scheme, as they have closed to new members, which exacerbates the problems associated with DB schemes for the sponsor. Using the Royal Mail experience as a case study, I was able to understand the need for a new pension scheme and legislation, thus presenting a model that tested the proposed pension schemes/plans against unfavorable economic and demographic assumptions. This report would help to better understand the pension market, especially in the UK, and to see the benefits of the proposed schemeinfo:eu-repo/semantics/publishedVersio

Modeling Risk-based Pension Insurance Premiums

This paper describes how the Pension Protection Fund (PPF) in the U.K. quantifies and prices the risks it carries. It also discusses how the PPF interprets these outcomes in terms of a levy or premium to be charged to the pension plans that it protects. PPF has existed since 2005: it has experienced rapid growth as a consequence of the failure of U.K. pension scheme sponsors and the persistent underfunding of their plans, and it has withstood the global financial crisis, partly due to the Fund’s ability to charge a levy consistent with the risks it faces and its skill in securing stakeholder acceptance of its process. Considering the example of the U.S. Pension Benefit Guaranty Corporation (PBGC), the PPF was able to introduce the world’s first risk-based pension protection levy, a key step in winning stakeholder support for the pricing mechanism; the components of the levy-setting process are described in this paper. We examine the PPF’s goal to be self-sufficient by 2030. We also review the framework whereby investment and levy strategies can be evaluated in the context of the PPF’s long-term objectives, and we describe the internal model at high level to compute measures of success of different strategies. The Board has been able to use this framework to assess the impact of a change to the basis of indexation of PPF compensation, the cost of removing its compensation cap, and the effect of a potential change in pension scheme funding valuations to permit smoothing of discount rates

Pension Arrangements and Retirement Choices in Europe: A Comparison of the British, Danish and German Systems. ENEPRI Research Reports No. 5, 1 February 2005

This paper develops a general equilibrium simulation model of a heterogeneous population in which both consumption/saving and labour/leisure choices are endogenous. The authors use it to explore the effects of the different state benefit systems on the labour supply of old and older workers in Denmark, Germany and the UK. In broad terms, they find that differences in labour force participation can be accounted for by the differences in benefit structures. These conclusions are not altered when they allow for the effects of poor health at different ages. The UK system is found to be preferable by young persons while the German arrangement is preferred by old and older people (who make up the majority in the simulated population)

Linking pensions to life expectancy: tackling conceptual uncertainty through Bayesian Model Averaging

Linking pensions to longevity developments at retirement age has been one of the most common policy responses of pension schemes to aging populations. The introduction of automatic stabilizers is primarily motivated by cost containment objectives, but there are other dimensions of welfare restructuring in the politics of pension reforms, including recalibration, rationalization, and blame avoidance for unpopular policies that involve retrenchments. This paper examines the policy designs and implications of linking entry pensions to life expectancy developments through sustainability factors or life expectancy coefficients in Finland, Portugal, and Spain. To address conceptual and specification uncertainty in policymaking, we propose and apply a Bayesian model averaging approach to stochastic mortality modeling and life expectancy computation. The results show that: (i) sustainability factors will generate substantial pension entitlement reductions in the three countries analyzed; (ii) the magnitude of the pension losses depends on the factor design; (iii) to offset pension cuts and safeguard pension adequacy, individuals will have to prolong their working lives significantly; (iv) factor designs considering cohort longevity markers would have generated higher pension cuts in countries with increasing life expectancy gap