nr 082 - Valuation of Conditional Pension Liabilities and Guarantees under Sponsor Vulnerabilities

DNB Working Papers
Date 25 January 2006

This paper analyzes the relationship between a pension fund with conditionally indexed de.ned benefit liabilities and its sponsor, using contingent claims analysis. As pension funds run a mismatch risk, future surpluses and shortfalls will occur. Surpluses are divided between beneficiaries and sponsor through conditional indexation and refunding. Covering an eventual loss at the pension fund level is a function of the sponsor's financial ability to do so. This paper suggests that this system creates an asymmetric allocation of the residual risk between sponsor and beneficiaries. The main conclusion is that the sponsor's vulnerability negatively impacts the optimum risk profile of a defined benefit scheme with conditional indexation and thereby the market value of conditional indexation. JEL Classi.cation: G11; G23. Keywords: De.ned bene.t, pension put, conditional indexation, vulnerable options