Funding Ratio Options

Abstract:     
This paper defines an approximation to the value of funding ratio put options for pension funds. This option is, by construction, the ideal option to hedge the risk of a funding ratio falling below some required minimum level. It’s value can be used for several applications, for example as a risk measure for internal risk management or regulation, as a benchmark for (other) derivative solutions to hedge insolvency risks, or to value guarantees made by sponsors to eliminate a funding shortfall. A numerical example shows that the impact of the presence of mortality volatility risk on the value of funding ratio put options is significant.

Keywords: pension fund, funding ratio, insolvency risk, regulation

JEL Classification: G23, G24, G28

working papers series