De-Risking Defined Benefit Plans

Insurance: Mathematics and Economics, Vol. 63, pp. 52-65, 2015

45 Pages Posted: 20 Feb 2015 Last revised: 25 Jan 2016

See all articles by Yijia Lin

Yijia Lin

University of Nebraska at Lincoln - Department of Finance

Richard D. MacMinn

National Chengchi University; The University of Texas

Ruilin Tian

North Dakota State University - Department of Accounting, Finance, and Information Systems

Date Written: February 18, 2015

Abstract

To identify an appropriate pension de-risking method, this paper proposes an optimization model that minimizes the expected total pension cost subject to a conditional value at risk (CVaR) constraint on pension funding level. Using this model, we examine three pension hedging strategies, i.e., longevity hedge, buy-in and buyout; each strategy is examined with hedging costs that include a risk premium, search and information cost, underfunding cost, and counter-party risk cost. The numerical examples demonstrate that these hedging costs have a significant impact on the hedging decision. The hedge ratio (total pension cost) decreases (increases) with the transaction cost, the counter-party default probability and the underfunding ratio. In addition, the buy-out underperforms the longevity hedge and the buy-in for underfunded plans and the longevity hedge is less sensitive to the default risk than the buy-in.

Keywords: defined benefit pension plan, longevity hedge, buy-in, buy-out

Suggested Citation

Lin, Yijia and MacMinn, Richard D. and Tian, Ruilin, De-Risking Defined Benefit Plans (February 18, 2015). Insurance: Mathematics and Economics, Vol. 63, pp. 52-65, 2015, Available at SSRN: https://ssrn.com/abstract=2567022

Yijia Lin (Contact Author)

University of Nebraska at Lincoln - Department of Finance ( email )

Lincoln, NE 68588-0490
United States

Richard D. MacMinn

National Chengchi University ( email )

Taipei
Taiwan

The University of Texas ( email )

2317 Speedway
Austin, TX Texas 78712
United States

Ruilin Tian

North Dakota State University - Department of Accounting, Finance, and Information Systems ( email )

Fargo, ND
United States
7012316544 (Phone)
7012316545 (Fax)

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