Pension Deals and Value-Based ALM

Abstract

We use the new approach of value-based ALM to investigate pension deals ranging from pure defined benefit to pure defined contribution and to asset allocations of 100% in equities versus 100% in bonds. We will show that seemingly attractive pension deals, that have for instance low average contribution rates and high expected surpluses, may have low present values for certain stakeholders. Value-based ALM will show who will gain and loose from changing the current pension deal. This information in our opinion will help to construct a more sustainable pension deal.

Value-based ALM adds new information relative to classical ALM in the form of present values of future cash flows, the economic value of future surpluses and deficits as well as stakeholder information, showing the intergenerational solidarity expressed in economic value terms. We think this information should no longer be disregarded and should be included in doing ALM and constructing pension deals in the future.

Keywords: value-based ALM, pension funds, option pricing, embedded options

JEL Classification: G13, G23, H55, M41