Market-Consistent Valuation of Pension Liabilities

Antoon Pelsser, Ahmad Salahnejhad, Ramon van den Akker

Research output: Working paperDiscussion paperOther research output

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Abstract

Pension funds and life insurance companies have liabilities on their books with extremely long-dated maturities that are exposed to non-hedgeable actuarial risks and also to market risks. In this paper, we show that it is computationally feasible to price pensions contracts in an incomplete market setting with time-consistent and market-consistent (TCMC) pricing operators. Furthermore, we compare the TCMC prices for life-insurance and pension contracts to alternative pricing methods that are currently used for pricing pension and life-insurance liabilities: the best estimate pricing method which is typically used for pension liabilities, and the EIOPA’s risk margin method that is used under Solvency II to value life-insurance liabilities. We show that the best estimate pricing method completely ignores the uncertainty in the non-hedgeable risks. We also show that the risk margin method is a significant step in the right direction to reflect most of this uncertainty in the pricing. However, the risk margin price still ignores some uncertainties, and is therefore not fully time-consistent. For long-dated contracts this effect should not be ignored.
Original languageEnglish
Place of PublicationTilburg
PublisherNETSPAR
Number of pages38
Publication statusPublished - Oct 2016

Publication series

NameNetspar Industry Paper
VolumeDesign 63

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Liability
Pensions
Pricing
Life insurance
Uncertainty
Margin
Maturity
Market risk
Pension funds
Insurance companies
Operator
Incomplete markets
Solvency II

Cite this

Pelsser, A., Salahnejhad, A., & van den Akker, R. (2016). Market-Consistent Valuation of Pension Liabilities. (Netspar Industry Paper; Vol. Design 63). Tilburg: NETSPAR.
Pelsser, Antoon ; Salahnejhad, Ahmad ; van den Akker, Ramon. / Market-Consistent Valuation of Pension Liabilities. Tilburg : NETSPAR, 2016. (Netspar Industry Paper).
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Pelsser, A, Salahnejhad, A & van den Akker, R 2016 'Market-Consistent Valuation of Pension Liabilities' Netspar Industry Paper, vol. Design 63, NETSPAR, Tilburg.

Market-Consistent Valuation of Pension Liabilities. / Pelsser, Antoon; Salahnejhad, Ahmad; van den Akker, Ramon.

Tilburg : NETSPAR, 2016. (Netspar Industry Paper; Vol. Design 63).

Research output: Working paperDiscussion paperOther research output

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N2 - Pension funds and life insurance companies have liabilities on their books with extremely long-dated maturities that are exposed to non-hedgeable actuarial risks and also to market risks. In this paper, we show that it is computationally feasible to price pensions contracts in an incomplete market setting with time-consistent and market-consistent (TCMC) pricing operators. Furthermore, we compare the TCMC prices for life-insurance and pension contracts to alternative pricing methods that are currently used for pricing pension and life-insurance liabilities: the best estimate pricing method which is typically used for pension liabilities, and the EIOPA’s risk margin method that is used under Solvency II to value life-insurance liabilities. We show that the best estimate pricing method completely ignores the uncertainty in the non-hedgeable risks. We also show that the risk margin method is a significant step in the right direction to reflect most of this uncertainty in the pricing. However, the risk margin price still ignores some uncertainties, and is therefore not fully time-consistent. For long-dated contracts this effect should not be ignored.

AB - Pension funds and life insurance companies have liabilities on their books with extremely long-dated maturities that are exposed to non-hedgeable actuarial risks and also to market risks. In this paper, we show that it is computationally feasible to price pensions contracts in an incomplete market setting with time-consistent and market-consistent (TCMC) pricing operators. Furthermore, we compare the TCMC prices for life-insurance and pension contracts to alternative pricing methods that are currently used for pricing pension and life-insurance liabilities: the best estimate pricing method which is typically used for pension liabilities, and the EIOPA’s risk margin method that is used under Solvency II to value life-insurance liabilities. We show that the best estimate pricing method completely ignores the uncertainty in the non-hedgeable risks. We also show that the risk margin method is a significant step in the right direction to reflect most of this uncertainty in the pricing. However, the risk margin price still ignores some uncertainties, and is therefore not fully time-consistent. For long-dated contracts this effect should not be ignored.

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Pelsser A, Salahnejhad A, van den Akker R. Market-Consistent Valuation of Pension Liabilities. Tilburg: NETSPAR. 2016 Oct. (Netspar Industry Paper).