Pension fund risk management: Multi-stakeholders, risk management and the embedded options approach

Abstract

Pension funds have gradually become institutions where various stakeholders — retirees, employers and employees — share the risks. These risk-sharing agreements imply that various complex options, with different characteristics, are ‘traded’ within the pension fund. Different stakeholders assume different kinds and levels of risk that need to be valued and managed. The approach put forward in this paper aims to make the valuation and risk characteristics of these embedded options transparent. This approach is gaining importance as the new form of risk management for pension funds. It has important applications in solvency management, merger and acquisition activities, pension fund redesign and hedging pension fund risks. The exact structure of the models and the corresponding assumptions are to a large extent omitted in the text. The underlying research in this paper and the quantitative results are based on the author's book, ‘Curious Contracts. Pension Fund Redesign for the Future’. Anyone wishing to check the results or understand the quantitative modelling of embedded options can download the text, free of charge, from www.cardano.com.