Chapter 9 - Sharing Downside Risk in Defined Benefit Pension Funds

Abstract

This chapter aims to develop a measurement model that provides information on how risks are allocated across pension fund participants. It calculates the total risk of the portfolio, and determines how risk can be attributed to the individual groups of participants. In order to do this, it uses a simulation model and a set of loss allocation rules. Based on the simulation results, it attributes the risk to individual groups of beneficiaries. Furthermore, it uses downside risk as a measure of risk, and uses the decomposition of downside risk. Thereafter, it decomposes downside risk along the risky assets to see where the risk originates and over the groups of participants in the pension fund. This information is important, as it provides the input for evaluating whether the risks are shared in a responsible way. This presentation format is based on decomposing downside risk over the participants involved in a pension fund. Next to the formal rules, there are informal rules that are dictated by negotiations and the willingness of participants to share losses. The decomposition of downside risk allows the group of participants to evaluate their relative share in the losses. This may facilitate the discussion between sponsor and beneficiaries on strategies in times of underfunding.