Feedback Effects of Default Insurance for Defined Benefit Schemes

Abstract

A simulation investigation of the effect of default insurance on the optimal equity allocation and deficit spread period of a model defined benefit pension scheme is performed, using the old and new frameworks of the Pension Protection Fund in the U.K. as a starting point. The old default insurance levy framework encourages an increase in the allocation to equities, creating an indirect effect of increased deficits. The new framework reverses the effect to a reduction in the allocation to equities, thus reducing deficits. In addition the gaming element of default insurance is investigated and found to significantly increase optimal equity allocation and deficit spread period, leading to a significant increase in deficits.