Funding ratio options

This paper defines an approximation to the value of funding ratio put options for pension funds.This option is, by construction, the ideal option to hedge the risk of a funding ratio falling below some required minimum level. It’s value can be used for several applications, for example as a riskmeasure for internal risk management or regulation, as a benchmark for (other) derivative solutions to hedge insolvency risks, or to value guarantees made by sponsors to eliminate a funding shortfall.A numerical example shows that the impact of the presence of mortality volatility risk on the value of funding ratio put options is significant.

Netspar, Network for Studies on Pensions, Aging and Retirement, is a thinktank and knowledge network. Netspar is dedicated to promoting a wider understanding of the economic and social implications of pensions, aging and retirement in the Netherlands and Europe.

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