Quantification of the Discontinuity Risk of Pension funds
This master thesis explores the sustainability of collective pension funds, if participation in a collective fund is not mandatory but becomes voluntary. It quantifies the discontinuity risk for a typical, collective pension fund in The Netherlands. That is, the risk that new entrants abstain from the collective pension contract and current participants leave the collective fund, since they perceive to be better o in an individual system. Specifically, this thesis researches how participants react during a discontinuity event and, consequently, how these reactions (i.e. dynamic in- and out ow) affect the sustainability of the collective fund. I introduce a new dynamic ALM-approach instead of the current static ALM-approach. The development of a discontinuity event is complex and depends on the reactions of the participants, whereby most likely an information cascade occurs. I quantify the reactions by constructing a reaction-function that takes the funding ratios as input. Using Monte Carlo simulations, it is quantitatively shown how dynamic in- and out ow of participants affects the sustainability of the collective pension fund in the short-term and long-term. Classical ALM analysis shows that the fund becomes more sensitive to shocks, since the fund’s population decreases and, therefore, policy instruments work less efficiently. Especially, the fund is less sustainable with respect to the long-run. Generational accounting based on value-based ALM shows that discontinuity risk affects the remaining participants with the same magnitude as benefit reductions and recovery premia do. For this reason, discontinuity risk not only affects the sustainability of pension funds, but also the remaining participants in the fund. If the fund is underfunded,the discontinuity risk with respect to new entrants and near retirees is high (up to 76.2% and 49.3% respectively). The probability of defaulting in 75 years lies between 7.4% and 42.4%, whereas the probability of default is 0% if the in- and outflow is static. Low interest rates increase the probability of default and increase the discontinuity risks even further. Funding ratios between 33% and 71% lead to a Sinking Giant, depending on how the fund transfers the pension rights.