The impact of simultaneous shocks to financial markets and mortality on pension buy-out prices

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Arik A., Ugur Ö., Kleinow T.

ASTIN BULLETIN-THE JOURNAL OF THE INTERNATIONAL ACTUARIAL ASSOCIATION, vol.53, pp.392-417, 2023 (SCI-Expanded) identifier identifier

  • Publication Type: Article / Article
  • Volume: 53
  • Publication Date: 2023
  • Doi Number: 10.1017/asb.2023.11
  • Journal Name: ASTIN BULLETIN-THE JOURNAL OF THE INTERNATIONAL ACTUARIAL ASSOCIATION
  • Journal Indexes: Science Citation Index Expanded (SCI-EXPANDED), Social Sciences Citation Index (SSCI), Scopus, Business Source Elite, Business Source Premier, zbMATH
  • Page Numbers: pp.392-417
  • Keywords: Defined benefit pension plan, mortality, jump diffusion models, pension buyout, mortality and financial markets, RISK, RATES
  • Middle East Technical University Affiliated: Yes

Abstract

In this paper, we determine the fair value of a pension buyout contract under the assumption that changes in mortality can have an impact on financial markets. Our proposed model allows for shocks to occur simultaneously in mortality rates and financial markets, so that strong changes in mortality rates can affect interest rates and asset prices. This approach challenges the common but very strong assumption that mortality and market risk drivers are independent. A simulation-based pricing framework is applied to determine the buyout premium for a hypothetical fully funded pension scheme. The results of an extensive sensitivity analysis show how buyout prices are affected by changes in mortality and financial markets. Surprisingly, we find that the impact of shocks is similar whether or not these shocks occur simultaneously or not, although there are some differences in annuity prices and buyout premiums. We clearly see that the intensity and severity of shocks, and asset price volatility play a dominant role for buyout prices.