New research from a pensions expert shows that defined benefit pension schemes can operate at an acceptable level of risk for the sector.
Dr Pradip Tapadar, of the University’s School of Mathematics, Statistics and Actuarial Science, is co-author of the research that has concluded that policymakers should take a more ‘holistic’ approach to regulatory capital requirements.
Membership of UK defined benefit (DB) occupational pension schemes has seen a sharp decline, with a trend of moving away from DB to defined contribution (DC) schemes – primarily due to the increasing unwillingness of sponsors to bear the risks inherent in DB pension schemes.
The decline in DB scheme membership has social policy implications, as the responsibility of looking after individuals in old age with inadequate pensions will ultimately fall on the state.
Dr Tapadar and his co-author Dr Wei Yang, of the Southwestern University of Finance and Economics, China, considered the role of the Pension Protection Fund (PPF) in financial risk management of UK defined benefit pension sector.
Published in the Annals of Actuarial Science, the research found that in 2012 there were still 6,316 eligible schemes with some 11.7million members registered with the Pension Protection Fund (PPF).
The researchers analysed the impact of applying economic capital techniques to defined benefit pension schemes in the United Kingdom.
They proposed two alternative economic capital quantification approaches, first, for individual defined benefit pension schemes on a stand-alone basis and then for the pension sector as a whole by quantifying economic capital of the PPF, which takes over eligible schemes with deficit, in the event of sponsor insolvency.
The researchers found that economic capital requirements for individual schemes are significantly high. However, they showed that sharing risks through the PPF reduces the aggregate economic capital requirement of the entire sector. This, they conclude, produces an acceptable level of risk for define benefit schemes.