Pension schemes as options on pension fund assets: implications for pension fund management

This paper shows that the three principal types of funded pension scheme (defined benefit, defined contribution and targeted money purchase) are related through a set of options on the underlying financial assets held in the fund. The value of these options depends on both contribution inflows and the financial asset allocation chosen by the fund manager. The option values can therefore be used to assess both the appropriateness of the funding level and the effectiveness of the asset allocation in achieving the objectives of asset-liability management. In particular, they can be used to determine the probability of scheme insolvency.