The Use of Derivatives to Hedge Embedded Options : The Case of Pension Institutions in Denmark
The main purpose of this paper is to
examine the growing use of derivatives by Danish pension
institutions as a risk management tool to hedge embedded
options on their balance sheets. Throughout the 1980s and
1990s it was a widespread practice for Danish pension
institutions to guarantee a minimum interest rate on new
pension policies. With the new millennium global interest
rates declined steeply and equity markets came crashing
down. Suddenly the guarantees on pension contracts were in
the money. The policies already written could not be
changed, leaving liabilities and assets mismatched, profits
in the red, and capital reserves drained. Out of necessity,
and in some cases virtue, Danish pension institutions turned
in scale to derivatives, allowing for a more active approach
to hedging, asset and liability management, and even profit
generation. Through the use of derivatives, pension
institutions have avoided the need to renegotiate their
guaranteed contracts with policy holders. They have
succeeded as an industry in transforming their pay-off
curves and have emerged with better matched asset/liability
positions and lower exposure to interest rate risk. But the
expanded use of derivatives also raises some risk management
and regulatory issues, such as operational and counterparty
risks as well as effective internal control systems and
regulatory oversight.
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Bibliographic Details
Main Authors: |
Ladekarl, Jeppe,
Ladekarl, Regitze,
Andersen, Erik Brink,
Vittas, Dimitri |
Language: | English |
Published: |
World Bank, Washington, DC
2007-03
|
Subjects: | ACCOUNTING,
ACCOUNTING RULES,
ACCOUNTING STANDARDS,
ANNUITIES,
ASSET PRICES,
ASSETS,
BALANCE SHEETS,
BOND YIELDS,
BONDS,
BUNDLING,
CAPITAL REQUIREMENTS,
CENTRAL BANK,
COUNTERPARTY RISKS,
COVERAGE,
CREDIT RISK,
CREDIT RISK EXPOSURE,
DEREGULATION,
DERIVATIVES,
DISCOUNT RATE,
DIVIDENDS,
EXPECTED RETURN,
FINANCIAL MARKETS,
FINANCIAL PRODUCTS,
FINANCIAL RISK,
FISCAL POLICY,
FIXED INCOME,
FIXED INCOME MARKETS,
FOREIGN CURRENCY,
FOREIGN EQUITIES,
FUTURES,
GDP,
GOVERNMENT BONDS,
GROWTH RATE,
HOUSING,
INCOME,
INCOME TAXES,
INSPECTIONS,
INSURANCE PRODUCTS,
INTEREST RATE,
INTEREST RATE SWAPS,
INTEREST RATES,
INVESTMENT BANKERS,
INVESTMENT RETURN,
INVESTMENT RETURNS,
LIFE INSURANCE,
LIFE INSURANCE COMPANIES,
MARKET RISK,
MORTGAGES,
NOMINAL INTEREST RATES,
OCCUPATIONAL PENSION PLANS,
PAID UP CAPITAL,
PAYOUT,
PENSION COVERAGE,
PENSION FUNDS,
PENSION PLANS,
PENSION POLICIES,
PENSION SCHEMES,
PENSIONS,
POLICYHOLDERS,
PORTFOLIO,
PORTFOLIOS,
PRICE LEVELS,
PRIVATE EQUITY,
PRUDENTIAL REGULATION,
REGULATORY FRAMEWORK,
REGULATORY RULES,
RESERVES,
RETAINED EARNINGS,
RETURN ON INVESTMENTS,
RISK EXPOSURE,
RISK MANAGEMENT,
SAVINGS,
SIDE EFFECTS,
SOLVENCY,
STATEMENTS,
SWAPS,
TAX REVENUES,
VALUATION,
WAGES, |
Online Access: | http://documents.worldbank.org/curated/en/2007/03/7435986/use-derivatives-hedge-embedded-options-case-pension-institutions-denmark
https://hdl.handle.net/10986/7182
|
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