Valuation of Hybrid Pension Scheme Liabilities under Inflation

Abstract

In recent years, it is of great interest to evaluate the level of liabilities of the hybrid pension system as the mixed pension schemes are favored by various countries around the world. This paper further improves the hybrid pension liability assessment method proposed by Broeders et al by accounting for inflation risk and assuming that inflation risk is measured by a price index that follows geometric Brownian motion. A simulation-based pricing framework is then introduced to assess the hybrid pension liability. The results show that the introduction of inflation risk increases the total outstanding liability of hybrid pensions. Furthermore, inflation is negatively correlated with the total outstanding liability of the hybrid pension scheme, while inflation volatility is positively correlated with it.