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There is more interest risk than is desirable in theory when it comes to the current pension contracts of particpants aged 60 or older. This is one of the assertions of researchers Roel Mehlkopf (Tilburg University) en Servaas van Bilsen (University of Amsterdam) in a Netspar analysis of the (implicit) distribution of equity risk and interest risk during the life cycle of pension fund participants.

Due to this interest risk, their payments are insufficiently protected against unexpected interest rate movements. The current defined benefit agreement offers inadequate options for distributing interest risk among younger and older participants. The long-term obligation of younger participants can cause a high degree of volatility in a pension fund’s coverage ratio if all interest risks are not covered. This interest primarily affect – in spite of the distribution period – older participants.

Not enough flexibility

The researchers observed that the existing benefits regulation exhibits little flexibility in how equity and interest risk is distributed. An important lesson for the future here is that interest risk differs from equity risk and therefore needs to be distributed over the lifespan of the participants. As a result, an ‘ideal’ pension contract deals differently with different types of risk and has sufficient instruments for correctly distributing risks among the participants, both young and old.

More information?

Researcher Roel Mehlkopf will present a webinar on Thursday 11 June, based on the ‘Interest risk, lifecycle and pension contract’ Netspar Brief. Sign up to attend at www.netspar.nl.