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...

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Main Authors: Ladekarl, Jeppe, Ladekarl, Regitze, Andersen, Erik Brink, Vittas, Dimitri
Format: Policy Research Working Paper
Language:English
Published: World Bank, Washington, DC 2012
Subjects:
Online Access:http://documents.worldbank.org/curated/en/2007/03/7435986/use-derivatives-hedge-embedded-options-case-pension-institutions-denmark
http://hdl.handle.net/10986/7182
id okr-10986-7182
recordtype oai_dc
spelling okr-10986-71822021-04-23T14:02:33Z The Use of Derivatives to Hedge Embedded Options : The Case of Pension Institutions in Denmark Ladekarl, Jeppe Ladekarl, Regitze Andersen, Erik Brink Vittas, Dimitri 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 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. 2012-06-05T20:29:16Z 2012-06-05T20:29:16Z 2007-03 http://documents.worldbank.org/curated/en/2007/03/7435986/use-derivatives-hedge-embedded-options-case-pension-institutions-denmark http://hdl.handle.net/10986/7182 English Policy Research Working Paper; No. 4159 CC BY 3.0 IGO http://creativecommons.org/licenses/by/3.0/igo/ World Bank World Bank, Washington, DC Publications & Research :: Policy Research Working Paper Publications & Research Europe and Central Asia Denmark
repository_type Digital Repository
institution_category Foreign Institution
institution Digital Repositories
building World Bank Open Knowledge Repository
collection World Bank
language English
topic 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
spellingShingle 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
Ladekarl, Jeppe
Ladekarl, Regitze
Andersen, Erik Brink
Vittas, Dimitri
The Use of Derivatives to Hedge Embedded Options : The Case of Pension Institutions in Denmark
geographic_facet Europe and Central Asia
Denmark
relation Policy Research Working Paper; No. 4159
description 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.
format Publications & Research :: Policy Research Working Paper
author Ladekarl, Jeppe
Ladekarl, Regitze
Andersen, Erik Brink
Vittas, Dimitri
author_facet Ladekarl, Jeppe
Ladekarl, Regitze
Andersen, Erik Brink
Vittas, Dimitri
author_sort Ladekarl, Jeppe
title The Use of Derivatives to Hedge Embedded Options : The Case of Pension Institutions in Denmark
title_short The Use of Derivatives to Hedge Embedded Options : The Case of Pension Institutions in Denmark
title_full The Use of Derivatives to Hedge Embedded Options : The Case of Pension Institutions in Denmark
title_fullStr The Use of Derivatives to Hedge Embedded Options : The Case of Pension Institutions in Denmark
title_full_unstemmed The Use of Derivatives to Hedge Embedded Options : The Case of Pension Institutions in Denmark
title_sort use of derivatives to hedge embedded options : the case of pension institutions in denmark
publisher World Bank, Washington, DC
publishDate 2012
url http://documents.worldbank.org/curated/en/2007/03/7435986/use-derivatives-hedge-embedded-options-case-pension-institutions-denmark
http://hdl.handle.net/10986/7182
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