Quantitative Risk Assessment Tools
Quantitative tools for measuring risk in defined benefit (DB) and defined contribution (DC) pension funds and how to integrate these in overall risk assessments
Risk-based supervision (RBS) is a structured approach which focuses on the identification of potential risks faced by pension plans or funds and the assessment of the financial and operational factors in place to minimise and mitigate those risks. This process then allows the supervisory authority to direct its resources towards the issues and entities which pose the greatest threat.
Module 2 of the IOPS Toolkit deals with the tools that can be used by a pension supervisory authority in the quantitative assessment of risk. Such quantitative assessments can play an important part in the overall risk-assessment process which is at the heart of risk-based supervision. Poor results from these quantitative tests imply higher levels of residual risk at the entity which is being analysed, which the supervisory authority would then factor into its overall risk analysis or risk score.
Section 1 looks at the quantitative regulatory requirements that provide the foundation for the quantitative assessment of risk.
- For DB funds these include: valuation requirements; minimum funding requirements; factor-based solvency margins; and stress-related solvency margins.
- For DC funds these are: investment limits; minimum return limits (guarantees); value at risk limits; and target-based risk measures.
Risk-based supervision can incorporate these quantitative regulations into the overall risk-assessment process in the following three ways:
- combining a `rules-based` and a `risk-based` approach compliance with quantitative restrictions is checked, and if not met a lower score would be factored into the overall risk assessment of the fund;
- quantitative requirements can be made more `risk-based` by testing whether compliance would still hold in adverse circumstances (i.e. by stress testing) - the results of these stress-tests would then be incorporated in the overall risk score;
- where the quantitative regulations are already risk-based, compliance with these risk-based regulations would be fed into the overall risk score.
Section 2 discusses the following techniques for the quantitative assessment of risk:
- comparison of valuation assumptions
- analysis of surplus
- roll-forward calculations
- duration analysis
- sensitivity testing
- deterministic stress testing
- stochastic stress testing
- value at risk (VaR) calculations.
Practical, worked examples of these techniques are provided in the supporting material for the Module
Section 3 goes on to discuss integrating quantitative tools into risk assessments stressing that qualitative judgment is also required to assess the results of these quantitative tests effectively, and as some factors and issues do not easily lend themselves to qualitative analysis.
Mr. Nzomo Mutuku of the Retirement Benefits Authority, Kenya discusses the quantitative indicators used in risk-based pension supervision.
For further videos relating to this module, see resources