Implementing Active Management Risk in the Standard Model for the Required Funding Ratio

Abstract

The funding ratio, calculated as the total assets divided by the total liabilities, is a frequently used indicator for the financial health of a pension fund. Using six risk elements the standard model calculates the required funding ratio, which is an additional buffer on top of a funding ratio of 100% such that there should exist only a 2.5% chance that within a year the funding ratio will be below 100%. In this thesis we analyze this model and try to improve the calculation of the required funding ratio by adding an extra risk element, which we call the active management risk; the risk of (actively) deviating from a benchmark. We give measures and methods to calculate this risk element. After analyzing these measures and methods we try to implement this risk element in the standard model to see its effect on the required funding ratio.