The value of guarantees on pension fund returns

Contingent claims analysis is used to value government guarantees associated with defined contribution pension plans. Values are derived for two types of guarantees on the rate of return earned by an individual pension fund: a guarantee of a fixed minimum rate of return and a guarantee of a minimum rate of return that is set relative to the performance of other pension funds. The value of a minimum pension benefit guarantee for a participant in a mandatory defined contribution pension plan is also derived. Values for each of these guarantees are illustrated using typical parameter values. Martingale pricing theory provides a unifying framework for valuing these guarantees by either an explicit formula or numeric computation using a Monte Carlo simulation.