The Valuation of Option Features in Retirement Benefits

This article extends and applies a contingent claims valuation approach to option features in retirement fund benefits. The approach incorporates retirement, mortality, and other decrements and allows for differences between the benefit payments and standard option payoffs. A discrete lattice implementation commonly used for valuing financial options is found to be unsatisfactory for the valuation of these option features. Simulation is found to be more efficient. Simulation is then used to calculate benefit values for a range of ages for a simplified fund. The results of the valuations for a number of simulation scenarios demonstrate that a traditional deterministic actuarial valuation can understate the cost of these benefits by as much as 25 to 35 percent.