Thus the work active members may often be better positioned to impose

Thus the work active members may often be better

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carry a large part of the losses. Thus, the work active members may often be better positioned to impose discipline on managements than the members who have retired. Furthermore, the work active may recover losses of pension rights by raising the work effort, thus countering the negative effects on living standards which result from losses in pension institutions. 5.2 Industry-wide crises Pension institutions may collectively run into problems. There may, for example, be a big fall in stock prices which causes investments to lose value. The real interest rate may fall to a low level. An unexpected rise in inflation may erode the purchasing power of fixed-interest investments. The economic development since the beginning of the 1990s has demonstrated that several of such negative outcomes may happen at the same time. The question is how it is possible to counter a crisis which is due to external events which the individual pension institutions are usually unable to affect. One solution is to seek insurance through the financial markets through financial derivatives. Pension institutions may, for example, through swaption contracts receive payments from other agents in the financial markets if, for example, the interest rate falls below a certain level. Correspondingly, pension institutions may seek protection from falls in stock prices through option contracts which cover against stock prices falling below a certain low level. As described in section 2, coverage through financial derivatives is a solution which has been widely used by the Danish industry after the 2000-2003 stock price fall. This applies also to the pension industries in other countries. The financial crisis in 2008 has, however, raised serious questions as to the appropriateness of this strategy. Thus, the collapse of the American investment 9
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bank, Lehmann Brothers, in September 2008 has demonstrated that a counterparty risk results in relation to financial contracts. Lehman Brothers was not a big player in the market but is was a counterparty to billions of dollars worth of interest rate and inflation swap contracts entered into by pension funds seeking to hedge their exposures by adopting a liability-driven investment. 4 The authorities came to the rescue of most financial institutions which had written options, including the investment bank Bear Stearns and the insurer AIG, but it is not certain that this will be seen also in future crises. The events of 2008 have demonstrated the risks related to private sector solutions relying on other financial institutions. Another solution is that the public sector steps up its sales of long-term public bonds. Governments may, for example, in their financing of public deficits to a larger extent rely on issues bonds with a very long duration, e.g. 30, 50 or 60 years. By providing the pension institutions with a safe investment outlet, the public sector provides insurance against fluctuations in asset prices.
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