Shane Whelan, L527

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Asset-Liability Management for Actuaries

• Shane Whelan, L527

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Chapter 2

• The Professional Business Context
• (where actuarial control cycle is applied)

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Stakeholders

• The advice given to a client by an actuary will,
  in many cases, impact on other stakeholders.
• The actuary needs to consider the interests of
  all stakeholders and imbed the the advice in that
  context - not only or solely the interest of the
  client.
• E.g., appointed actuary to life insurer advising
  board of directors would have to consider
  interests of
• Policyholders (by groups), shareholders (if any),
  employees, regulator, intermedaries, etc.
• E.g., advising trustees of a pension fund on,
  say, asset allocation
• See later.

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But at the End of the Day

• At the end of the day, it will be the client who
  decides which solution to adopt.
• Properly, appropriately, and prudently advised by
  an actuary.
• And advice must be value-for-money.
• Note that an actuary may also have an executive
  role. Beware the danger that such an executive
  actuary will take decisions based on his or her
  own advice
• Can seek further advice or peer review of the
  decision made if necessary.

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Pension Funds Outline of the Stakeholders
stake

• Members of benefit schemes and their dependants
• Paying contributions
• Receipt of promised benefits on future events
  such as death, retirement, illness, withdrawal.
• Other duty of care?
• Trustees of the Scheme
• paying the benefits promised under the scheme as
  they fall due, hence
• administration record keeping, collecting
  contributions
• investing the assets of the scheme
• maintaining solvency

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Pension Funds the Stakeholders stake

• Sponsoring Employer
• Meeting/managing the cost of providing the
  benefits
• meeting legislative requirements
• providing protection and retirement benefits that
  meet the needs of the members and their
  dependants?
• Regulator
• Ensuring regulatory requirements are met
• Ensuring on-going suitability of requirements
• Other
• But increasingly less significant Government
  (tax, social welfare), auditors and other
  advisers, fund managers, non-member employees,
• Smaller and smaller ripples through a fully
  connected economy.
•                   
•                    
• embers of benefit schemes and their dependants
• receipt of promised benefits on future events
  such as death, retirement, illness, withdrawal.
• Other duty of care?
• Trustees of the Scheme
• paying the benefits promised under the scheme as
  they fall due
• Hence administration record keeping, collecting
  contributions

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Assess Impact on Shakeholders if

• Trustees adopt a very aggressive mismatch
  investment strategy.
• Trustees decide to invest largely in sponsoring
  employers own business and in that sector.
• Trustees agree to large increase to MD pension,
  and he retires early next month.
• Benefit improvements that cost more.
• Employer will not contribute the cost of accruing
  benefits.

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Main Providers of Benefits on future
life-contingent events

• Actuaries are often asked to advise institutions
  providing benefits in the long-term future
  contingent on some life event
• Examples might include institutions providing
• Benefits on events less predictable in time
• E.g., death, sickness, redundancy, home fire,
  theft
• Benefits on events more predictable in time
• E.g., retirement, mortgage repayment
• Fully flexible provision for future contingencies
• E.g., savings in the form of savings accounts,
  investment trusts, etc
• Less flexible provision for longer term future
• E.g., fixed term savings, endowment policy,
  immediate and deferred annuities.

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Main Providers of Benefits on future
life-contingent events

• So we need to know the broad market/other
  providers of these type of benefits. Key
  providers are
• The State
• Employer
• The individual themselves, through
• Financial institutions or other corporations.
• The role played can be expected to change over
  the futureespecially the role of the State.
• We shall take as a case study in this lecture the
  provision of retirement benefits.

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The State Pension Provision

• The State has a major role in the provision of
  such benefits since the start of the 20th century
  as it tries to ensure the population receives or
  has the opportunity to receive income after
  retirement.
• through direct provision
• through encouragement of provision (tax, subsidy)
  
• or through the regulation of providers.
• The historical, political, economic and fiscal
  viewpoints of the State will determine the
  precise form of the roles. Solutions include
• Provide the benefits
• Compel individuals or employers
• Educate
• Regulate industry
• Provide the instruments

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The 21st Century Common Problem
Source Palacios Pallares-Miralles (2000),
International Patterns of Pension Provision,
World Bank.
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Public Pension Schemes Quality, Current Burden,
Capitalised liability
Source Palacios Pallares-Miralles (2000),
International Patterns of Pension Provision,
World Bank.
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Employers

• Employers may make provision by financing cost
  due to
• compulsion or encouragement from the State
• a paternalistic desire to look after employees
  and their dependants financially beyond the level
  provided by the State
• Surveys indicate that paternalism is still the
  main motivation in the UK.
• a desire to attract and retain the services of
  good quality employees
• As part of total remuneration flexible benefit
  schemes
• Employers may facilitate provision of benefits
• Set up scheme with provider but employee makes
  all the contributions

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Individuals

• Individuals may finance own pension through
• non-specific individual savings, e.g., through
  the accumulation of property and equity release
  schemes
• a formal benefit based scheme which may be
  operated by the State, an employer, an insurer or
  another financial organisation.
• may group together (trade union, religious
  organisation, CCRCs) with others and pool their
  finances.
• This will help to protect the individuals against
  some of the uncertainties (random variation) that
  may exist in the cost of financing the benefits
  and may also lead to more cost effective
  provision.

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Financial Other Institutions

• Where an employer and/or an individual is looking
  to provide benefits they may go through an
  intermediary financial institutions such as life
  insurers, general insurers, banks, investment
  houses etc.
• Such institutions may even stimulate demand for
  their product lobbying, advertising, education.
• Remember the old saying that insurance is sold,
  not bought

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What solutions can be proposed for OECD Pension
Problem?

• Increasing the age at which benefits can be drawn
  perhaps to 70, or higher.
• So reduce the ratio of retired to working
  populations and the benefits will be paid for
  less time
• Reducing the level of benefits or their rate of
  escalation
• E.g., escalate in line with price inflation
  rather than earnings increases.
• Toughening the eligibility requirements
• Means test longer working life
• Get others more involved to share burden
• Employers individual themselves
• But how do you incentivise?

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Solution for State

• Whatever solution or combination of solutions is
  settled on, the macro-economic and
  socio-political impact must be assessed.
• Put on web article in the Dec Newsletter of the
  SoA in Ireland, There is no country for old men.

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Developments in Pension Provision

• Most developed countries are tinkering with their
  PAYGO DB schemes to reduce burden.
• Some are moving toward fully-funded DC
  arrangements Australia, Hong Kong, Latin
  America, Poland.
• From nil in 1981, now 80 million workers in world
  contribute to mandatory individual retirement
  accounts.
• Trend to individual retirement accounts is
  obvious in Europe - Switzerland Netherlands
  1985, UK 1988, Denmark 1993, Sweden 1999.
• Multinationals seek to put in place uniform
  retirement strategies.
• DC provision is trend in occupational provision
  around world.

Sources Schwarz Demirguc-Kunt (1999) Taking
Stock of Pension Reforms Around the World, World
Bank. Palacios Pallares-Miralles (2000),
International Patterns of Pension Provision,
World Bank. Merrer (2000), Managing
Multinational Retirement Programs, Mercer
(1999), Defined Contribution Retirement Plans
Around the World A Guide for Employers.
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Developments in DB in UK, Netherlands,
Switzerland, Ireland

• Private pension provision is incentivised, e.g.,
  Stakeholder (UK), PRSAs (Ireland).
• New schemes are essentially all DC and, perhaps,
  DB changing to DC when workforce turnover high.
• DB remain a feature in state enterprises or large
  companies with stable final demand. But
  increasingly regulatedFAS17, MFR, EC Directive.
• Sheltered hub of DB for long time to come?

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Developments in DB Pension Provision in France,
Germany, Italy.

• France commitment to social solidarity (PAYGO)
  private pension provision shelved in March 2000
  in favour of tinkering with Repartition
  structure.
• Germany tinkering Pillar 1 benefits downwards
  CPI rather than wage linkage, trying to introduce
  demographic factor but immense resistance to
  lowering replacement ratio.
• Italy large reform to occupational pensions in
  1993 to allow voluntary DC arrangements.
• In short, lack-lustre attempts to pre-fund or
  incentivise private provision.

Sources EU, Internal Market Directorate-General,(
May 2000) Study on Pension Schemes of the Member
States of the European Union. Financial Times
Survey, 12 May 2000, Pension Fund Investment.
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Forthcoming Developments in EU

• 2005 Deadline for Integration of Financial
  Services in EU
• Common requirements for share-listings
• Convergence in financial reporting standards
• Broaden investment scope of UCITS and Pension
  Funds
• IORP Directive in final draft
• Enabling higher proportion in equity and currency
  mismatched assets.
• Free to appoint any manager or custodian in any
  member state
• But tax co-ordination proposals still outstanding
  due in 2001. With Nice in mind, this could
  cause delays.
• Almost a decade now with only talk from
  withdrawn June 1993 draft directive, annulment of
  proposal by European Court of Justice in 1997, to
  current near-final draft.

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Completes Chapter 2

• The Professional Business Context
• (where actuarial control cycle is applied)

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Applications/Examples of Actuarial Control Cycle
2

• Problem A new life company wants to sell
  non-profit, non-escalating, annuities. Design and
  implement a suitable method of pricing and
  reserving for these contracts.

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Applications/Examples of Actuarial Control Cycle
3

• Problem A new software company is considering
  setting up a pension fund. Design a solution.

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Asset-Liability Management for Actuaries

• Shane Whelan, L527