asset & liabilities management- uio · pension reserve for a person 600,000 700,000 800,000...

Asset & LiabilitiesManagement from anindustrial point of view

january 2013

www.pwc.no

Pension reserve for a person

600,000

700,000

800,000

900,000

1,000,000

Illustrative

PwC

-100,000

0

100,000

200,000

300,000

400,000

500,000

20 30 40 50 60 70 80 90

leeftijd (jaar)

Re

se

rve

(eu

ro)

Age

Res

erve

Slide 2februar 2013Asset & Liabilities Management from an industrial point of view

Type pension fund

Deelnemersbestanden

150

200

250

Aan

tal

deeln

em

ers

per

leeft

ijd

Jong

Standaard

Oud

Nu

mb

ero

fm

emb

ers

young

standard

old

PwC

0

50

100

25 35 45 55 65 75 85 95Leeftijd

Aan

tal

deeln

em

ers

per

leeft

ijd

age

Nu

mb

ero

fm

emb

ers


Cash Flows- pension liabilities over time (for a’standard’ pension fund)

Current cash flows

0

5,000,000

10,000,000

15,000,000

20,000,000

25,000,000

30,000,000

35,000,000

40,000,000

cash flows 5 years from now

0

5,000,000

10,000,000

15,000,000

20,000,000

25,000,000

30,000,000

35,000,000

40,000,000

45,000,000


0

5,000,000

10,000,000

15,000,000

20,000,000

25,000,000

30,000,000

35,000,000

40,000,000

45,000,000

50,000,000


0

10,000,000

20,000,000

30,000,000

40,000,000

50,000,000

60,000,000

PwC

0

0 5 10 15 20 25 30 35 40 45 50 55 60

Time

0

0 5 10 15 20 25 30 35 40 45 50 55 60

Time

0

5,000,000

10,000,000

15,000,000

20,000,000

25,000,000

30,000,000

35,000,000

40,000,000

0 5 10 15 20 25 30 35 40 45 50 55 60

Be

dra

g

0

10,000,000

20,000,000

30,000,000

40,00,000

0 5 10 15 20 25 30 35 40 45 50 55 60

Bed

rag

0

0 5 10 15 20 25 30 35 40 45 50 55 60

TIme

0

0 5 10 15 20 25 30 35 40 45 50 55 60

TIme

Time Time Time Time


Changing environment

IFRS/IORP/Solvency 2

GovernanceEarly retirement

TrustAging Communication

PwC

Pension fund

RegulatorSocial security

Market riskEquity, interest rate

TransparencyLife-coursesaving plan

Financialsolid(ar)ity

Risk awareness


Risk Management Pension Fund

PENSION FUND

PwC

ASSETS LIABILITIES

Surplus



PENSION FUND

consultancy / ALM / risk management / governance

PwC

ASSETS LIABILITIES

Surplus

Investment Administration



0

10.0

00

20.0

00

30.0

00

40.0

00

50.0

00

60.0

00

70.0

00

80.0

00

90.0

00

2007

2008

2009

2010

2011

Fund

popula

tion

/accru

als

PwC

2013

2015

2017

2019

2021

2023

2025

2027

2029

2031

2033

2035

2037

Fund

popula

tion

/accru

als

surplusSlide 8

februar 2013Asset & Liabilities Management from an industrial point of view


0

10.0

00

20.0

00

30.0

00

40.0

00

50.0

00

60.0

00

70.0

00

80.0

00

90.0

00

2007

2008

2009

2010

2011

Fund

popula

tion

/accru

als

Investment risk

Risk management

Interest risk

PwC

2013

2015

2017

2019

2021

2023

2025

2027

2029

2031

2033

2035

2037

Fund

popula

tion

/accru

als

surplus

Balance Sheet risk

Longevity risk

Solvency risk


Assets & Liabilities Management

• Toolbox to support decision tre/ processes

• Instruments ALM

• Investment policies

• Premium payments

PwC

• Pension plan amendments

• Given liabilities -> optimal solution

• Liabilities are dependent on

• Member stock

• Pension plan

• Actuarial/ demographic principals (like mortality)


Risk Management - developments

• Greater focus on ERM (enterprise wide risk management)

• IORP/ Solvency 2

• Strategic, operational, compliance, reporting

• ALM

PwC

• Assets

• Asset classes

• Alpha and beta

• Liquidity, volatility

• Liabilities

• ’Pensjonsreformen’


Risk management = core

• Risk management is central in decision -tre in the board room

• Quantitative analyses

• External managers

• Asset classes

PwC

• Regulator focuses on

• Management financial risk/ solvency risk

• communication to pension fund members

• Operational and compliance risk

• Risk management aims to decide on a policy for the economic risks apension fund is exposed to.


Risk management- principals

• Management through guidelines and restrictions

• Control framework should have

• Ensure for all risks sources: identification,understanding and quantification

PwC

understanding and quantification

• Ensure that each assumption on risk is in line withinvestment goals

• Ensure that each risk is within the limits set by theboard

• Ensure that each risk is sufficient compensated

februar 2013Asset & Liabilities Management from an industrial point of viewSlide 13

Complexity in decision tree

• Regarding any decision, the board has to take into account

• Solvency ratio (assets/liabilities)

• Risk appetite

• Requests/demands different stakeholders

PwC

• Regulatory restrictions (Finanstilsynet, Solvency 2, IORP 2)

• Macro economical aspects / financial markets

• …

• Subjective assessment of the board


Asset management

….taking risk to achieve excess of return..

• Strategic asset allocation (90%)

• Tactic asset allocation (6%)

• Operational asset allocation (4%)

PwC

• Operational risk

• Selection/ timing

• External managers/ internal managers

• Monitoring


Asset classes - return

Large cap equities passive

Large cap equities enhanced

Large cap equities activeSmall cap equities passive

Active high yield bonds

commodities

Capitial Asset Pricing Model (CAPM):

R(asset)- R(risk free) = (asset)+ (asset) *[E(R(market)-R(risk free)] +Ɛ

PwC

Exotic

Equity long-short

Market neutral strategies

Private equity

Infrastructure

Active high yield bonds


Asset classes - risk

Equity developed

46%

Credits>1%

Interest rates and exchange risk 0%

PwC

Exotic

Equity EM5%

Private Equity9%

Hedge Funds9%

Real Estate29%

Commodities2%


Factor Model

Idiosyncratic return :weighted sum of individual

K

ititixtxtxtx rr

1,,,,,, )(

N

w )(

PwC

weighted sum of individualcontributions

Exposure to factors :weighted sum ofindividual exposures

j

tjtjtjtxtx w1

,,,,, )(

N

jtijtjtix w

1,,,,,


Factor Decomposition of Risk

What is the exposure of the risk factors?

xxFxsum BB '

PwCfebruar 2013Asset & Liabilities Management from an industrial point of view

Slide 19

What is the exposure of the risk factors?

What is the volatility of the risk factors?

What is the correlation of the risk factors?

What is investment risk?

• Different opnions

• Loss

• Volatility

• ..

PwC

• Time horizon

• Day, year, 30 year

• Different measure units

• Standard deviation

• Value at Risk (VaR)

• ..


Investment risk

• Risk described as probability distributions based on historicalinformation

• Risk is the potential for loss accepted by the investor in order to earna return.

• Three elements:

PwC

• Three elements:

- The range of possible losses

- The likelihood of a loss

- The impact of the loss on the organization.


Investment risk:...probability distribution

1.5%

2.0%

2.5%surface: 100%


Slide 22

0.0%

0.5%

1.0%

1.5%

-33%

-23%

-13%

-3%

7%

17%

27%

37%

47%

50% probability withreturn 7%

...standard deviation

1.5%

2.0%

2.5%


Slide 23

0.0%

0.5%

1.0%

1.5%

-33%

-23%

-13%

-3%

7%

17%

27%

37%

47%

±1SD = 68%

±2SD = 95%

…or Value at Risk

1.5%

2.0%

2.5%

VaR 2,5% = -13%


Slide 24

0.0%

0.5%

1.0%

1.5%

-33%

-23%

-13%

-3%

7%

17%

27%

37%

47%

Interest rate risk Equity risk Alternative risk

Market risk

Exchange riskSpread risk

tap tap tap tap tap

Value-at-Risk

PwC

÷÷÷÷÷

1

1

1

21

221

112

L

MOMM

L

L

NN

N

N

rr

rr

rr- Gaussian/normal

- Student-t

- Bootstrapping

- Parametric

- Monte Carlo

- Historical Simulation - Solvens ratio

- Surplus

Value-at-Risk Methode

correlation

Value-at-Risk

Dependence Structure

Risk variablesSolvency ratio

Pro

ba

bil

ity

Value-at-Risk


..reality...

1.5%

2.0%

2.5%Fat tails

skew


Slide 26

0.0%

0.5%

1.0%

1.5%

-33%

-23%

-13%

-3%

7%

17%

27%

37%

47%

reality

Diversification

30%

40%

average = 5,2%SD = 14,4%

For different time horizons

Correlation 30%


Slide 27

-20%

-10%

0%

10%

20%

1 2 3 4 5 6 7 8 9 10

Asset A

Asset B

average 3,8%SD = 7,8%

Diversification

average = 5,2%SD = 14,4%

Correlation 30%

average = 4,5%SD = 9,2%Diversification = 1,9%


Slide 28

average = 3,8%SD = 7,8%

Investment theory

CAPM as standard model

• Assumption perfect market

• Only return for non- diversifiable (systematic)risk


Slide 29

Exp

ect

ed

retu

rn

Risk increases, but lessthen proportional

Return increasesproportional

Investment theory


Slide 30

Exp

ect

ed

retu

rn

Efficient FrontierMaximal (expected) return per

unit risk

Combining different assetclasses the ‘efficient frontier’

moves up

Investment theory


Slide 31

Forv

ente

tavk

ast

nin

g Capital Market LineWith risk-free investment/

leverage the efficiencyincreases even more

Marketsportfolio

Risk-freeinvestment

Investment policy

• Strategic asset allocation

• Hedging risk

• Assessment new asset classes

• Diversification

PwC

• …

• Risk and return (reward) of the investments are assessed in light ofpension liabilities

• Status: Solvency ratio

• Movements : premium and pension payments


Complexity investment decisions

• An investment policy is ’good’ when

• Risk is lower or unchanged, and

• Return is higher or unchanged,

For all variables

PwC

• But what if

• Risk and return are both lower, or

• Risk and return are both higher, or

• Risk and return has not improved for all variables

• In these cases the board has to decide based on subjectivity


Investments philosophy

• Assets allocation or risk management

• Passive/ active risk

• Exchange risk/ interest rate risk

• Choice of asset classes/ - instruments

• Traditional investments

PwC

• Traditional investments

• Alternative investments

• Geography

• Alternatives

• Active or passive asset management

• Optimal portfolio allocation

• Outcome ALM analyses

• Strategic decisions and consequences on return on investments


Risk / return

• No reward (return) without taking risk

• Definition risk

• Fluctuations on market value investments

PwC

• Fluctuations on market value liabilities

• Investment policy in light off liabilities


Risk budgeting

3 levels for risk budgeting :

Strategic risk budgeting (solvency ratio- risk)

Tactical risk budgeting

Active risk budgeting

PwC

Tool box:

avoid , reduce, transfer, and accept

Measure instruments:

Internal risk model with flexible time horizon (ALM)

Stress testing: historical, regulatory, mismatch, ...


ALM Top Down Approach

Asset-Only Analysis

• Establish and monitorbenchmark risk budgets ofmanagers for each fund andeach security

ASSETS / LIABILITIESASSETS / LIABILITIES

DEKKINGSGRAAD

Ka

ns

dic

hth

eid

FUNDED RATIO

SA

NN

SY

NL

IGH

ET

Risk budgeting

PwC

Bottom Up Integral Approach• Establish and monitor risk

budgets taking into account allidentified marked risks on alllevels

ALM Top Down Approach

• Establish and monitorbenchmark risk budgets

TITLERTITLER

FONDFOND

ASSET KATEGORIASSET KATEGORI

MANAGERSMANAGERS

STATEGISK / TAKTISKSTATEGISK / TAKTISK

ASSETS / LIABILITIESASSETS / LIABILITIES

INCOME / GROWTHINCOME / GROWTH


Interest rate risk term structure- Top downDiscount rate = 3,3%

Pensjonsmidler Forpliktelser

Equities 42 Pension Liabilities 100Property 35 Surplus 40

Fixed Income 63140 140

Discount rate = 2,6%

Pensjonsmidler Forpliktelser

Equities 42 Pension Liabilities 111

Property 35 Surplus 32

Fixed Income 66


Slide 38

Fixed Income 66143 143

-15 %

-10 %

-5 %

0 %

5 %

10 %

15 %

20 %

-1,10%

-1,00%

-0,90%

-0,80%

-0,70%

-0,60%

-0,50%

-0,40%

-0,30%

-0,20%

-0,10%

0,00%

0,10%

0,20%

0,30%

0,40%

0,50%

0,60%

0,70%

0,80%

0,90%

1,00%

1,10%

Interest rate change

Change in Solvens Ratio

Interest rate risk term structure

2,50 %

3,00 %

3,50 %

spot (zero)

forward

Interest Rate Term Structure and Forward curve


Slide 39

0,00 %

0,50 %

1,00 %

1,50 %

2,00 %

0 10 20 30 40 50 60

Liabilities pension fund - cash flows

200,00

250,00

300,00


Slide 40

-

50,00

100,00

150,00

1 6 11 16 21 26 31 36 41 46 51 56 61 66 71 76 81 86 91 96

Interest rate risk term structure- parallel shift

2,50 %

3,00 %

3,50 %

4,00 %Interest rate term structure: current and parallel shift

PwC

0,00 %

0,50 %

1,00 %

1,50 %

2,00 %

2,50 %

0 10 20 30 40 50 60

spot (zero)

S_up

S_down


Liabilities pension fund – net cash flows

40 000

60 000

80 000 S1+

S1-

PwC

-60 000

-40 000

-20 000

-

20 000

1 4 7 10 13 16 19 22 25 28 31 34 37 40 43 46 49 52 55 58 61 64 67 70 73 76 79


Interest rate risk term structure-Historical changes

4

5

6

7

PwC

0

1

2

3

1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41 43 45 47 49

22/04/09 level+ level- twist+ twist- curvature+ curvature-Curve

Confidence level: 97.5% ; Time horizon: 1 year

Zero coupon curve; PC1: Level; PC2: Twist ; PC3: Curvature


0.4

0.5

0.6

0.7

0.8

0.9

1

Discount Factor Decomposition-Principal Components

PwC

Discount Curves; PC1: Level; PC2: Twist ; PC3: Butterfly

Confidence level: 97.5% ; Time horizon: 1 year

0

0.1

0.2

0.3

1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41 43 45 47 49

22/04/09 level+ level- twist+ twist- curvature+ curvature-

44

Liabilities - cash flowsPrincipal Component- Level

40 000

60 000

80 000

100 000PC1+

PC1-

PwC

-80 000

-60 000

-40 000

-20 000

-

20 000

1 4 7 10 13 16 19 22 25 28 31 34 37 40 43 46 49 52 55 58 61 64 67 70 73 76 79


Liabilities - cash flowsPrincipal Component- Twist

10 000

20 000

30 000

40 000 PC2+

PC2-

PwC

-40 000

-30 000

-20 000

-10 000

-

10 000

1 4 7 10 13 16 19 22 25 28 31 34 37 40 43 46 49 52 55 58 61 64 67 70 73 76 79


Liabilities - cash flowsPrincipal Component- Curvature

4 000

6 000

8 000

10 000 PC3+

PC3-

PwC

-8 000

-6 000

-4 000

-2 000

-

2 000

1 4 7 10 13 16 19 22 25 28 31 34 37 40 43 46 49 52 55 58 61 64 67 70 73 76 79


0

500

1000

1500

2000

2.5

12.5

22.5

32.5

42.5

52.5

62.5

72.5

82.5

92.5

Ca

sh

Flo

ws

(mln

.e

uro

)Liabilities

Fixed Income

Nett

Cash Flows (example)

PwC

Annual cash flows of net pension liabilities

1500

1000

500 2.5

12.5

22.5

32.5

42.5

52.5

62.5

72.5

82.5

92.5

Maturity (5-year buckets)

Ca

sh

Flo

ws

(mln

.e

uro

)

48

Thank you for your attention

Urmila KisoenActuary CEFA

Senior [email protected] 64 279

© 2013 PwC. Med enerett. I denne sammenheng refererer "PwC" seg til PricewaterhouseCoopers AS, AdvokatfirmaetPricewaterhouseCoopers AS, PricewaterhouseCoopers Accounting AS og PricewaterhouseCoopers Skatterådgivere ASsom alle er separate juridiske enheter og uavhengige medlemsfirmaer i PricewaterhouseCoopers International Limited.

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asset & liabilities management- uio · pension reserve for a person 600,000 700,000 800,000...

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