liability side risk management modelling for future dc funds
DESCRIPTION
A look at the asset allocation decision of DC Pension FundsTRANSCRIPT
V908
Liability-side risk management -modelling future DC fund liabilities
MATTHEW BURGESS, DIRECTOR, ACTUARIAL AND BENEFITS CONSULTINGRUSSELL INVESTMENTSTONY MILLER, SENIOR CONSULTANTRUSSELL INVESTMENTS
1
Agenda
1. Changed environment
2. Russell total fund evaluator
3. The model and the variables
4. Practical applications
2
Changed environment
Increased focus on liquidity management:GFC raised concerns with illiquid investmentsCooper recommends liquidity projections taking into account cash flowsAPRA : only 6% of funds stress test liquidity
Increased focus on governance:Cooper recommends increased governance requirements MySuper will result in fund re-structuringPotential for more fund mergers
Funds will benefit from better liquidity and governance modelling
3
Benefit payments and rollovers from fund
Environment originally
Cash
members accounts
Default option
Transfers
Employer contributions
Member contributions
Rollovers
Fixed interest
Property Aust equity O/seas equity
Simple asset structures
Contribution tax
Insurance premiums
Fees and costs
Net investment
returns
4
Liquidity management
Pensioners
Illiquid investments
Active membersSpouse
Employer subgroupsIncreased governance – Cooper?
Complex investments
Increased regulator activity
Increased switching
My Super?
Retained MembersReserves management More investment options
More complex fees
How things have changed
5
Benefit payments and rollovers from fund
Environment now
Spouse and other members
Allocated pensioners
Cash
Active members Group A
Cash
Currency
Pension Payments
Active members Group B
Conservative
Retained and
inactive members
Balanced
Transfers
Liquids Illiquids
Employer contributions
Member contributions
Rollovers
Other contributions
Growth High growth
Fixed interest
Defensive alts
Direct prop
Listed prop
Private equity
Aust equity O/seas equity Growth alts
Member switches
Asset rebalancing
Liquidity management
Management currency impact
Fees and costs
Net investment
returnsContribution tax
Insurance costsInsurance
premiumsFees and costs
Net investment
returns
2.Russell total fund evaluator
7
Russell total fund evaluator
Applies complex defined benefit actuarial techniques to build a “whole of fund” model for DC funds
New tool – providing enhanced insights
Allows for the actual economic and demographic drivers of the fund – realistic base assumptions
Platform for “time weighted” scenario building
8
-400
-200
0
200
400
600
800
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
Russell TFE
"Simple" Approach
A revised approach – exampleCash flow projections$ millions
Basic modelling of liabilities to-date reflected original simplicity of funds and weight of cash flow
9
Exit rates
Mortality by age
Disablement by age
Pension payment rates
Contributions
Retention rates
Currency treatment
The assumptions
Investment returns
Inflation
Asset allocation strategy
Expense deductions
Insurance deductions
Switching by age
Transfers / rollovers
10
Comprehensive information
Cash flow projections (by components)ContributionsBenefitsDeductions and costsSwitches
11
Cash flow projections
-500,000,000
-400,000,000
-300,000,000
-200,000,000
-100,000,000
0
100,000,000
200,000,000
300,000,000
400,000,000
500,000,000
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21
Pensions
Benefit Payments
Net Contributions
Summary cash flows – sample fund
12
Comprehensive information
Cash flow projections (by components)ContributionsBenefitsDeductions and costsSwitches
Projected membership (by class)Active, retained, pensioners, other
13
0
2,000
4,000
6,000
8,000
10,000
12,000
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19
Pensioners – sample mature fundMembership projectionsNumber of pensioners
14
Comprehensive information
Cash flow projections (by components)ContributionsBenefitsDeductions and costsSwitches
Projected membership (by class)Active, retained, pensioners, other
Projected assets (segmented)Member Investment optionAsset classes or subclassesLiquid/illiquid
15
Total assets by option
0
1,000
2,000
3,000
4,000
5,000
6,000
7,000
8,000
9,000
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
Cash
Stable
Low Growth
Balanced
Growth
Projected asset values
16
Member options after 5 yearsProjected asset allocations (by age group)
Projected Asset Allocations (by Age Group)
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
15-20 20-25 25-30 30-35 35-40 40-45 45-50 50-55 55-60 60-65 65-70 70-75 75-80 80+
Cash
Stable
Low Grow th
Balance
Grow th
3.The fund and the variables
18
Collect the member data
Age | Category | Account balances across options
The model in action
19
The model in action
Roll forward 1 year: Membership and assets
Year 1
Investment earningsNew contributionsFee deductionsInsurance costsExits (death, tpd, retirement, resignation)RetentionSwitchingNew member
++–––+o+
20
Continue over time: Tracking membership and assets
++–––+o+
++–––+o+
++–––+o+
++–––+o+
++–––+o+
++–––+o+
++–––+o+
++–––+o+
++–––+o+
++–––+o+
++–––+o+
++–––+o+
++–––+o+
++–––+o+
++–––+o+
++–––+o+
++–––+o+
++–––+o+
++–––+o+
++–––+o+
The model in action
Year 5 Year 10 Year 15 Year 20
21
Year 5
++–––+o+
Year 10 Year 15 Year 20
++–––+o+
++–––+o+
++–––+o+
++–––+o+
++–––+o+
++–––+o+
++–––+o+
++–––+o+
++–––+o+
++–––+o+
++–––+o+
++–––+o+
++–––+o+
++–––+o+
++–––+o+
++–––+o+
++–––+o+
++–––+o+
++–––+o+
The model in action
Collate over time: Aggregate and analyse results by year, age, category, option and asset class
4.Practical applications
23
Multiple applications of the Russell total fund evaluator
A – Stress testing
B –Satisfy regulator - APRA
C – Cash flow prediction
D – Strategic decision making
E – Budgeting change
F – Building a MySuper product
G – Benefit of a fund merger
H – Managing operating risk reserve
24
0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
30.0%
35.0%
40.0%
45.0%
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
Year
Illiquidity RatioTargetUpper Range
Illiquidity ratio (default option)
Apply illiquid investment strategy
25
Stress test current strategy utilising scenarios
Investment market shocks
Currency settlements
Member switching
Loss of membership
Other
OK or modify?
26
Scenario: Year 6 – 25% fall in listed assets, member switches to cash, currency depreciation
0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
30.0%
35.0%
40.0%
45.0%
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
Year
Illiquidity RatioTargetUpper Range
Illiquidity ratio (default option)
27
-1,200
-1,000
-800
-600
-400
-200
0
200
400
600
800
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
LiquidsIlliquids
Scenario – cash flow impact: Year 6 – 25% fall in listed assets, member switches to cash, currency depreciation
Total cash flows available for reinvestment
28
0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
30.0%
35.0%
40.0%
45.0%
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
Year
Illiquidity RatioTargetUpper Range
Scenario test: Reduced illiquid investment programIlliquidity ratio (default option)
29
Multiple applications of the Russell total fund evaluator
A – Stress testing
B –Satisfy regulator - APRA
C – Cash flow prediction
D – Strategic decision making
E – Budgeting change
F – Building a MySuper product
G – Benefit of a fund merger
H – Managing operating risk reserve
30
Multiple applications of the Russell total fund evaluator
A – Stress testing
B –Satisfy regulator - APRA
C – Cash flow prediction
D – Strategic decision making
E – Budgeting change
F – Building a MySuper product
G – Benefit of a fund merger
H – Managing operating risk reserve
31
Evaluator output – sample only
-400
-300
-200
-100
0
100
200
300
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20Average
Mature
Comparison of projected cash flows – mature fund vs average fundBase, $ millions
32
Multiple applications of the Russell total fund evaluator
A – Stress testing
B –Satisfy regulator - APRA
C – Cash flow prediction
D – Strategic decision making
E – Budgeting change
F – Building a MySuper product
G – Benefit of a fund merger
H – Managing operating risk reserve
33
Strategic planning - mature fund
-200
-150
-100
-50
0
50
100
150
200
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
Base
90% Retention
60% Retention
25% Extra Contributions (above 45)
Projected cash flows – base vs increased retention vs lower retention vsincreased volume contributions$ millions
34
0
2,000
4,000
6,000
8,000
10,000
12,000
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
SG 9%
SG 12%
Fund statisticsProjected asset values – SG from 9.0% to 12.0% for average fund$ millions
35
-50
0
50
100
150
200
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
SG 9%SG 12%
Projected cash flows – SG from 9.0% to 12.0% for average fund$ millions
Fund statistics – net cash flow impact
36
Multiple applications of the Russell total fund evaluator
A – Stress testing
B –Satisfy regulator - APRA
C – Cash flow prediction
D – Strategic decision making
E – Budgeting change
F – Building a MySuper product
G – Benefit of a fund merger
H – Managing operating risk reserve
37
Evaluator testing – fee deductions
0
2
4
6
8
10
12
0 1 2 3 4 5 6 7 8 9Year
Base
Higher Retention
10% More Contributions
Comparison of cost deductions – Base vs increased retention vs increased volume contributions$ millions
38
Multiple applications of the Russell total fund evaluator
A – Stress testing
B –Satisfy regulator - APRA
C – Cash flow prediction
D – Strategic decision making
E – Budgeting change
F – Building a MySuper product
G – Benefit of a fund merger
H – Managing operating risk reserve
39
Multiple applications of the Russell total fund evaluator
A – Stress testing
B –Satisfy regulator - APRA
C – Cash flow prediction
D – Strategic decision making
E – Budgeting change
F – Building a MySuper product
G – Benefit of a fund merger
H – Managing operating risk reserve
40
Multiple applications of the Russell total fund evaluator
A – Stress testing
B –Satisfy regulator - APRA
C – Cash flow prediction
D – Strategic decision making
E – Budgeting change
F – Building a MySuper product
G – Benefit of a fund merger
H – Managing operating risk reserve
41
DC liability modelling
New interactive models
Enhanced insights from realistic analysis
Tailored to fund circumstances
Apply annually with updated data
Part of good governance processes
42
43
Russell Investments
Issued by Russell Investment Management Ltd ABN 53 068 338 974, AFS Licence 247185 (RIM).
This document provides general information only and was not prepared having regard to your objectives, financial situation or needs. Before making an investment decision, you need to consider whether this information is appropriate to your objectives, financial situation or needs. This information has been compiled from sources considered to be reliable, but is not guaranteed.
Copyright © 2010 Russell Investments. All rights reserved. This material isproprietary and may not be reproduced, transferred, or distributed in any form without prior written permission from Russell Investments.