PRMIA Meeting 16 July 2003

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PRMIA Meeting16 July 2003
abcd
Liability Benchmark PortfolioThe relationship
between Pension assets and liabilitiesInstitute/F
aculty Working Party
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Terms of reference

• To address and make recommendations to the
  Myners/Sandler Steering Group on the contents of
  a briefing document for trustees and sponsors on
  the relationship between pension fund assets and
  liabilities.

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Assets and Liabilities

• Assets
• majority traded therefore market prices
• Liabilities
• untraded
• benefit payments in the future
• these are a series of cashflows

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What liabilities to consider

• Pension entitlement for a member is based on
• service to date
• current salary
• including statutory revaluation, and increases
• exclude discretionary payments
• Present value of the accrued liabilities are a
  measure of their fair value
• Liabilities are not traded so we need a proxy
• the Liability Benchmark Portfolio (LBP)

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The liabilities
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What is the LBP?

• Liability benchmark portfolio is
• the portfolio of assets such that, in the absence
  of future contributions, benefit accrual or
  random fluctuations around demographic
  assumptions, the scheme maintains its current
  solvency level (the ratio of assets to
  liabilities) as economic conditions change.

As at 1 January 2003 PV 175m
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Relationship between assets and liabilities?

• Is given by the relationship between the schemes
  assets and the LBP (a liaby proxy).
• Consider a scheme which holds assets

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LBP v asset returns
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LBP v asset returns
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LBP v asset returns
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LBP v asset returns
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LBP v asset returns
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Technical details

• Pension liabilities are too long
• duration is important
• Liabilities link to inflation (cap of 5 and
  floor of 0)
• these are embedded options
• influences the proportion of FI and IL in the LBP
• Yield curves are not flat

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Yield curves at 1 January 2002
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Yield curves at 1 January 2003
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Limitations of the LBP

• needs to be dynamic changes with economic
  conditions
• Does not capture demographic changes
• No allowance for the benefit outgoes and
  contributions paid

• Regular re-estimation mitigates these risks

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Mis-interpretations

• Pensions are identical to corporate debt
• not (usually) traded,
• demographics,
• term of the liabilities,
• issuance, and redemption,
• Pensions are 100 guaranteed - No
• Funding
• works for any solvency level
• Investment strategy
• Trustees decision
• Time horizons

Pensions are still debt-like
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11th June White Paper

• Debt on the employer is the full buy-out cost
• Clarifies the nature of the pension promise
• Pension Protection fund
• Cost estimated at 340-375m
• Premiums based in flat levy and risk-based
  premium

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Conclusions

• A practical way of understanding the relation
  between pension scheme assets and liabilities
• transparent
• standard financial techniques
• some actuaries already use similar approaches
• educational tool for better informed decision
  making
• consistent with Myners

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PRMIA Meeting16 July 2003
abcd
Liability Benchmark PortfolioThe relationship
between Pension assets and liabilitiesInstitute/F
aculty Working Party