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Actuarial Control Cycle Specify objectives Environment Professionalism Monitor Develop a Experience Solution 1  Actuarial Control Cycle Provid...

Actuarial Control Cycle Specify objectives Environment Professionalism Monitor Develop a Experience Solution 1  Actuarial Control Cycle Provides a methodology Not rocket science! ✓ Identify the problem ✓ Decide how best to resolve the problem ✓ Check how successful we have been ✓ Learn how to better solve next time! ▪ An iterative process, i.e. a cycle 3  Pension Provision Benefits are typically provided by: The State Employers/groups of employers Individuals/groups of individuals + post-retirement income?  Pension Provision Benefits are typically provided by: The State ▪ Benefit provision to some/all? ▪ Education ▪ Regulation  Encourage/compel the population  Bodies providing benefits/with custody of funds ✓ Marketing rules ✓ Benefit/contribution limits ✓ Reporting requirements ✓ Investment restrictions ✓ Security of benefits ✓ Beneficiary rights  Pension Provision Benefits are typically provided by: The State What are the advantages of state led compulsory private sector pension arrangements?  Pension Provision Benefits are typically provided by: The State What are the advantages of state led compulsory private sector pension arrangements? Ensure/assist in adequate pension provision Remove/reduce state burden to provide pension provision Result in larger schemes with economies of scale (investment & administration) Avoiding the need for financial incentives (reduced cost)  Pension Provision How should the state fund pension benefits? Build up funds in advance to meet future pension payments OR Meet current pension payments directly from current workforce contributions (PAYG) Rationale: ▪ Many members provides stability to membership profile ▪ Easy to raise additional finance when necessary BUT! ▪ Unfunded arrangements have led to unforeseen expenditure  Question What measures could the UK government put in place to make the state pension more affordable in the future?  Question What measures could the UK government put in place to make the state pension more affordable in the future? Increase the minimum qualifying years: Require more National Insurance contribution years for individuals to qualify for the full state pension. Increase the state pension age: Gradually raise the pension age in line with life expectancy to reduce the duration of payments. Link pension increases to inflation: Adjust state pension increases to inflation rates, rather than earnings, to control annual growth. Means-testing pensions: Limit state pension payments to those with lower incomes, reducing the burden on public funds. Raise National Insurance contributions: Increase National Insurance rates to boost the funds available for future pensions.  Question What measures could the UK government put in place to make the state pension more affordable in the future? Encourage private pensions: Provide incentives for individuals to contribute more to private or workplace pensions, reducing reliance on the state pension. Adjust pension entitlements: Reduce or cap the maximum state pension entitlement for higher earners. Reduce the triple lock: Replace or reform the triple lock mechanism (currently linking pension rises to the highest of inflation, wage growth, or 2.5%) to lower long-term costs. Encourage later retirement: Offer tax or pension incentives for people who choose to work beyond the state pension age. Reform public sector pensions: Align public sector pension schemes more closely with private sector models, potentially reducing state pension costs. Further Reading: IFS Pensions Review: The future of the state pension: https://ifs.org.uk/publications/future-state-pension  Pension Provision Benefits are typically provided by: The State Employers/groups of employers Individuals/groups of individuals + post-retirement income?  Pension Provision Why might an employer operate/sponsor a pension scheme for employees?  Pension Provision Why might an employer operate/sponsor a pension scheme for employees? Recruiting Staff Motivating Staff (e.g. loyal) Retaining Staff Also... Paternalistic reasons Competitors Financial incentives (e.g. from the state)  Pension Provision Why might an employer operate/sponsor a pension scheme for employees? Recruiting Staff Motivating Staff Retaining Staff Especially now! Pension Provision Pension Provision Pension Provision 19  Interested Parties 1. The individual How does a pension scheme create value for the individual? “Providing customers with quality services at a good price” “Providing pension plan stakeholders a pension income at a satisfactory level and at a reasonable cost”  Interested Parties 1. The individual Both form and level of benefits will differ The pension provision may be partial or full Need to consider other assets, income and financial liabilities (commitments)  Interested Parties 1. The individual Both form and level of benefits will differ The pension provision may be partial or full Need to consider other assets, income and financial liabilities (commitments) How much benefit is needed? Savings? Expected future outgo? Personal circumstances? Other provisions? Retirement age?  Interested Parties 1. The individual Need can be assessed via: Net Replacement Ratio (NRR) NRR = After tax income in the year after retirement After tax income in the year before retirement  Interested Parties 1. The individual But NRR is a very crude and potentially misleading measure. Why?  Interested Parties 1. The individual But NRR is a very crude and potentially misleading measure. Why? Excludes non-income producing investments that may mature at a later date The income after retirement may be short term (e.g. TF lump sum) Ignores changes in the pension (does it increase with inflation?) Ignores changes in expenditure  Interested Parties 1. The individual But NRR is a very crude and potentially misleading measure. Why? Ignores changes in expenditure Is a 100% NRR really necessary or desirable? Consider:  Loans  Savings no longer needed  Day to day costs ▪ Travel to work ▪ Free travel?  But, possibly more leisure/healthcare money required  Interested Parties 1. The individual Generally most people need a NRR < 100% but low income employees may need closer to 100%  Interested Parties 1. The individual 2. The Sponsor Clearly need to control costs Stable Predictable Value for money Flexible But also the timings of the costs may be very important Non-financial matters  Interested Parties 1. The individual 2. The Sponsor Non-financial matters (if sponsor is an employer): Attract and retain the right staff Other business needs. E.g. Simple administration Tax efficiency  Interested Parties 1. The individual 2. The Sponsor 3. Pension Scheme Trustees  Interested Parties 3. Pension Scheme Trustees Act separately from the employer, holding the assets invested in the scheme for the benefit of the participants Should have knowledge and understanding of legislation relating to pension schemes as well as the principles relating to the funding of pension schemes and the investment of scheme assets Should be familiar with certain scheme documents such as the Trust Deed and Rules, the Statement of Investment Principles and the Statement of Funding Principles Responsible for the proper running of the scheme – from the collection of contributions, to the investment of assets and payment of benefits  Interested Parties 3. Pension Scheme Trustees Different types of trustees Individual trustee Corporate trustee Member-nominated trustees (MNTs) Employer-nominated trustees (ENTs) or employer-nominated directors (ENDs) Independent trustees  Interested Parties 3. Pension Scheme Trustees Typical trustee duties Act in line with the trust deed and rules Act prudently, responsibly and honestly Act in the best interests of your beneficiaries Act impartially  Interested Parties 3. Pension Scheme Trustees Typical trustee powers Accept contributions into the scheme Decide upon the investment strategy Invest the scheme's assets Amend the rules of the scheme Admit members on special terms Increase (or 'augment') members' benefits Deal with a funding surplus (defined benefit only) Wind up a scheme  Interested Parties 3. Pension Scheme Trustees Typical trustee responsibilities Contributions Financial records and requirements Investment Your professional advisers Pension scheme records Members Reporting certain matters to the regulator  Interested Parties 3. Pension Scheme Trustees Trustees will often employ the services of: I. Pension Providers & Administrators ▪ Manage the day-to-day scheme administration Manage new/leaving members Capture and manage other scheme data Keep accurate and complete records Member communication services Annual statements Other misc. member documentation ▪ Agreement in place Services provided The standard of service Action to be taken if standard falls short  Interested Parties 3. Pension Scheme Trustees Trustees will often employ the services of: I. Pension Providers & Administrators II. Investment consultants ▪ Help with investment decisions ▪ Monitoring of the portfolio, managers and cash flow Should be able to understand and clearly explain the investment options they offer to the scheme  Interested Parties 3. Pension Scheme Trustees Trustees will often employ the services of: I. Pension Providers & Administrators II. Investment consultants III. Fund Managers ▪ Manages the scheme investments ▪ Trustees should satisfy themselves that: The fund manager has sufficient knowledge and experience The investment activities are being carried out competently and within regulations  Interested Parties 3. Pension Scheme Trustees Trustees will often employ the services of: I. Pension Providers & Administrators II. Investment consultants III. Fund Managers IV. Actuaries? ▪ If running a ‘Defined Benefit’ Scheme Will advise on scheme funding Conduct actuarial valuations Provide advice on matters such as: ✓ Transfer values ✓ Drawing up the Statement of Funding Principles ✓ Valuation assumptions  Interested Parties 3. Pension Scheme Trustees Trustees will often employ the services of: I. Pension Providers & Administrators II. Investment consultants III. Fund Managers IV. Actuaries? V. Others ▪ Accountants ▪ Lawyers ▪ Financial Advisors  Interested Parties 3. Pension Scheme Trustees Governance  Persuasive Writing Exercise You are a scheme actuary and, given your knowledge of pensions, you have been asked to help draft a short persuasive memo to your company’s HR department advocating for the implementation of a new employer-sponsored pension scheme. Draft the main paragraph for the memo, which should address the benefits to the employer, such as recruiting, motivating, and retaining staff. It should be a maximum of 150 words. Consider: What persuasive techniques did you use to make your case compelling? How did you balance the technical details with persuasive language?  Persuasive Writing Exercise: Sample Answer To HR, We should have a pension scheme because it would be good for our staff. It’s something a lot of other companies do, and employees would probably stay longer if we offer it. Also, it might not cost us much, so it’s worth thinking about. This could also help when we need to hire more people.  Persuasive Writing Exercise: Sample Answer To HR, We should have a pension scheme because it would be good for our staff. It’s something a lot of other companies do, and employees would probably stay longer if we offer it. Also, it might not cost us much, so it’s worth thinking about. This could also help when we need to hire more people. Question: What do you think are the main weaknesses of this answer?  Persuasive Writing Exercise: Sample Answer To HR, We should have a pension scheme because it would be good for our staff. It’s something a lot of other companies do, and employees would probably stay longer if we offer it. Also, it might not cost us much, so it’s worth thinking about. This could also help when we need to hire more people. Question: What do you think are the main weaknesses of this answer? ✓ Vagueness: The arguments are weak and unconvincing, lacking depth or evidence. ✓ Lack of Structure: There’s no clear progression or reasoning leading to a strong conclusion. ✓ Unprofessional Tone: The language is overly casual for a formal business memo. ✓ Lack of Specificity: No concrete benefits or facts are provided to support the recommendation. ✓ Minimal Effort: The memo appears hastily written, with minimal attention to detail or persuasion. Persuasive Writing Exercise: Sample (better!) Answer Dear HR Department, Introducing an employer-sponsored pension scheme is a strategic move that will greatly benefit both our employees and the company. In today’s competitive job market, talented professionals prioritise long-term financial security, and a robust pension plan is one of the top benefits they consider when choosing an employer. By offering a pension scheme, we will not only attract high-calibre candidates but also retain our current staff, fostering loyalty and reducing turnover. Moreover, pension contributions are tax-efficient, providing the company with potential financial incentives while improving our reputation as an employer of choice. With economies of scale, administrative costs are minimised, and we can offer this benefit with little strain on our resources. Implementing this scheme will demonstrate our commitment to the well-being of our employees, positioning us as a forward-thinking and competitive employer in our industry. Question: What do you think the main strengths of this answer are?  Persuasive Writing Exercise: Sample Answer Dear HR Department, Introducing an employer-sponsored pension scheme is a strategic move that will greatly benefit both our employees and the company. In today’s competitive job market, talented professionals prioritise long-term financial security, and a robust pension plan is one of the top benefits they consider when choosing an employer. By offering a pension scheme, we will not only attract high-calibre candidates but also retain our current staff, fostering loyalty and reducing turnover. Moreover, pension contributions are tax-efficient, providing the company with potential financial incentives while improving our reputation as an employer of choice. With economies of scale, administrative costs are minimised, and we can offer this benefit with little strain on our resources. Implementing this scheme will demonstrate our commitment to the well-being of our employees, positioning us as a forward-thinking and competitive employer in our industry. Question: What do you think the main strengths of this answer are? ✓ Persuasive Tone: The memo uses compelling language that clearly outlines the mutual benefits for both the employer and employees. ✓ Clear Benefits: It highlights specific advantages such as attracting talent, retaining staff, and tax efficiency. ✓ Professional Language: The tone is formal and appropriate for communication with an HR department. ✓ Structure: It is well-organised, moving from attracting talent to financial efficiency and closing with reputational benefits. ✓ Call to Action: The recommendation is clear and strongly supported, encouraging the HR department to consider the pension scheme.  Persuasive Writing Exercise Now take a few minutes to compare your answer to the two sample answers and consider what you could have done to improve your answer. 49  Actuarial Control Cycle Specify objectives Environment Professionalism Monitor Develop a Experience Solution  Scheme Design Designing an employer pension scheme Need to consider: ▪ Regulatory environment ▪ Beneficiary needs/attitudes ▪ Cost considerations ▪ Events leading to benefit payments ▪ Benefit form  Scheme Design For each of the following, give one example of a change that has led to changing benefit design: I. Changing Employee Needs II. Changing Employer Needs III. Changing Legislative Requirements  Scheme Design For each of the following, give one example of a change that has led to changing benefit design: I. Changing Employee Needs More flexibility or choice II. Changing Employer Needs Greater cost control III. Changing Legislative Requirements Minimum level of pension increases  Scheme Design 1. Defined Benefit Schemes 2. Defined Contribution Schemes 3. Hybrid Schemes  Scheme Design 1. Defined Benefit Schemes Final Salary Schemes ▪ Based upon: The member’s final salary Period of membership of the scheme ▪ Pension amount is typically expressed as: Accrual Rate x Final Pensionable Earnings (FPE) x Pensionable Service (PS) e.g. Pension at NRA = 1/60 x FPE x PS e.g. 40 years service on a final salary of £60,000 would provide a pension of £40,000 (i.e. two thirds of FPE)  Scheme Design 1. Defined Benefit Schemes Average Earnings Schemes Based upon the individual’s average career earnings (possibly revalued) Accrual Rate x Final Pensionable Earnings (FPE) x Pensionable Service (PS)  Scheme Design 1. Defined Benefit Schemes Average Earnings Schemes Based upon the individual’s average career earnings (possibly revalued) Accrual Rate x Final Pensionable Earnings (FPE) x Pensionable Service (PS) Q: When might a revalued career average scheme and a final salary scheme provide broadly the same benefits to an employee at retirement?  Scheme Design 1. Defined Benefit Schemes Average Earnings Schemes Based upon the individual’s average career earnings (possibly revalued) Accrual Rate x Final Pensionable Earnings (FPE) x Pensionable Service (PS) Q: When might a revalued career average scheme and a final salary scheme provide broadly the same benefits to an employee at retirement? A: Schemes have the same accrual rate Definition of PE is based on basic salary only Earnings revaluation in the revalued career average scheme is equal to the individual’s salary growth FPE in the FS scheme is defined as last year’s pensionable earnings Scheme Design – Scheme Types  Scheme Design – Scheme Types 1. Defined Benefit Schemes Q: Suggest some reasons why defined benefit schemes may be popular with employees  Scheme Design – Scheme Types 1. Defined Benefit Schemes Q: Suggest some reasons why defined benefit schemes may be popular with employees A: Pension at retirement will be a known proportion of earnings, enabling employees to plan for the future Benefits are good value for members nearer to retirement, because the cost of each year’s accrual increases with age Final Salary schemes provide good value benefits for those with high earnings growth  Scheme Design – Scheme Types 1. Defined Benefit Schemes Costs of the benefits ▪ Not known exactly until all benefits are paid ▪ Can be estimated in advance on the basis of ‘actuarial assumptions’ Future investment returns Employment patterns Salary growth Inflation Mortality ▪ Ultimately the cost to the scheme depends on the actual experience of these factors ▪ Cost is often met via employees making fixed rate contributions and the employer meeting the balance of the cost  Scheme Design – Scheme Types 1. Defined Benefit Schemes Risks ▪ Beneficiary risks: Not receiving the promised level of benefit Underfunding Sponsor insolvency Fraud ▪ Future accrual levels may change reducing expected benefits ▪ Employer may change future employee contribution levels ▪ Inflation erosion After leaving employment/in retirement (as potentially no longer linked to salary or inflation growth)  Scheme Design – Scheme Types 1. Defined Benefit Schemes Risks ▪ Sponsor risks:  Funds required when not anticipated  Costs of providing benefits are greater than expected The ‘actuarial assumptions’ are too optimistic. Examples?  Scheme Design – Scheme Types 1. Defined Benefit Schemes Risks ▪ Sponsor risks:  Funds required when not anticipated  Costs of providing benefits are greater than expected The ‘actuarial assumptions’ are too optimistic. Examples? ✓ # employees joining the scheme (& their ages) ✓ # retirements in good health & ill health (what age?) ✓ # and ages of withdrawals ✓ # members dying before and after retirement ✓ Existence of spouse/dependants on death of member ✓ Ages of spouse/dependants ✓ Salary growth (inflationary & promotional) ✓ Price inflation ✓ Investment returns ✓ Exercise of options by beneficiaries. What options will affect cashflow? ✓ + non quantifiable e.g. member expectations (surplus?)  Scheme Design 1. Defined Benefit Schemes 2. Defined Contribution Schemes 3. Hybrid Schemes  Scheme Design 2. Defined Contribution Schemes Contributions generally fixed Benefit depends upon accumulated value of contributions Advantages include: Less regulatory restrictions Generally greater member flexibility on retirement Lends itself to AVCs Investment control!!!  Scheme Design 2. Defined Contribution Schemes Contributions generally fixed Benefit depends upon accumulated value of contributions Advantages include: Less regulatory restrictions Generally greater member flexibility on retirement Lends itself to AVCs Investment control!!! Q: Can you list some of the major attractive properties to employers?  Scheme Design – Scheme Types 2. Defined Contribution Schemes Contributions generally fixed Benefit depends upon accumulated value of contributions Advantages include: Less regulatory restrictions Generally greater member flexibility on retirement Lends itself to AVCs Investment control!!! Q: Can you list some of the major attractive properties to employers? A: Cost control Flexibility for members may enhance attractiveness to staff Portability, especially to shorter service employees Less statutory obligations meaning less compliance costs  Scheme Design – Scheme Types 2. Defined Contribution Schemes Variations on the simple form may include contributions increasing with age, service or both Beneficiary risks: ▪ Benefits totally depend upon: Investment returns achieved Terms on which annuities can be bought Market value of ‘pot’ when the annuity is purchased Hence ultimate benefit not known until retirement when the pension benefits are secured ❖ Making it difficult to plan retirement ❖ Benefit may be lower than expected, due to the investment risk  Scheme Design – Scheme Types 2. Defined Contribution Schemes Benefit may be lower than expected, due to the investment risk Investment returns lower than expected Mismatching of investments to benefits ultimately secured But note that the benefit may be lower due to member purchasing more generous benefits than originally intended Additional risks include (as per DB) sponsor insolvency, investment provider insolvency, fraud  Scheme Design – Scheme Types 2. Defined Contribution Schemes Sponsor risks: ▪ Uncertainties are much less than DB # of members they have to pay contributions Pensionable Earnings which contribution % may be based upon Much better cost control than DB Note age or service related contributions may pose a risk ▪ Paternalistic considerations Scheme Design – Scheme Types Summarise the advantages and disadvantages of Defined Benefit and Defined Contribution pension schemes from both the perspective of the employer and the employee  Scheme Design – Comparison of DB & DC Defined Contribution (Employer’s perspective) More control over costs Less regulation compliance requirements Administrations systems required for individual member funds Vulnerable if the resulting benefits are poor Little contribution flexibility Lack of exposure to investment risks or rewards  Scheme Design – Comparison of DB & DC Defined Contribution (Employer’s perspective) Flexibility Potentially larger benefit pot Easier for employees to understand and appreciate Investment choice and control Benefit not known in advance Exposure to investment risks and returns  Scheme Design – Comparison of DB & DC Defined Contribution (Employer’s perspective) Flexibility for contributions Per member admin costs lower Can help with employer’s policies Legislative compliance requirements can be onerous and expensive Costs will vary according to the scheme’s experience which is generally outside the scheme’s control Exposure to investment risks and returns  Scheme Design – Comparison of DB & DC Defined Contribution (Employer’s perspective) Benefits those doing very well! Benefits are known in terms of salary and service Flexibility Possibly poor benefits for early leavers Difficult to understand and possibly fully appreciate  Scheme Design 1. Defined Benefit Schemes 2. Defined Contribution Schemes 3. Hybrid Schemes  Scheme Design – Scheme Types 3. Hybrid Schemes Have an element of both DB & DC provision May be a DB scheme with a DC ‘underpin’ May be a DC scheme with a DB ‘underpin’ May be a sum of both E.g. DB pension of: 1/80 x FPE x PS Plus DC element equal to member’s contributions  Scheme Design – Scheme Types Other potential Risks & Uncertainties Inappropriate advice given to members, employer or trustees Incompetence or insufficient experience of advisor Advisor lacking integrity Use of an unsuitable model or parameters High running costs such as professional fees and administration costs Incorrect benefit payments Late investment of contributions, possibly resulting in lost investment return Fines for non-compliance 7 Pinnacles Training and Consulting 81 Limited, UK  Actuarial Valuations What is an ‘Actuarial Valuation’? I. Opportunity to assess if the assets are sufficient to meet the liabilities accrued to date II. Opportunity to assess the cost of providing benefits which will accrue after the valuation date….the “Normal Contribution Rate” (NCR) III. Decision to be made regarding the future contributions to be paid  Actuarial Valuations When is an Actuarial Valuation carried out? Why? Legislation Trustees get to see funding position and future service costings Provide sponsoring employer with contribution information  Actuarial Liability Accrued Liabilities Calculation requires assumptions Financial assumptions Demographic assumptions ‘The Basis’ Liabilities will likely be long term  Financial Assumptions Usually the most critical Investment return (discount rate) Salary growth Inflation Pension increases (may be capped) Expenses Assumptions are for a very long time period Real rates are important  Financial Assumptions Expenses May be met by scheme itself or by the sponsoring company If scheme meets cost then allowance should be made in the calculations Investment expenses Professional advisor fees Admin Alternative approach – reduce interest rate assumption  Demographic Assumptions Mortality Early retirement % Ill Health early retirement Withdrawals at each age Married % Member and spouse age difference Child benefits  Demographic Assumptions Will use group population statistical data (unless very large scheme) E.g. PA(90) (– e.g. 2 years?) May be able to ignore some demographic assumptions (if cost neutral) ‘Broad brush’ approach may be applied  Actuarial Liability We will look at past service and future service separately The past service Actuarial Liability (for a typical DB scheme) Past service liability will differ by member type: Pensioners Deferred members Active members Future service?  Discount Factor/Present Value https://www.khanacademy.org/economics-finance-domain/core-finance/interest- tutorial/present-value/v/introduction-to-present-value https://www.youtube.com/watch?v=ks33lMoxst0#t=440 90  Actuarial Liability Recall the DB pension amount is typically expressed as: Accrual Rate x Final Pensionable Earnings (FPE) x Pensionable Service (PS) e.g. Pension at NRA = 1/60 x FPE x PS The past service actuarial liability for each pensioner will therefore be: Pensioner AL = Total pension x annuity ▪ The annuity represents the value of 1 unit per annum payable for the remainder of the person’s life ▪ Will be based on: I. Interest II. Pension increases III. Mortality assumptions  Actuarial Liability Recall the DB pension amount is typically expressed as: Accrual Rate x Final Pensionable Earnings (FPE) x Pensionable Service (PS) e.g. Pension at NRA = 1/60 x FPE x PS The past service actuarial liability for each deferred member will therefore be: Deferred AL = Total pension @ DOL x (1+infl)NRA-(Age @ DOL) x Probability of survival x annuity @ NRA x Discount Factor (discounting from retirement age back to the valuation date)  Actuarial Liability Recall the DB pension amount is typically expressed as: Accrual Rate x Final Pensionable Earnings (FPE) x Pensionable Service (PS) e.g. Pension at NRA = 1/60 x FPE x PS The past service actuarial liability for each active member will therefore be: Active AL = Accrual Rate x Current Pensionable Earnings x (1+salary)NRA- (Age @ DOV) x Pensionable Service (PS) x Probability of survival* x annuity @ NRA x Discount Factor (discounting from retirement age back to the valuation date) * Lower than for deferreds. Why?  Discount Factor The Discount factor reflects expected return on assets held in pension fund Requires actuarial judgement Pensions Institute Discussion Paper: “What Discount Rate Should be used to Value Defined Benefit Pension Liabilities?” Discount Factor Discount Factor  Asset Value Assets and Liabilities should be valued in a consistent way Market Value? Discounted income method? ▪ Gives less volatile results  Funding Position Total Assets - Total Liabilities = Surplus or deficit Funding Position – Case Study  Funding Position – Case Study Summary of the Benefit Structure for the Dr Mojo & Associates Pension Plan Eligibility Permanent employees are eligible to join the plan provided they are under age 70 Normal Retirement Date (NRD) Age 70 for all current members. Pensionable Salary Pensionable salary is fixed each 31 December as the basic salary of the member over the previous year Final Pensionable Earnings (FPE) Average of pensionable salaries on the two 31 Decembers preceding retirement, death or leaving  Funding Position – Case Study Summary of the Benefit Structure for the Dr Mojo & Associates Pension Plan PENSION BENEFITS Normal Retirement Pension 1/80th of FPE for each year and number of full months of plan membership (subject to a maximum of 50 years) Leaving Service A deferred pension is payable from NRD based on the period of membership completed and FPE at the date of leaving The deferred pension is revalued at the retail prices inflation index up to NRD A transfer value, equal in value to the deferred pension, may be taken to another pension  Funding Position – Case Study Assumptions Inflation: 5% Salary increases: 4% basic + 2% promotional Investment returns: 7% Male Annuity value at age 70: 15 Female Annuity value at age 70: 18 Male Annuity value at age 75: 11 Assets: Market Value @ Valuation Date = £35,639  Funding Position – Case Study Scenario Dr Mojo’s business has been a success as a result of some sound risk management practice (Rick O’Shea was replaced!). The business has grown and Dr Mojo has decided to put in place a highly sought after defined benefit pension plan in order to keep hold of his valuable employees and attract more talent as the business grows. The Plan currently has 3 members (1 active, 1 deferred and 1 pensioner) and Dr Mojo has asked a consulting actuary to carry out a valuation of the liabilities and thus the funding position of the scheme.  Funding Position – Case Study Scenario Details: Date of valuation: 1 January 2014 Pensioner Current pension in payment = £1000 Date of birth: 1 January 1939 Sex: Male Deferred Member* Date of joining Scheme: 1 March 2008 Date of Leaving: 1 June 2011 Salary history: Salary @ 31 Dec 2010 was £20,000 basic + £5,000 bonus. Salary @ 31 Dec 2009 was £14,000 basic + £2,000 bonus. Date of birth: 1 January 1959 Sex: Male Active Member** Date of joining Scheme: 1 Jan 2007 Salary history: Salary @ 31 Dec 2013 was £30,000 basic + £10,000 bonus. Salary @ 31 Dec 2012 was £20,000 basic + £6,000 bonus. Date of birth: 1 January 1974 Sex: Female Calculate the total liability and hence funding position of the scheme at the valuation date *You can assume the probability of surviving to retirement is 90% **You can assume the probability of surviving to retirement is 70%  Funding Position – Case Study Pensioner Liability: Date of valuation: 1 January 2014 Pensioner Current pension in payment = £1000 Date of birth: 1 January 1939 Sex: Male Age @ DOV: 75 Annuity rate for male aged 75 = 11 Pensioner AL = Total pension x annuity Pensioner Actuarial Past Service Liability = 1000 x 11 = £11,000  Funding Position – Case Study Deferred Member Liability: Deferred AL = Total pension @ DOL x (1+infl)NRA-(Age @ DOL) x Probability of survival x annuity @ NRA x Discount Factor (discounting from retirement age back to the valuation date) Date of valuation: 1 January 2014 Deferred Member* Date of joining Scheme: 1 March 2008 Date of Leaving: 1 June 2011 Salary history: Salary @ 31 Dec 2010 was £20,000 basic + £5,000 bonus. Salary @ 31 Dec 2009 was £14,000 basic + £2,000 bonus. Date of birth: 1 January 1959 Sex: Male Information needed NRD: Age @ DOL: Service accrued at DOL: FPE @ DOL: Pension @ DOL: Term from DOL to retirement date: Revalued pension to NRD: Term from valuation date to retirement date: Deferred PS AL =  Funding Position – Case Study Deferred Member Liability: Deferred AL = Total pension @ DOL x (1+infl)NRA-(Age @ DOL) x Probability of survival x annuity @ NRA x Discount Factor (discounting from retirement age back to the valuation date) Date of valuation: 1 January 2014 Deferred Member* Date of joining Scheme: 1 March 2008 Date of Leaving: 1 June 2011 Salary history: Salary @ 31 Dec 2010 was £20,000 basic + £5,000 bonus. Salary @ 31 Dec 2009 was £14,000 basic + £2,000 bonus. Date of birth: 1 January 1959 Sex: Male Information needed NRD: 1 January 2029 (age 70) Age @ DOL (1/1/59 to 1/6/11): 52 and 5 months Service accrued at DOL (1/3/08 to 1/6/11): 3 yrs 3 mths FPE @ DOL:(20,000+14,000)/2 = £17,000 Pension @ DOL: Accrual Rate x Final Pensionable Earnings (FPE) x Pensionable Service (PS) =(17,000/80) x (3 + (3/12)) = £690.63 Term from DOL to NRD: (1/6/11 to 1/1/29) = 17 yrs 7 mths Revalued pension to NRD: 690.63 x (1.05)70-52 and 5 mths=17yrs and 7 mths Term from valuation date to NRD: (1/1/14 to 1/1/29) = 15 years exact! Deferred PS AL: 690.63 x (1.05)70-52 and 5 mths=17yrs and 7 mths x 90% x 15 x (1/1.07)15 = £9,716.58  Funding Position – Case Study Active Member Past Service Liability: Active AL = Accrual Rate x Current Pensionable Earnings x (1+salary)NRA-(Age @ DOV) x Pensionable Service x Probability of survival* x annuity @ NRA x Discount Factor (discounting from retirement age back to the valuation date) Date of valuation: 1 January 2014 Active Member** Date of joining Scheme: 1 Jan 2007 Salary history: Salary @ 31 Dec 2013 was £30,000 basic + £10,000 bonus. Salary @ 31 Dec 2012 was £20,000 basic + £6,000 bonus. Date of birth: 1 January 1974 Sex: Female Information needed NRD: Age @ DOV: Service accrued at DOV: PE @ DOV: Term from valuation date to retirement date: FPE = Active PS AL:  Funding Position – Case Study Active Member Past Service Liability: Active AL = Accrual Rate x Current Pensionable Earnings x (1+salary)NRA-(Age @ DOV) x Pensionable Service x Probability of survival* x annuity @ NRA x Discount Factor (discounting from retirement age back to the valuation date) Date of valuation: 1 January 2014 Active Member** Date of joining Scheme: 1 Jan 2007 Salary history: Salary @ 31 Dec 2013 was £30,000 basic + £10,000 bonus. Salary @ 31 Dec 2012 was £20,000 basic + £6,000 bonus. Date of birth: 1 January 1974 Sex: Female NRD: 1 January 2044 (age 70) Age @ DOV: 1/1/74 to 1/1/14 = 40 years exactly Service accrued at DOV: 1/1/07 to 1/1/14 = 7 years exactly PE @ DOV: £30,000 Term from valuation date to retirement date = 1/1/14 to 1/1/44 = 30 years exactly! FPE = (30,000 x 1.0670-40 + 30,000 x 1.0669-40 )/2 = £167,428.19 Active PS AL: 1/80 x 167,428.19 x 7 x 70% x 18 x (1/1.07)30 = £24,248.98  Funding Position Total Assets - Total Liabilities = Surplus or deficit??  Funding Position Total Assets = £35,639 Total Liabilities = £44,966 Deficit of £9,327 Or 35,639/44,966 = 79.3% funded i.e. underfunded (significantly?)  Funding Position Total Assets = £35,639 Total Liabilities = £44,966 Deficit of £9,327 What about other bases?? Solvency Government led Pessimistic Optimistic  Changing Basis Active and deferred members New liability = Old liability x New annuity/Old annuity x New discounting/Old discounting Pensioners New liability = Old liability x New annuity/Old annuity Useful rules of thumb 1% increase in interest rate >> approx 9% decrease in annuity 1 year change in mortality age rating >> approx 2.5% change in annuity The increase in past service liabilities is approximately 4% compound for each year retirement is earlier  Solvency Basis Assumes the scheme will close (wind-up) at the valuation date Tests whether the plan has sufficient assets to pay all benefits that have been earned by members to that date Assumptions should correspond to a life office assumptions if they were insuring winding up benefits  Solvency Basis Assumptions: Discount rate for PIPs ▪ Actuary’s estimate of the rate an insurance company would be prepared to guarantee if the pension was insured ▪ Discount rate will depend upon the pension increases ❖ Level pension ❖ Fixed increases ❖ Inflation linked increases Discount rate for deferred pensions will likely be lower  Solvency Basis Assumptions: Mortality ▪ Actuary’s estimate of insurance company’s mortality used when pricing immediate annuities ▪ Post retirement mortality for deferred members may be lighter Pension increases ▪ Again assume what the insurance company assumes ▪ Likely to be more cautious than the ongoing assumption  Solvency Basis Assumptions: Revaluation in deferment ▪ Again as per the insurance company Marital status ▪ Age difference ▪ % married Margins ▪ Allowance for risks, contingencies, expenses and profits ❖ Explicitly or implicitly allowed for  Future Service Costs Two main methods 1. Projected Unit Method (PUM) ▪ Used when membership profile is unlikely to change significantly, i.e. stable: ❖ Proportion of each sex ❖ Age distribution ❖ Salary distribution 2. Attained Age Method (AAM) ▪ Used when membership profile is likely to change ❖ E.g. few new entrants (or none if closed) ❖ Smaller schemes Which method is likely to produce the highest contribution rate?  Future Service Costs - Calculations Projected Unit Method Contribution rate is calculated as follows: Total value of next one year's liabilities for all active members Value of next year's salary for the same members Why only one year? ▪ Membership profile remains the same ▪ Calculation say in 5 years time should be the same Numerator =1 Active AL = Accrual Rate x Current Pensionable Earnings x (1+salary)NRA-(Age @ DOV) x Pensionable Service x Probability of survival* x annuity @ NRA x Discount Factor (discounting from retirement age back to the valuation date)  Future Service Costs - Calculations Projected Unit Method Contribution rate is calculated as follows: Total value of next one year's liabilities for all active members Value of next year's salary for the same members Why only one year? ▪ Membership profile remains the same ▪ Calculation say in 5 years time should be the same Denominator Σ Next Year’s Earnings / (1+discount rate)0.5  Future Service Costs - Calculations Projected Unit Method: Example Total value of next one year's liabilities for all active members Value of next year's salary for the same members = 1/80 x (30,000 x 1.0670-40 + 30,000 x 1.0669-40 )/2 x 1 x 70% x 18 x (1/1.07)30 £25,000 / (1.07)0.5 = ??  Future Service Costs - Calculations Projected Unit Method: Example Total value of next one year's liabilities for all active members Value of next year's salary for the same members = 1/80 x (30,000 x 1.0670-40 + 30,000 x 1.0669-40 )/2 x 1 x 70% x 18 x (1/1.07)30 £25,000 / (1.07)0.5 = 3,464 24,168 = 14.3%  Future Service Costs - Calculations Attained Age Method Contribution rate is calculated as follows: Total value of all future service liabilities for all active members Value of all future year's salary for the same members Numerator calculation is very similar to PUM ▪ Except pen serv period is from DOV to NRD Future salary calculation is very different ▪ Need to allow for future salary growth and the probability of the individual “surviving” for all future years Denominator [Next Year’s Earnings / (1+discount rate)0.5]+[Earnings in 2 years time/ (1+discount rate)1.5]+[Earnings in 3 years time/ (1+discount rate)2.5]+…..up to NRD  Future Service Costs - Calculations Attained Age Method Contribution rate tends to be higher than PUM ▪ AAM incorporates an allowance for the average age profile of the scheme membership to increase Professional fees should be allowed for in the contribution rate if paid for by the scheme Insured death benefits (if applicable) cost should also be included Company contribution will obviously be the total contribution minus the member’s (fixed?) contribution  Membership Profile/Nature of Scheme Membership Profile Young members >> longer term Closed scheme >> shorter term Accuracy of our assumptions decreases over time % of member type will dictate relative importance of assumptions  Membership Profile/Nature of Scheme Nature of Scheme - Issues to consider: Profile of the liabilities ▪ Nature ▪ Term Funding Position ▪ Surplus ▪ Deficit Fund Size ▪ Increasing ▪ Static ▪ Decreasing  Membership Profile/Nature of Scheme Nature of Scheme - Issues to consider: Expected cashflows and hence liquidity requirements Risk attitude Employer strength  Membership Profile/Nature of Scheme Typical Life Cycle of a Benefit Scheme New scheme with no past service Mature scheme with new entrants Mature scheme closed to new entrants  Membership Profile/Nature of Scheme New scheme with no past service Will have little assets Little or no benefits will be getting paid out allowing assets to grow very quickly Long termed liabilities for mainly active members Shouldn’t be onerous liquidity requirements Poor investment performance not critical  Membership Profile/Nature of Scheme Mature scheme with new entrants Long liability term Accruing liability mainly iro future salary increases to accrued past service Need to consider net cashflow position when considering investment suitability Funding position will be important ▪ The Trustee ‘Catch 22’! ▪ Discussions with employer are important  Membership Profile/Nature of Scheme Mature scheme closed to new entrants May be cashflow negative ▪ May be regularly forced into asset realisation ▪ Hence assets should be: ❖ High income or ❖ Sufficiently liquid and marketable  Analysis of Surplus Profit = Revenue - Expenditure Surplus* = Asset value – Liability value *depends upon basis used Surplus/deficit may naturally disappear as the scheme’s experience unfolds  Actuarial Control Cycle Specify objectives Environment Professionalism Monitor Develop a Experience Solution  Actuarial Control Cycle Specify objectives Environment Professionalism Monitor Develop a Experience Solution  Analysis of Surplus (AOS) Why might we want to perform an AOS? To assist management in decision making ▪ Show the financial effect of divergences between valuation assumptions and actual experience ▪ Identify non-recurring components of surplus, thus enabling appropriate decisions to be made about the distribution of surplus ▪ Provide MI ▪ Provide information on trends for future valuations  Analysis of Surplus (AOS) Why might we want to perform an AOS? To provide information for other purposes ▪ Provide data for use in executive remuneration schemes ▪ Source of information for accounting purposes  Analysis of Surplus (AOS) Why might we want to perform an AOS? For data calculations and checks ▪ Validate the calculations and assumptions used ▪ Provide a check on the valuation data and process (if carried out independently) ▪ Reconcile the values for successive years  Analysis of Surplus (AOS) To show the financial effect of divergences between valuation assumptions and actual experience Allows us to: ▪ See which assumptions have led to surplus or deficit ▪ Quantify the financial impact of each assumption  Analysis of Surplus (AOS) Identify non-recurring components of surplus, thus enabling appropriate decisions to be made about the distribution of surplus Why does a surplus arise?  Analysis of Surplus (AOS) Identify non-recurring components of surplus, thus enabling appropriate decisions to be made about the distribution of surplus Why does a surplus arise? ▪ Overall investment return ▪ Salary inflation ▪ Pension increases ▪ Early retirement rates ▪ Ill-health retirement rates ▪ Mortality rates pre retirement ▪ Mortality rates post retirement ▪ Withdrawal rates ▪ Proportions married ▪ Promotional salary scale ▪ New entrant rates ▪ Proportion commuting pension for cash at each age  Analysis of Surplus (AOS) Identify non-recurring components of surplus, thus enabling appropriate decisions to be made about the distribution of surplus Should consider the speed of corrective action And also industrial relations Session 2 142 143  Actuarial Control Cycle Suitability of assets Assets available Specify objectives Environment Professionalism Monitor Develop a Experience Solution  Investment Strategy SYSTEM T S = Security Y = Yield S = Spread (or diversification) T = Term E = Exchange rate M = Marketability T = Tax  Investment Strategy SYSTEM T: Security Income Capital Real terms Monetary terms Market value security  Investment Strategy SYSTEM T: Yield Running yield Total expected return Return in real terms  Investment Strategy SYSTEM T: Spread/Diversification  Investment Strategy Diversification Reducing risk by investing in a wide range of assets “But divide your investments among many places, for you do not know what risks might lie ahead” “My ventures are not in one bottom trusted, nor to one place; nor is my whole estate upon the fortune of this present year: Therefore, my merchandise makes me not sad.” Harry Markowitz  Investment Strategy Diversification Reducing risk by investing in a wide range of assets Relies upon lack of positive correlation between the assets Example:  Investment Strategy Diversification Impact on returns? Narrows the range of possible outcomes worst best Diversification and variance of returns Lowest Highest Diversifiable and non-diversifiable risk CAPM >> Investors should only be compensated for non- diversifiable risk  Investment Strategy SYSTEM T: Term Assets v Liabilities But should also consider asset/liability type  Investment Strategy SYSTEM T: Exchange rate Currency risk  Investment Strategy SYSTEM T: Marketability Ability to trade an asset at a given price in given volumes i.e. can be sold quickly, easily and cheaply ▪ With low expenses ▪ With little impact on the market price An asset is marketable if it can be sold quickly, cheaply and easily - i.e. with low expenses and little impact on the market price. An asset is liquid if it is marketable and it has a stable market price. (This is because liquidity refers to the speed and certainty with which an asset can be converted into cash.)  Investment Strategy SYSTEM T: Tax  Investment Strategy Investment Classes Potential restrictions Investment within the sponsoring employer Trustees/Trust deed and rules ▪ Environmentally friendly companies? ▪ Bonds to match liability profile Stock selection decision usually taken care of by investment managers  Investment Strategy Investment Classes Real or nominal? Real Assets ▪ Domestic equities ▪ Overseas equities ▪ Property ▪ Index-linked government bonds Nominal Assets ▪ Fixed interest government bonds ▪ Other domestic fixed interest assets ▪ Overseas bonds ▪ Cash  Investment Strategy Investment Classes Other potential assets? Hedge funds Private equity holdings Commodity funds Structured credit Private Finance Investment (PFI) arrangements + other ‘alternative’ investments  Investment Strategy Investment Classes Domestic equities Generally marketable (if quoted) Have reasonable liquidity, but disposal of unusually large holdings or less marketable shares may have to take place gradually over a period of time Short term volatility of market prices is high Diversification possible via different companies and different industries Should produce a significant real return in the long term  Investment Strategy Investment Classes Domestic equities Better returns than other assets (long term) ? But!! ? ?  Investment Strategy Investment Classes ▪ Domestic equities The economic argument Expected equity real Improved living return standards/GDP growth Really?  Investment Strategy Investment Classes Domestic equities Real nature (+) Higher expected long term returns (+) ▪ Also low dealing costs and large volumes can be bought and sold (+) Volatility can arise between assets and liabilities if the relationship doesn’t hold (-) Market values can be volatile (-) Income stream can be volatile (-) Income stream generally quite low (-) Even over longer periods the returns can vary significantly (-)  Investment Strategy Investment Classes Volatility risk Equity Risk V Equity Return Default risk Marketability risk Is it worth it for pension funds??  Investment Strategy Investment Classes Domestic equities Does equity volatility matter for pension schemes?  Investment Strategy Investment Classes Domestic equities: Summary of main features Real return likely over the long term Very large market Generally a wide range of stocks are available ▪ Allowing good diversification Arguably suitable to back salary related liabilities Historically they have produced superior returns Volatile market values Dividend income not always stable Relatively low initial income stream Relatively low dealing costs  The cult of equity Faith and experience has told us that over time equities will outperform government bonds and cash Credit Suisse's Global Investment Returns Sourcebook Accounting/Actuarial Bias Enables Equity Investment by Defined Benefit Pension Plans: North American Actuarial Journal, July 2005  The cult of equity Credit Suisse's Global Investment Returns Sourcebook  The cult of equity Credit Suisse's Global Investment Returns Sourcebook  The cult of equity Credit Suisse's Global Investment Returns Sourcebook But exactly how long is ‘long term’? I.e. how long you have to hold equities to be certain that the premium fully compensates for the risk of a sudden loss of value? ▪ 20 years (US)? ▪ 23 years (UK)? ▪ 66 years (France)? The future?  The cult of equity Accounting/Actuarial Bias Enables Equity Investment by Defined Benefit Pension Plans: North American Actuarial Journal, July 2005  Investment Strategy Investment Classes Overseas equities Similar in many ways to domestic equities But dealing expenses will be typically higher May (?) provide some diversification ▪ Also potential diversification of risk of demographic ageing of a population Opportunity for higher returns? ▪ Fast growing economies ▪ Industries not available in domestic country  Investment Strategy Investment Classes Overseas equities Disadvantages ▪ Volatility of returns (incl currency) ▪ Lower correlation with domestic inflation ▪ Greater dealing costs ▪ Tax disadvantages? ▪ Low income yields in many markets ▪ Political risk  Investment Strategy Investment Classes Property Directly or indirectly Advantages ▪ Likely real return in the long term ▪ Rent review clauses>>rents can only go up ▪ Generally lower volatility of returns than equities ▪ May be tax advantages ▪ Diversification  Investment Strategy Investment Classes Property Disadvantages ▪ Lower long term expected returns ▪ Poor liquidity and marketability ▪ Large unit size of property investments  Investment Strategy Investment Classes Bonds Issued by national and local governments, government agencies, supranational organisations, wide-range of companies If issued by developed country governments they are generally very secure (historically anyway!) Demand for government bonds generally comes from institutional investors British government securities: Gilts US government bonds: Treasury bonds  Investment Strategy Investment Classes Fixed Interest (conventional) Bonds Provides an income stream, fixed in monetary terms and also a final redemption proceed that is also fixed in monetary terms Investment and risk characteristics: ▪ Security if issued by a reputable government is generally extremely good with little risk of default ▪ Risk exists in real terms (& can be volatile) ▪ Market value risk. Why might this be a problem?  Investment Strategy Investment Classes Fixed Interest (conventional) Bonds Provides an income stream, fixed in monetary terms and also a final redemption proceed that is also fixed in monetary terms Investment and risk characteristics: ▪ Market value risk. Why might this be a problem? ❖ Investors may need to prove financial strength by reference to the market value of assets ❖ Investors who may have to sell at the lower market prices (eg if an investor is required to meet a liability sooner than anticipated)  Investment Strategy Investment Classes Fixed Interest (conventional) Bonds Provides a income stream, fixed in monetary terms and also a final redemption proceed that is also fixed in monetary terms Investment and risk characteristics: ▪ Security if issued by a reputable government is generally extremely good with little risk of default ▪ Risk exists in real terms (& can be volatile) ▪ Market value risk ▪ Marketability is generally excellent ▪ Market value fluctuates daily ▪ Expenses usually low  Investment Strategy Investment Classes Fixed Interest (conventional) Bonds Investment and risk characteristics: ▪ Expected returns  If held to redemption monetary returns are known and fixed. BUT.. An investor buying an n-year bond to meet an n-year liability may have coupon payments from the bond which may need to be reinvested on unknown terms If the investor plans to sell before redemption then the sale price is not known in advance Uncertain real returns  Investment Strategy Investment Classes Fixed Interest (conventional) Bonds Investment and risk characteristics: ▪ Risk V Return?  Conventionally argued as being low return due to low risk  Return may be high if: Held during a period when redemption yields are falling Buying when gross redemption yields are high, hence locking into a high nominal return  Investment Strategy Investment Classes Fixed Interest (conventional) Bonds Other characteristics ▪ Wide variety by term and coupon provides flexibility for matching monetary liabilities ▪ Good marketability allows investors to enhance returns. Ie switching ▪ High running yield ▪ Good match for benefits with nil or fixed increases  Investment Strategy Investment Classes Index-linked government bonds Only been in issue ▪ In UK since 1981 ▪ In US since 1997 ▪ In France since 1998 Interest payments and final redemption proceeds linked to inflation, hence yield not known in advance  Investment Strategy Investment Classes Index-linked government bonds Advantages ▪ Guaranteed real returns if held to redemption ▪ Good correlation with earnings growth ▪ Low volatility of real returns ▪ May have tax advantages ▪ Diversification against equities ▪ Match for salary related benefits  Investment Strategy Investment Classes Index-linked government bonds Disadvantages ▪ Other assets may produce higher returns over the long term ▪ Small size of available market compared with equities and fixed interest government bonds ▪ Lack of availability of bonds with long enough terms  Investment Strategy Investment Classes Index-linked government bonds Is the real return from index linked government bonds always certain? If not when is it not?  Investment Strategy Investment Classes Index-linked government bonds No the real return is not always certain. As is the case with conventional government bonds, to be guaranteed to receive the gross redemption yield: The bond needs to be held to redemption Reinvestment of coupons needs to be at the same return Note, if you use the coupon to meet the cashflow needs when the payment is received only the first constraint is required May also be a time lag linking the coupon payments to inflation  Investment Strategy Investment Classes Overseas bonds Will likely have higher dealing costs May allow the pension scheme to take advantage of interest rates of economies at different stages in the economic cycle Diversification And the main downside?  Investment Strategy Investment Classes Overseas bonds Will likely have higher dealing costs May allow the pension scheme to take advantage of interest rates of economies at different stages in the economic cycle Diversification And the main downside? ▪ The extra risk from currency exposure  Investment Strategy Investment Classes Cash Short term investment May be used as a ‘working balance’ to enable them to make other transactions smoothly Can possibly produce a better short term return For a DC scheme the % may increase closer to retirement  Investment Strategy Investment Classes Derivatives Not a pure investment Typically bought OTC from IBs Allow hedging ▪ Inflation ▪ Currency ▪ Other market fluctuations Can be used for Portfolio Management ▪ Asset allocation  Investment Strategy Investment Classes Employer related investments Employer equity Land/property used by the employer Scheme deficits? Why do it? Why not to do it!? Most schemes don’t self invest  Fundamental Principles of Occupational Pension Fund Investment Trustee principles Ensure sufficient assets are available to meet liabilities when they fall due Select investments that are appropriate to the nature and term of the liabilities and the employer’s appetite for risk Investments should be selected so as to maximise the return on the fund Should bring about lower contributions overall Possibly provide scope to increase member benefits  Fundamental Principles of Occupational Pension Fund Investment Why is precise liability matching so complicated/difficult? Past service liabilities will differ depending on whether scheme continues or is wound up ▪ If scheme does continue active liability depends on salary increases Timing of future benefits is unknown Availability of appropriate investments. Synthetic bonds? Assets with long enough term? Mortality dependence  Fundamental Principles of Occupational Pension Fund Investment What about DC/MP schemes? Is there really a matching problem? Should this mean being more speculative? Similarities between an ongoing DB scheme (actives) Employer may target (or guarantee!) a real, nominal or DB level Volatile assets (close to retirement) much more of an issue than for DB ▪ Asset volatility in relation to annuity rates is what really matters  Fundamental Principles of Occupational Pension Fund Investment A loyal employee has built up a large defined contribution pension pot through his employer over a number of years service. He has now decided to retire in 6 months time. What should he invest in, if: I. He wants to purchase a pension at retirement? II. He wants to (& can!) take the full pot as cash at retirement?  Fundamental Principles of Occupational Pension Fund Investment A loyal employee has built up a large defined contribution pension pot through his employer over a number of years service. He has now decided to retire in 6 months time. What should he invest in, if: I. He wants to purchase a pension at retirement? II. He wants to (& can!) take the full pot as cash at retirement? I. Pension is likely to be bought from a life office or calculated based on current annuity rates, hence best option is likely to be medium/long government bonds. Reason being the life office will likely have invested in government bonds to match the pension liabilities. The pension will be more expensive if govt bond yields fall. Hence should invest in an asset which will rise in value if this happens  Fundamental Principles of Occupational Pension Fund Investment A loyal employee has built up a large defined contribution pension pot through his employer over a number of years service. He has now decided to retire in 6 months time. What should he invest in, if: I. He wants to purchase a pension at retirement? II. He wants to (& can!) take the full pot as cash at retirement? II. In this case cash would be most appropriate to avoid the potential matching volatility  Fundamental Principles of Occupational Pension Fund Investment Myners Investment Principles (UK) DB Schemes 1. Effective Decision Making 2. Clear Objectives 3. Focus on Asset Allocation 4. Expert Advice 5. Explicit Mandates 6. Activism 7. Appropriate benchmarks 8. Performance Measurement 9. Transparency 10. Regular Reporting  Fundamental Principles of Occupational Pension Fund Investment Myners Investment Principles (UK) DB Schemes 1. Effective Decision Making ▪ Decisions made by those with the necessary skills, information and resources (e.g. Trustees)  Fundamental Principles of Occupational Pension Fund Investment Myners Investment Principles (UK) DB Schemes 2. Clear Objectives ▪ Trustees should set out an overall investment objective for the fund that: ❖ Represents their best judgement of what is necessary to meet the fund’s liabilities ❖ Takes account of their risk attitude  Fundamental Principles of Occupational Pension Fund Investment Myners Investment Principles (UK) DB Schemes 3. Focus on Asset Allocation ▪ % spread ▪ Decision-makers should consider a full range of investment opportunities ▪ Should reflect fund’s own characteristics  Fundamental Principles of Occupational Pension Fund Investment Myners Investment Principles (UK) DB Schemes 4. Expert Advice ▪ Opened to competition ▪ Prepared to pay sufficient fees  Fundamental Principles of Occupational Pension Fund Investment Myners Investment Principles (UK) DB Schemes 5. Explicit Mandates ▪ Active intervention in the running of companies which they invest  Fundamental Principles of Occupational Pension Fund Investment Myners Investment Principles (UK) DB Schemes 6. Activism ▪ Trustees should agree with investment managers an explicit written mandate agreeing: ❖ Objective benchmark and risk parameters consistent with the fund’s objectives and risk tolerances ❖ The manager’s approach to achieving ❖ Clear timescales of measurement and evaluation  Fundamental Principles of Occupational Pension Fund Investment Myners Investment Principles (UK) DB Schemes 7. Appropriate Benchmarks ▪ Trustees should: ❖ Discuss with their investment manager whether their index benchmark is appropriate ❖ Ensure if index divergence limits are set then index construction approximations are recognised ❖ For each asset class consider whether passive or active investment is best  Fundamental Principles of Occupational Pension Fund Investment Active V Passive Management Two different approaches to investment management Active Management: ▪ Portfolio manager buys/sells stocks/bonds with ‘good potential’ ▪ Attempting to meet the portfolio’s objectives ❖ How? ❖ Financial Analysis ❖ Economic Analysis ❖ Quantitative Methods Passive Management: ▪ No or little attempt to identify overpriced or under-priced stocks ▪ Buy-and-hold (hence much less turnover) ▪ Eg an index tracking mandate  Fundamental Principles of Occupational Pension Fund Investment Myners Investment Principles (UK) DB Schemes 7. Appropriate Benchmarks ▪ Trustees should: ❖ Discuss with their investment manager whether their index benchmark is appropriate ❖ Ensure if index divergence limits are set then index construction approximations are recognised ❖ For each asset class consider whether passive or active investment is best ❖ If active management is selected ensure targets and risk controls are set to reflect this  Fundamental Principles of Occupational Pension Fund Investment Myners Investment Principles (UK) DB Schemes 8. Performance Measurement ▪ Trustees should ensure this is carried out ▪ Formal assessment procedures  Fundamental Principles of Occupational Pension Fund Investment Myners Investment Principles (UK) DB Schemes 9. Transparency ▪ SIP should set out: ❖ Who is taking decisions and why ❖ Fund’s investment objective ❖ Fund’s planned asset allocation strategy ❖ On mandates given to advisors and managers ❖ On fee structures in place  Fundamental Principles of Occupational Pension Fund Investment Myners Investment Principles (UK) DB Schemes 10. Regular Reporting ▪ Trustees should publish their SIP and the results of their monitoring of advisors and managers ▪ Key information should be sent annually to members  Fundamental Principles of Occupational Pension Fund Investment Myners Investment Principles (UK) DC Schemes 1. Effective Decision Making 2. Clear Objectives 3. Focus on Asset Allocation 4. Choice of default fund 5. Expert Advice 6. Explicit Mandates 7. Activism 8. Appropriate benchmarks 9. Performance Measurement 10. Transparency 11. Regular Reporting I. Set out the asset sectors that might feature in the investment portfolio of a typical large UK final salary scheme and summarise the main characteristics of each. II. Describe, in the context of an occupational pension scheme, what is meant by self- investment. Give examples of investments that night be considered to constitute self-investment and explain why self-investment can lead to problems. 212 I. Set out the asset sectors that might feature in the investment portfolio of a typical large UK final salary scheme and summarise the main characteristics of each. I. Set out the asset sectors that might feature in the investment portfolio of a typical large UK final salary scheme and summarise the main characteristics of each. I. Set out the asset sectors that might feature in the investment portfolio of a typical large UK final salary scheme and summarise the main characteristics of each. Describe, in the context of an occupational pension scheme, what is meant by self- investment. Give examples of investments that night be considered to constitute self- investment and explain why self-investment can lead to problems. Describe, in the context of an occupational pension scheme, what is meant by self- investment. Give examples of investments that night be considered to constitute self- investment and explain why self-investment can lead to problems. ABOVE THIS=DONE FIN3019 ASSIGNMENT NExt year Highlight relevance in these slides more. Add in 2024: https://www.linkedin.com/posts/nathan-baugh_it-took-me-25-years-to-become-a- decent-writer-activity-7062765868891459584- ODif?utm_source=share&utm_medium=member_desktop https://www.linkedin.com/posts/thinkingslow_contentmarketing-writing-activity- 7065238953972375552-c_5w?utm_source=share&utm_medium=member_desktop Attendance Connect to QUB_WIFI Register at: http://go.qub.ac.uk/actattend4 Campus Code: 1234 A SHORT COURSE ON WRITING SKILLS & TIPS BSc Actuarial Science and Risk Management (FIN3019) Dr Mark Farrell (FIA) FIN3019 ASSIGNMENT Why?  There is a big misperception that actuaries are simply number crunchers. But the truth is, if you can’t use words to explain why the numbers matter, they won’t matter. In my opinion, communication skills are just as important as technical skills for actuaries! Kirsten Flynn Senior Pricing Actuary, Australia Matt Saker (IFoA President, 2022/23) The only way some people know you is through your writing. It can be your most frequent (or only!) point of contact with people important to your career—senior clients, regulators, senior management. It reveals how your mind works. Readers who don’t know you judge you from the evidence in your writing. Whether you are writing a novel, essay, article or email, good writing is an essential part of getting your readers to understand your ideas.  A Valuable Skill Gain clarity Improve your thinking Image Source: https://perell.com/  A Valuable Skill Gain clarity Improve your thinking Enhance your reputation Land jobs online by showing your skill  A Valuable Skill Gain clarity Improve your thinking Enhance your reputation Land jobs online by showing your skill Attract people you can't find offline Uncover opportunities Increase your ‘Luck Surface Area’  A Valuable Skill Increase your ‘Luck Surface Area’ Writing Tips  Tip #1: Consider The Context Who is your audience? Why are they reading this?  Your Assignment (for context) You are asked to produce a well-researched and practical, online article on an actuarial topic. The topic can be on anything actuarial and will not necessarily be related to this course. The audience persona is a busy intelligent professional (not necessarily an actuary/actuarial trainee) seeking information. Think blog post article NOT academic essay. Meant to test your ability to communicate via the written word to a professional audience (not necessarily actuarial).  Tip #1: Consider The Context Who is your audience? Professional: write for a professional audience (respect the reader – i.e. avoid cutesy/hyperbolic/fluff stuff). Busy: don’t waste their time with fluff. Online: make it easy to read and digest (discussed further in next slide).  Tip #1: Consider The Context Why are they reading this? They are seeking information/insights into a problem. Practical: It’s not an intellectual pondering exercise! Make it practical by providing a practical takeaway. Is this actionable? Ask yourself: ✓ What could the reader do with this information? ✓ What does the reader really want? ✓ What's their mindset when they reach your content? Well-researched: ✓ This often involves explaining your argument and giving evidence for your points.  Tip #2 (for your context): Make It Easy To Read As it’s an online article read by busy people - make it easy to digest (always consider the end reader). Use lots of: Headings and subheadings Bullet Lists Quotes Infographics and images (if it helps to clarify or visualise a point) Short sentences and paragraphs (generally) Avoid walls of text. Keep your thoughts and writing as succinct as possible.  Tip #2 (for your context): Make It Easy To Read Keep your thoughts and writing as succinct as possible. Writing better does not mean writing more. ▪ You writing should require a minimum of time and effort on the reader’s part. ▪ The importance of this increases with the importance of your reader.  Tip #2 (for your context): Make It Easy To Read Keep your thoughts and writing as succinct as possible. Example Article: How To Pass Actuarial Exams And Still Have a Life The study techniques you use are up to you. However, there are 9 important study methods to be aware of so you can choose the ones that best suit you. Method 1 Method 2 Method 3 Etc.  Tip #2 (for your context): Make It Easy To Read Keep your thoughts and writing as succinct as possible. Example Article: How To Pass Actuarial Exams And Still Have a Life The study techniques you use are up to you. However, there are 9 important study methods to be aware of so you can choose the ones that best suit you. Studying for actuarial exams is a profoundly challenging activity. Throughout history, scholars and students have found that there are many different methods that can be used when one embarks on the journey of studying for exams. Many students have found there are a plethora of techniques available at their disposal. This means…  Tip #2 (for your context): Make It Easy To Read Keep your thoughts and writing as succinct as possible. Source: marketingexamples.com  Tip #3: Have A Great Introduction You need to: 1. Hook your reader, 2. tell them they are in the right place and 3. convince them to keep reading  Tip #3: Have A Great Introduction How do you do this?  Tip #3: Have A Great Introduction How do you do this? There are lots of tried and tested ways to do this. One example is to use the AIDA, method.  Example Introduction: “How To Pass Actuarial Exams And Still Have a Life” You don’t have to give up your social life to become an actuary.  Example Introduction: “How To Pass Actuarial Exams And Still Have a Life” You don’t have to give up your social life to become an actuary. Interesting facts Stories Personal connection with the audience  Example Introduction: “How To Pass Actuarial Exams And Still Have a Life” You don’t have to give up your social life to become an actuary. According to the XYZ survey carried out in 2023, 85% of actuaries don’t know the most efficient tools and techniques that can be used to study and pass their exams with only 10 hours of study per week. Interesting facts Stories Personal connection with the audience  Example Introduction: “How To Pass Actuarial Exams And Still Have a Life” You don’t have to give up your social life to become an actuary. According to the XYZ survey carried out in 2023, 85% of actuaries don’t know the most efficient tools and techniques that can be used to study and pass their exams with only 10 hours of study per week. E.g. Show the reader how the content will solve their problem.  Example Introduction: “How To Pass Actuarial Exams And Still Have a Life” You don’t have to give up your social life to become an actuary. According to the XYZ survey carried out in 2023, 85% of actuaries don’t know the most efficient tools and techniques that can be used to study and pass their exams with only 10 hours of study per week. E.g. Show the reader how the content will solve their problem. For example, by providing some proof.  Example Introduction: “How To Pass Actuarial Exams And Still Have a Life” You don’t have to give up your social life to become an actuary. According to the XYZ survey carried out in 2023, 85% of actuaries don’t know the most efficient tools and techniques that can be used to study and pass their exams with only 10 hours of study per week. We tested these tools and techniques on 10 actuarial students over 3 years, and they all qualified without failing a single exam. E.g. Show the reader how the content will solve their problem. For example, by providing some proof.  Example Introduction: “How To Pass Actuarial Exams And Still Have a Life” You don’t have to give up your social life to become an actuary. According to the XYZ survey carried out in 2023, 85% of actuaries don’t know the most efficient tools and techniques that can be used to study and pass their exams with only 10 hours of study per week. We tested these tools and techniques on 10 actuarial students over 3 years, and they all qualified without failing a single exam.  Example Introduction: “How To Pass Actuarial Exams And Still Have a Life” You don’t have to give up your social life to become an actuary. According to the XYZ survey carried out in 2023, 85% of actuaries don’t know the most efficient tools and techniques that can be used to study and pass their exams with only 10 hours of study per week. We tested these tools and techniques on 10 actuarial students over 3 years, and they all qualified without failing a single exam. Let’s walk through the 5 key tools and techniques all actuarial students should know about. Tip #3: Have A Great Introduction: Another Method To Consider Remember you have a busy target audience. It's often best to follow the bottom line up (BLUF) approach. BLUF is the practice of beginning a message with its key information. This provides the reader with the most important information first. Another Method To Consider: The Minto Pyramid Principle Read more on Google or here: https://www.barbaraminto.com/  Tip #4: Edit Like Your Life (Article) Depends On It How do you do this?  Tip #4: Edit Like Your Life (Article) Depends On It Rewriting and editing is difficult. Too many writers have very strong beginnings followed by mediocre middles and terrible endings simply because they have run out of editing steam. Remember that editing often takes as long or longer than writing, so be prepared to put the time in. Write then let it sit and come back with fresh eyes (do this numerous times). Read it aloud!  Tip #5: Use Adverbs Very Carefully Adverbs are words that add colour or emphasis to a verb (e.g., gently, quite, then, there). Lazy writers often use adverbs to modify a weak verb instead of searching for a stronger verb. Examples: In all three examples the strong verb paints a much more compelling picture of the action.  Tip #6: Avoid ‘Sticky’ Sentences A sticky sentence is one that is full of glue words. Glue words are the empty space that readers need to get through before they can get to your ideas. Dave walked over into the back yard of the school in order to see if there was a new bicycle that he could use in his class. Dave checked the school’s back yard for a new bicycle to use in class. Image Source: ProWritingAid  Tip #7: Vary Your Sentence Length: Write Music! To maintain your readers’ interest, use a variety of sentence lengths: some short and punchy, others long and flowing.  Tip #7: Vary Your Sentence Length: Write Music! “This sentence has five words. Here are five more words. Five-word sentences are fine. But several together become monotonous. Listen to what is happening. The writing is getting boring. The sound of it drones. It’s like a stuck record. The ear demands some variety.”  Tip #7: Vary Your Sentence Length: Write Music! “This sentence has five words. Here are five more words. Five-word sentences are fine. But several together become monotonous. Listen to what is happening. The writing is getting boring. The sound of it drones. It’s like a stuck record. The ear demands some variety.” “Now listen. I vary the sentence length, and I create music. Music. The writing sings. It has a pleasant rhythm, a lilt, a harmony. I use short sentences. And I use sentences of medium length. And sometimes when I am certain the reader is rested, I will engage him with a sentence of considerable length, a sentence that burns with energy and builds with all the impetus of a crescendo, the roll of the drums, the crash of the cymbals – sounds that say listen to this, it is important.” Gary Provost  Tip #8: Create A “Banned Words” List Examples: great, around, a lot, just, that, really, very, thing, much, unfortunate/fortunate, already, actual/actually, think  Tip #9: Start With An Outline Provides a framework to help assemble the ‘pieces.’ Prevents writer’s block. Helps to ensure you include all critical pieces. AI tools (e.g. ChatGPT) can be useful for this.  Tip #10: Avoid Weak Phrases “It seems,” “I think,” “I believe”. “I think all new trainee actuaries should learn at least one programming language”  Tip #10: Avoid Weak Phrases “It seems,” “I think,” “I believe” “I think all new trainee actuaries should learn at least one programming language” “All new trainee actuaries should learn at least one programming language” Tip #11: Always Keep In Mind Your Topic And Audience Who are you writing for? What problem are helping them to solve (if any)? What can I assume the reader already knows? Are there any subject matter experts I can speak to?  How To Make Your Content Valuable Add quotes from subject matter experts. Produce a graphic that helps the reader’s understanding of the topic. Add a completely new perspective or present a perspective in a different way. Provide tangible examples Final Tip… Rules Can Also Be Broken (some of the time) Summary of Key Points (according to Dilbert – Scott Adams) Source: https://dilbertblog.typepad.com/the_dilbert_blog/2007/06/the_day_you_bec.html Source: https://dilbertblog.typepad.com/the_dilbert_blog/2007/06/the_day_you_bec.html  How to be concise Be ruthless with your editing. When in doubt, delete it. Source: https://www.julian.com/guide/write/rewriting  How to be concise Be ruthless with your editing. When in doubt, delete it. Keep clutter out. Source: marketingexamples.com Your Essay Assignment  Your Assignment You are asked to produce a well-researched and practical online article on an actuarial topic. The topic can be on anything actuarial and will not necessarily be related to this course. The audience persona is a busy intelligent professional (not necessarily an actuary/actuarial trainee) seeking information. Think blog post article NOT academic essay. Meant to test your ability to communicate via the written word to a non- technical audience. I will send you your topic title and a suggested outline. Worth 10% of the module.  Your Assignment Good Examples of Online Writing: https://www.lemonade.com/blog/ai-can-vanquish-bias/ (an engaging read by InsurTech CEO, Daniel Schreiber, on bias in insurance) https://cxl.com/blog/storytelling/ (take note of the ‘scannable’ nature of this post (lots of bullet points, headers, images and short paragraphs), which makes it easy to read and digest) https://www.johnnicholas.org/writing-fisherman/ (The author, John Nicholas, is a South African Product Actuary working in Germany)