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Asset & LiabilitiesManagement from anindustrial point of view
january 2013
www.pwc.no
Pension reserve for a person
600,000
700,000
800,000
900,000
1,000,000
Illustrative
PwC
-100,000
0
100,000
200,000
300,000
400,000
500,000
20 30 40 50 60 70 80 90
leeftijd (jaar)
Re
se
rve
(eu
ro)
Age
Res
erve
Slide 2februar 2013Asset & Liabilities Management from an industrial point of view
Type pension fund
Deelnemersbestanden
150
200
250
Aan
tal
deeln
em
ers
per
leeft
ijd
Jong
Standaard
Oud
Nu
mb
ero
fm
emb
ers
young
standard
old
PwC
0
50
100
25 35 45 55 65 75 85 95Leeftijd
Aan
tal
deeln
em
ers
per
leeft
ijd
age
Nu
mb
ero
fm
emb
ers
Slide 3februar 2013Asset & Liabilities Management from an industrial point of view
Cash Flows- pension liabilities over time (for a’standard’ pension fund)
Current cash flows
0
5,000,000
10,000,000
15,000,000
20,000,000
25,000,000
30,000,000
35,000,000
40,000,000
cash flows 5 years from now
0
5,000,000
10,000,000
15,000,000
20,000,000
25,000,000
30,000,000
35,000,000
40,000,000
45,000,000
cash flows 10 years from now
0
5,000,000
10,000,000
15,000,000
20,000,000
25,000,000
30,000,000
35,000,000
40,000,000
45,000,000
50,000,000
cash flows 15 years from now
0
10,000,000
20,000,000
30,000,000
40,000,000
50,000,000
60,000,000
PwC
0
0 5 10 15 20 25 30 35 40 45 50 55 60
Time
0
0 5 10 15 20 25 30 35 40 45 50 55 60
Time
0
5,000,000
10,000,000
15,000,000
20,000,000
25,000,000
30,000,000
35,000,000
40,000,000
0 5 10 15 20 25 30 35 40 45 50 55 60
Be
dra
g
0
10,000,000
20,000,000
30,000,000
40,00,000
0 5 10 15 20 25 30 35 40 45 50 55 60
Bed
rag
0
0 5 10 15 20 25 30 35 40 45 50 55 60
TIme
0
0 5 10 15 20 25 30 35 40 45 50 55 60
TIme
Time Time Time Time
Slide 4februar 2013Asset & Liabilities Management from an industrial point of view
Changing environment
IFRS/IORP/Solvency 2
GovernanceEarly retirement
TrustAging Communication
PwC
Pension fund
RegulatorSocial security
Market riskEquity, interest rate
TransparencyLife-coursesaving plan
Financialsolid(ar)ity
Risk awareness
Slide 5februar 2013Asset & Liabilities Management from an industrial point of view
Risk Management Pension Fund
PENSION FUND
PwC
ASSETS LIABILITIES
Surplus
Slide 6februar 2013Asset & Liabilities Management from an industrial point of view
Risk Management Pension Fund
PENSION FUND
consultancy / ALM / risk management / governance
PwC
ASSETS LIABILITIES
Surplus
Investment Administration
Slide 7februar 2013Asset & Liabilities Management from an industrial point of view
Risk Management Pension Fund
0
10.0
00
20.0
00
30.0
00
40.0
00
50.0
00
60.0
00
70.0
00
80.0
00
90.0
00
2007
2008
2009
2010
2011
Fund
popula
tion
/accru
als
PwC
2013
2015
2017
2019
2021
2023
2025
2027
2029
2031
2033
2035
2037
Fund
popula
tion
/accru
als
surplusSlide 8
februar 2013Asset & Liabilities Management from an industrial point of view
Risk Management Pension Fund
0
10.0
00
20.0
00
30.0
00
40.0
00
50.0
00
60.0
00
70.0
00
80.0
00
90.0
00
2007
2008
2009
2010
2011
Fund
popula
tion
/accru
als
Investment risk
Risk management
Interest risk
PwC
2013
2015
2017
2019
2021
2023
2025
2027
2029
2031
2033
2035
2037
Fund
popula
tion
/accru
als
surplus
Balance Sheet risk
Longevity risk
Solvency risk
Slide 9februar 2013Asset & Liabilities Management from an industrial point of view
Assets & Liabilities Management
• Toolbox to support decision tre/ processes
• Instruments ALM
• Investment policies
• Premium payments
PwC
• Pension plan amendments
• Given liabilities -> optimal solution
• Liabilities are dependent on
• Member stock
• Pension plan
• Actuarial/ demographic principals (like mortality)
Slide 10februar 2013Asset & Liabilities Management from an industrial point of view
Risk Management - developments
• Greater focus on ERM (enterprise wide risk management)
• IORP/ Solvency 2
• Strategic, operational, compliance, reporting
• ALM
PwC
• Assets
• Asset classes
• Alpha and beta
• Liquidity, volatility
• Liabilities
• ’Pensjonsreformen’
Slide 11februar 2013Asset & Liabilities Management from an industrial point of view
Risk management = core
• Risk management is central in decision -tre in the board room
• Quantitative analyses
• External managers
• Asset classes
PwC
• Regulator focuses on
• Management financial risk/ solvency risk
• communication to pension fund members
• Operational and compliance risk
• Risk management aims to decide on a policy for the economic risks apension fund is exposed to.
Slide 12februar 2013Asset & Liabilities Management from an industrial point of view
Risk management- principals
• Management through guidelines and restrictions
• Control framework should have
• Ensure for all risks sources: identification,understanding and quantification
PwC
understanding and quantification
• Ensure that each assumption on risk is in line withinvestment goals
• Ensure that each risk is within the limits set by theboard
• Ensure that each risk is sufficient compensated
februar 2013Asset & Liabilities Management from an industrial point of viewSlide 13
Complexity in decision tree
• Regarding any decision, the board has to take into account
• Solvency ratio (assets/liabilities)
• Risk appetite
• Requests/demands different stakeholders
PwC
• Regulatory restrictions (Finanstilsynet, Solvency 2, IORP 2)
• Macro economical aspects / financial markets
• …
• Subjective assessment of the board
Slide 14februar 2013Asset & Liabilities Management from an industrial point of view
Asset management
….taking risk to achieve excess of return..
• Strategic asset allocation (90%)
• Tactic asset allocation (6%)
• Operational asset allocation (4%)
PwC
• Operational risk
• Selection/ timing
• External managers/ internal managers
• Monitoring
Slide 15februar 2013Asset & Liabilities Management from an industrial point of view
Asset classes - return
Large cap equities passive
Large cap equities enhanced
Large cap equities activeSmall cap equities passive
Active high yield bonds
commodities
Capitial Asset Pricing Model (CAPM):
R(asset)- R(risk free) = (asset)+ (asset) *[E(R(market)-R(risk free)] +Ɛ
PwC
Exotic
Equity long-short
Market neutral strategies
Private equity
Infrastructure
Active high yield bonds
Slide 16februar 2013Asset & Liabilities Management from an industrial point of view
Asset classes - risk
Equity developed
46%
Credits>1%
Interest rates and exchange risk 0%
PwC
Exotic
Equity EM5%
Private Equity9%
Hedge Funds9%
Real Estate29%
Commodities2%
Slide 17februar 2013Asset & Liabilities Management from an industrial point of view
Factor Model
Idiosyncratic return :weighted sum of individual
K
ititixtxtxtx rr
1,,,,,, )(
N
w )(
PwC
weighted sum of individualcontributions
Exposure to factors :weighted sum ofindividual exposures
j
tjtjtjtxtx w1
,,,,, )(
N
jtijtjtix w
1,,,,,
Slide 18februar 2013Asset & Liabilities Management from an industrial point of view
Factor Decomposition of Risk
What is the exposure of the risk factors?
xxFxsum BB '
PwCfebruar 2013Asset & Liabilities Management from an industrial point of view
Slide 19
What is the exposure of the risk factors?
What is the volatility of the risk factors?
What is the correlation of the risk factors?
What is investment risk?
• Different opnions
• Loss
• Volatility
• ..
PwC
• Time horizon
• Day, year, 30 year
• Different measure units
• Standard deviation
• Value at Risk (VaR)
• ..
Slide 20februar 2013Asset & Liabilities Management from an industrial point of view
Investment risk
• Risk described as probability distributions based on historicalinformation
• Risk is the potential for loss accepted by the investor in order to earna return.
• Three elements:
PwC
• Three elements:
- The range of possible losses
- The likelihood of a loss
- The impact of the loss on the organization.
februar 2013Asset & Liabilities Management from an industrial point of viewSlide 21
Investment risk:...probability distribution
1.5%
2.0%
2.5%surface: 100%
PwCfebruar 2013Asset & Liabilities Management from an industrial point of view
Slide 22
0.0%
0.5%
1.0%
1.5%
-33%
-23%
-13%
-3%
7%
17%
27%
37%
47%
50% probability withreturn 7%
...standard deviation
1.5%
2.0%
2.5%
PwCfebruar 2013Asset & Liabilities Management from an industrial point of view
Slide 23
0.0%
0.5%
1.0%
1.5%
-33%
-23%
-13%
-3%
7%
17%
27%
37%
47%
±1SD = 68%
±2SD = 95%
…or Value at Risk
1.5%
2.0%
2.5%
VaR 2,5% = -13%
PwCfebruar 2013Asset & Liabilities Management from an industrial point of view
Slide 24
0.0%
0.5%
1.0%
1.5%
-33%
-23%
-13%
-3%
7%
17%
27%
37%
47%
Interest rate risk Equity risk Alternative risk
Market risk
Exchange riskSpread risk
tap tap tap tap tap
Value-at-Risk
PwC
÷÷÷÷÷
1
1
1
21
221
112
L
MOMM
L
L
NN
N
N
rr
rr
rr- Gaussian/normal
- Student-t
- Bootstrapping
- Parametric
- Monte Carlo
- Historical Simulation - Solvens ratio
- Surplus
Value-at-Risk Methode
correlation
Value-at-Risk
Dependence Structure
Risk variablesSolvency ratio
Pro
ba
bil
ity
Value-at-Risk
februar 2013Asset & Liabilities Management from an industrial point of viewSlide 25
..reality...
1.5%
2.0%
2.5%Fat tails
skew
PwCfebruar 2013Asset & Liabilities Management from an industrial point of view
Slide 26
0.0%
0.5%
1.0%
1.5%
-33%
-23%
-13%
-3%
7%
17%
27%
37%
47%
reality
Diversification
30%
40%
average = 5,2%SD = 14,4%
For different time horizons
Correlation 30%
PwCfebruar 2013Asset & Liabilities Management from an industrial point of view
Slide 27
-20%
-10%
0%
10%
20%
1 2 3 4 5 6 7 8 9 10
Asset A
Asset B
average 3,8%SD = 7,8%
Diversification
average = 5,2%SD = 14,4%
Correlation 30%
average = 4,5%SD = 9,2%Diversification = 1,9%
PwCfebruar 2013Asset & Liabilities Management from an industrial point of view
Slide 28
average = 3,8%SD = 7,8%
Investment theory
CAPM as standard model
• Assumption perfect market
• Only return for non- diversifiable (systematic)risk
PwCfebruar 2013Asset & Liabilities Management from an industrial point of view
Slide 29
Exp
ect
ed
retu
rn
Risk increases, but lessthen proportional
Return increasesproportional
Investment theory
PwCfebruar 2013Asset & Liabilities Management from an industrial point of view
Slide 30
Exp
ect
ed
retu
rn
Efficient FrontierMaximal (expected) return per
unit risk
Combining different assetclasses the ‘efficient frontier’
moves up
Investment theory
PwCfebruar 2013Asset & Liabilities Management from an industrial point of view
Slide 31
Forv
ente
tavk
ast
nin
g Capital Market LineWith risk-free investment/
leverage the efficiencyincreases even more
Marketsportfolio
Risk-freeinvestment
Investment policy
• Strategic asset allocation
• Hedging risk
• Assessment new asset classes
• Diversification
PwC
• …
• Risk and return (reward) of the investments are assessed in light ofpension liabilities
• Status: Solvency ratio
• Movements : premium and pension payments
Slide 32februar 2013Asset & Liabilities Management from an industrial point of view
Complexity investment decisions
• An investment policy is ’good’ when
• Risk is lower or unchanged, and
• Return is higher or unchanged,
For all variables
PwC
• But what if
• Risk and return are both lower, or
• Risk and return are both higher, or
• Risk and return has not improved for all variables
• In these cases the board has to decide based on subjectivity
Slide 33februar 2013Asset & Liabilities Management from an industrial point of view
Investments philosophy
• Assets allocation or risk management
• Passive/ active risk
• Exchange risk/ interest rate risk
• Choice of asset classes/ - instruments
• Traditional investments
PwC
• Traditional investments
• Alternative investments
• Geography
• Alternatives
• Active or passive asset management
• Optimal portfolio allocation
• Outcome ALM analyses
• Strategic decisions and consequences on return on investments
Slide 34februar 2013Asset & Liabilities Management from an industrial point of view
Risk / return
• No reward (return) without taking risk
• Definition risk
• Fluctuations on market value investments
PwC
• Fluctuations on market value liabilities
• Investment policy in light off liabilities
Slide 35februar 2013Asset & Liabilities Management from an industrial point of view
Risk budgeting
3 levels for risk budgeting :
Strategic risk budgeting (solvency ratio- risk)
Tactical risk budgeting
Active risk budgeting
PwC
Tool box:
avoid , reduce, transfer, and accept
Measure instruments:
Internal risk model with flexible time horizon (ALM)
Stress testing: historical, regulatory, mismatch, ...
Slide 36februar 2013Asset & Liabilities Management from an industrial point of view
ALM Top Down Approach
Asset-Only Analysis
• Establish and monitorbenchmark risk budgets ofmanagers for each fund andeach security
ASSETS / LIABILITIESASSETS / LIABILITIES
DEKKINGSGRAAD
Ka
ns
dic
hth
eid
FUNDED RATIO
SA
NN
SY
NL
IGH
ET
Risk budgeting
PwC
Bottom Up Integral Approach• Establish and monitor risk
budgets taking into account allidentified marked risks on alllevels
ALM Top Down Approach
• Establish and monitorbenchmark risk budgets
TITLERTITLER
FONDFOND
ASSET KATEGORIASSET KATEGORI
MANAGERSMANAGERS
STATEGISK / TAKTISKSTATEGISK / TAKTISK
ASSETS / LIABILITIESASSETS / LIABILITIES
INCOME / GROWTHINCOME / GROWTH
februar 2013Asset & Liabilities Management from an industrial point of viewSlide 37
Interest rate risk term structure- Top downDiscount rate = 3,3%
Pensjonsmidler Forpliktelser
Equities 42 Pension Liabilities 100Property 35 Surplus 40
Fixed Income 63140 140
Discount rate = 2,6%
Pensjonsmidler Forpliktelser
Equities 42 Pension Liabilities 111
Property 35 Surplus 32
Fixed Income 66
PwCfebruar 2013Asset & Liabilities Management from an industrial point of view
Slide 38
Fixed Income 66143 143
-15 %
-10 %
-5 %
0 %
5 %
10 %
15 %
20 %
-1,10%
-1,00%
-0,90%
-0,80%
-0,70%
-0,60%
-0,50%
-0,40%
-0,30%
-0,20%
-0,10%
0,00%
0,10%
0,20%
0,30%
0,40%
0,50%
0,60%
0,70%
0,80%
0,90%
1,00%
1,10%
Interest rate change
Change in Solvens Ratio
Interest rate risk term structure
2,50 %
3,00 %
3,50 %
spot (zero)
forward
Interest Rate Term Structure and Forward curve
PwCfebruar 2013Asset & Liabilities Management from an industrial point of view
Slide 39
0,00 %
0,50 %
1,00 %
1,50 %
2,00 %
0 10 20 30 40 50 60
Liabilities pension fund - cash flows
200,00
250,00
300,00
PwCfebruar 2013Asset & Liabilities Management from an industrial point of view
Slide 40
-
50,00
100,00
150,00
1 6 11 16 21 26 31 36 41 46 51 56 61 66 71 76 81 86 91 96
Interest rate risk term structure- parallel shift
2,50 %
3,00 %
3,50 %
4,00 %Interest rate term structure: current and parallel shift
PwC
0,00 %
0,50 %
1,00 %
1,50 %
2,00 %
2,50 %
0 10 20 30 40 50 60
spot (zero)
S_up
S_down
Slide 41februar 2013Asset & Liabilities Management from an industrial point of view
Liabilities pension fund – net cash flows
40 000
60 000
80 000 S1+
S1-
PwC
-60 000
-40 000
-20 000
-
20 000
1 4 7 10 13 16 19 22 25 28 31 34 37 40 43 46 49 52 55 58 61 64 67 70 73 76 79
Slide 42februar 2013Asset & Liabilities Management from an industrial point of view
Interest rate risk term structure-Historical changes
4
5
6
7
PwC
0
1
2
3
1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41 43 45 47 49
22/04/09 level+ level- twist+ twist- curvature+ curvature-Curve
Confidence level: 97.5% ; Time horizon: 1 year
Zero coupon curve; PC1: Level; PC2: Twist ; PC3: Curvature
Slide 43februar 2013Asset & Liabilities Management from an industrial point of view
0.4
0.5
0.6
0.7
0.8
0.9
1
Discount Factor Decomposition-Principal Components
PwC
Discount Curves; PC1: Level; PC2: Twist ; PC3: Butterfly
Confidence level: 97.5% ; Time horizon: 1 year
0
0.1
0.2
0.3
1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41 43 45 47 49
22/04/09 level+ level- twist+ twist- curvature+ curvature-
44
Liabilities - cash flowsPrincipal Component- Level
40 000
60 000
80 000
100 000PC1+
PC1-
PwC
-80 000
-60 000
-40 000
-20 000
-
20 000
1 4 7 10 13 16 19 22 25 28 31 34 37 40 43 46 49 52 55 58 61 64 67 70 73 76 79
Slide 45februar 2013Asset & Liabilities Management from an industrial point of view
Liabilities - cash flowsPrincipal Component- Twist
10 000
20 000
30 000
40 000 PC2+
PC2-
PwC
-40 000
-30 000
-20 000
-10 000
-
10 000
1 4 7 10 13 16 19 22 25 28 31 34 37 40 43 46 49 52 55 58 61 64 67 70 73 76 79
Slide 46februar 2013Asset & Liabilities Management from an industrial point of view
Liabilities - cash flowsPrincipal Component- Curvature
4 000
6 000
8 000
10 000 PC3+
PC3-
PwC
-8 000
-6 000
-4 000
-2 000
-
2 000
1 4 7 10 13 16 19 22 25 28 31 34 37 40 43 46 49 52 55 58 61 64 67 70 73 76 79
Slide 47februar 2013Asset & Liabilities Management from an industrial point of view
0
500
1000
1500
2000
2.5
12.5
22.5
32.5
42.5
52.5
62.5
72.5
82.5
92.5
Ca
sh
Flo
ws
(mln
.e
uro
)Liabilities
Fixed Income
Nett
Cash Flows (example)
PwC
Annual cash flows of net pension liabilities
1500
1000
500 2.5
12.5
22.5
32.5
42.5
52.5
62.5
72.5
82.5
92.5
Maturity (5-year buckets)
Ca
sh
Flo
ws
(mln
.e
uro
)
48
Thank you for your attention
Urmila KisoenActuary CEFA
Senior [email protected] 64 279
© 2013 PwC. Med enerett. I denne sammenheng refererer "PwC" seg til PricewaterhouseCoopers AS, AdvokatfirmaetPricewaterhouseCoopers AS, PricewaterhouseCoopers Accounting AS og PricewaterhouseCoopers Skatterådgivere ASsom alle er separate juridiske enheter og uavhengige medlemsfirmaer i PricewaterhouseCoopers International Limited.
982 64 279