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PRMIA Meeting 16 July 2003

abcd. PRMIA Meeting 16 July 2003 . Liability Benchmark Portfolio The relationship between Pension assets and liabilities Institute/Faculty Working Party.

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PRMIA Meeting 16 July 2003

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  1. abcd PRMIA Meeting16 July 2003 Liability Benchmark PortfolioThe relationship between Pension assets and liabilitiesInstitute/Faculty Working Party

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

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

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

  5. The liabilities

  6. Liability benchmark portfolio is the portfolio of assets such that, in the absence of future contributions, benefit accrual or random fluctuations around demographic assumptions, the scheme maintains its current solvency level (the ratio of assets to liabilities) as economic conditions change. What is the LBP? As at 1 January 2003 PV = £175m

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

  8. LBP v asset returns

  9. LBP v asset returns

  10. LBP v asset returns

  11. LBP v asset returns

  12. LBP v asset returns

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

  14. Yield curves at 1 January 2002

  15. Yield curves at 1 January 2003

  16. needs to be dynamic – changes with economic conditions Does not capture demographic changes No allowance for the benefit outgoes and contributions paid Limitations of the LBP • Regular re-estimation mitigates these risks

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

  18. “Debt on the employer” is the full buy-out cost Clarifies the nature of the pension promise Pension Protection fund Cost estimated at £340-375m Premiums based in flat levy and “risk-based” premium 11th June – White Paper

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

  20. abcd PRMIA Meeting16 July 2003 Liability Benchmark PortfolioThe relationship between Pension assets and liabilitiesInstitute/Faculty Working Party

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