Banks IPS -Constraints Time - Short - Linked to duration of liabilities Taxes - Taxable - After tax return is objective Liquidity - Short and Liquid Driven by bank w/ds and loan demands
Trang 11. Banks IPS
-Constraints
Time - Short - Linked to duration of liabilities Taxes - Taxable - After tax return is objective Liquidity - Short and Liquid Driven by bank w/ds and loan demands
Legal - RBC Guidelines Unique - None
-Return &
Risk
Risk - VAR Measures the size/sensitivity of A&Ls
LADG Leverage adjusted duration Gap -Duration of Bank Ass - Lev duration of Bank Liabilities
LADG - Predicts the change of MV of bank equity cap if In Rates change
Use ALM Framework - Below Average Risk Tolerance
Return - Positive Interest Rate Spread (Over cost of funds)
-Objectives
Directives come from the place of the securities portfolio in the A&L structure of the bank Portfolio is excess funds not lent out
Primary goal is to try to match the liabilities (deposits) and assets (Loans)
It's easier to adjust the characteristics of Invesment vs Assets and Liabilites, so portfolio duration is liability duration, unless manager wants to take duration risk Income is looked at last
4.Cash
Balance Plan
Credited each year w/ a pay credit and Int
Credit Sponsor bears investment risk
At retirement, you choose annuity or Lump Sum R/O
Management
Focuses on Short term changes in the liability
vs Changes in interest rates - Works best when pension is short term - near bankruptcy
IPS
-Constraints
Time - Perpetual Taxes - Tax Free - Watch UBTI Liquidity - Usually Low - Large Improvements may require liquidity
Legal - 501c3 and UMIFA Adoption - Prudent Investor Rule
Unique - Social Issues / Asset Class restrictions
- IPS - Risk &
Return
Risk Affected by need for outside funding
-% of funding needed Concerns are portfolio volatility and spending volatility
Return - Preserving Real Purchasing Power is Paramount Focus on TOTAL return, match inflation to inflation of the endowment
- Spending Rules
Examples:
Simple = Spending rate x $ Rolling 3 year average market value x Spending rate
Geometric Spending Rate - Smoothed Rate Calc
discount either before or after tax
IPS -Constraints
Time Horizon - Usually Infinite Tax Consid - Few UBTI Liquidity - Based on Spending Rules - Usually 5% of year end assets could leave a fraction
of annual spending as cash reserve
Legal - UMIFA Standards - Prudent Investor Rule
Unique - Foundation Specific - Moral/ethical investing is common
- IPS - Risk &
Return
Risk - Tend to be more aggressive then pensions - Based on time horizon Return - Driven by a formula like Req Payout + Inflation
VS Endowments
Foundations: Grant Making Entities Endowments: Long Term funds owned by non profit firms for OPS
vs DB Plan
IPS for DC Plan: Sponsor must provide:
1 At least 3 choices that allow for diversification and provide for free movement between investments
2 Education/Guidance
3 Limit Exposure to Company Stock
14.Liability Mimicking
For Satisfying future liability - use best mixture
of Nom Bonds Tips and Stocks
Cons The Liability portfolio will be costly and not provide a return above liability future services rendered and future participants calculations are uncertain and not modeled or pre-funded additional plan deposits will be required
For Pensions, it's best to use the liability portfolio as a benchmark not to actually implement it
15.Liability Relative Management
- Actives
Actives get divided into 2 categories:
1 Obligation for past service - acts like inactive
2 Obligations for future service - Uses % growth in wages and Calc NPV
If wage growth is at rate of inflation use real return on bonds as benchmark
If wage growth is above inflation, mimic w/ stocks
CFA Level 3 Book 2 - Managing Institutional Portfolios
Trang 216. Liability Relative
Management
-Inactive
For Active Pensions Best to decompose the Liabilites:
Inactive (retired or not working and not
of age) and Active (Currently working for the firm)
Inactives Future Benefits could be accrued as Fixed, inflation adjusted or indexed to inflation Use assets that mirror each of these
Companies
-Disintermediation
Risk
When Int Rates are high, Policy holders are likely to w/d cash This creates increased liquidity Over time Duration and Horizon have decreased
Companies - IPS
- Constraints
Time - Getting Shorter Taxes - High
Liquidity ALM, Marketability Risk -Surplus has little liquidity need
Legal/Reg - Heavy Regulations at state level Prudent Investor Rule, Specific Valuation Rules, Elligable Investment restrictions
Unique - Concentration of product offering, company size and Surplus
Companies - IPS
- Risk & Return
Objectives - NAIC requires an Asset Valuation Reserve (AVR) as reserve against losses There is a movement toward Risk Based Capital with means More Risk = More Reserve
Risks:
Valuation Risk - Duration of assets should
be close to duration of liabilities - ALM Management
Reinvestment Risk - Important for Guaranteed Products
Cash Flow Volatility - Reinvesting income
at good rates
Credit Risk on Debt
Return:
Shoot for Net Interest Spread - Greater than actuarial to grow surplus
Match/Segment Investment portfolios by business line
Mostly fixed in the portfolio until you hit surplus
Liabilities to
Assets
Asset Only Approach - Focus on selecting efficient portfolios This ignores that future liabilities could be subject to market risk
Better Solution:
Asset Allocation that recognizes Economic Liability
Liability Reserve Approach - Portfolio Mimics Liability Risk free Asset becomes the portfolio that mimics the liability
Companies - Health &
P&C - Characteristics
ALM Shorter Product Life Claims can be long tailed if disputed
Inflation Risk - Replacement Coverage
Timing is harder to predict then Life Underwriting has a "Profitability Cycle" - Reduce to retain customers, will reduce surplus
Operating Results are more variable then life
Companies IPS -Constraints
Time Horizon - Short - In periods of company loss you can use taxable bonds
Taxes- Taxable Companies - After Tax return is objective
Liquidity - Needs are high Typically mmkt, T-bills, laddered bonds, ALM matching
Legal - Less onerous than life insurance Risk based capital requirements are established Unique - Financial Status of firm, management or risk, and liquidity requirements
Companies IPS -Objectives
Risk - Quasi fiduciary requirement / geographic concentration risk Inflation Risk
Cash flows are erratic and unpredictable
Common Stock / Surplus Ratio has challenges
Return - LOW RISK - Key Factors - Comp Pricing - High Returns allow you to reduce prices
Profitability - Inv Income and ROI are Primary part of Comp Profit Surplus - More Surplus , More Ins you can sell
Total Return - Active Port Management is a focus, varied product mixes, returns vary among companies
Exposures: Liability Noise (2 types)
1 Plan demographics - More predicable to for large plans
2 Model Uncertainty - Less predictable (i.e Mortality of retirees when will deferreds retire?)
Trang 325.Pension IPS - Constraints Time Horizon - Termination Date or Active Lives vs Retired Lives
Taxes - (Unlikely anything is taxable) Liquidity - % of retired lives, $ of Contributions vs Ret Payout, Plan Features (Lump Sum) Legal/Reg - Erisa Rules, Pension Trustee is a Fiduciary
Unique Circ - ?Self Imposed Restrictions to Asset classes ETC
Return - Minimum Return should be Discount Rate used for PBO
2 Companies Financial Status UP Risk Tolerance UP
3 Company and Pension Fund Correlation UP Risk DOWN
4 Plan Features - Lump Sum Avail > Liquidity UP Risk DOWN
5 Workforce Characteristics - Younger Work Force Risk Tol UP