Valuation DB Pensions Con Keating TUC conference, London, 2013 [email protected]...
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Transcript of Valuation DB Pensions Con Keating TUC conference, London, 2013 [email protected]...
2
Valuation is a Dark ArtComparison of Current and Possible Methods
Assets Liabilities Surplus %
Illustrative Scheme
132,017,010
117,735,917
14,218,094 112%
Pensions Act
186,030,788 182,433,905
3,596,884 102%
Accounting
186,030,788 222,631,806
36,601,018 84%
Gilt
341,353,967 222,631,806
118,722,161 153%
Asset Implied
186,030,788 153,468,329
32,562,459 121%
3
An accurate and unbiased approachThe method
• Start with the primary fair value condition• present value of contributions must equal the present value of the
promised pensions• This defines the internal growth rate (IGR) of a scheme• This is the weighted average cost of capital for a sponsor employer or
equivalently the weighted rate of return on contributions to pensioners.• In order to compare apples with apples:
– Project Liability Expense Cash-Flows– Project Asset Income Cash-Flows– Compare these at the Internal Growth Rate integral to the awards.
• This produces accurately accurate, stable and unbiased results• The reported liabilities are accurate and the scheme funding ratio correct
4
Cash Flow Projections• Asset cash flows – Bonds contractual and Equities constant real income.
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 82 85 88 91-100,000,000
-80,000,000
-60,000,000
-40,000,000
-20,000,000
0
20,000,000
40,000,000
60,000,000
-20,000,000
0
20,000,000
40,000,000
60,000,000
80,000,000
100,000,000
Income and Expense
Cash Deficit / Surplus Total Income Total Expense
Cash
-Flo
w S
urpl
us /
Defi
cit
Inco
me
and
Expe
nse
5
Estimating the IGR
1948 1954 1960 1966 1972 1978 1984 1990 1996 2002 2008 2014 2020 2026 2032 2038 2044 2050 2056 2062 2068 2074 2080 2086 2092 20980
20000
40000
60000
80000
100000
120000
140000
0
5000
10000
15000
20000
25000
IGR (7.68% )
Amortised Contributions Liabilities Accreted Contribution Sum Present Values
Solve for IGR under Pv(C) = Pv(P)
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Valuation Illustrative Scheme
92898683807774716865625956535047444138353229262320171411 8 5 2 1 4 7 101316192225283134374043464952555861646770737679828588910
50000
100000
150000
200000
250000
300000
350000
400000
0
10000
20000
30000
40000
50000
60000
70000
80000
90000
100000
Asset and Liability Cash-Flow Valuationat IGR
Amortised Contributions Present Value Asset (Market Price)
Liabilities (RHS) Asset Cash Flows (RHS) Discounted Liabilities
Sum Present Values Discounted Asset Cashflow Sum Present Value Asset Cash Flow
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Contributions• Contributions are amortised as pensions are paid and members die.
1964 & prio
r1966
19681970
19721974
19761978
19801982
19841986
19881990
19921994
19961998
20002002
20042006
20082010
0.00%
10.00%
20.00%
30.00%
40.00%
50.00%
60.00%
70.00%
80.00%
90.00%
100.00%
Contribution Amortisation
Proportion of Contribution Proportion of Total Cash Contributions
8
Conclusions• The proposed method is precise and accurate.• It is a fair value approach.• It outperforms all existing and many possible methods• It is decision and prediction useful.• It varies only with variation in pension and contribution factors.• It carries with it incentives for DB scheme provision .• And long-term investment.
• Current figures overstate the deficit • If there is a deficit, there are multiple ways of filling it, of which
higher contributions is only one. • It is right to be concerned that pension finances are sound• but it is also right to be sensible.
• And if time permits...
9
How long?Price and Information• The minimum length of time to distinguish
price signal from noise• If we assume normality in return, we can estimate these times:
• Only with high return, low volatility strategies are market prices informative. Everywhere else, we are working with noise.
0.03 0.04 0.05 0.06 0.07 0.08 0.09 0.1Average Return
0.1
1
10
100
1000
Volatility 0.05
Volatility 0.07
Volatility 0.09
Volatility 0.11
Volatility 0.13
Volatility 0.15
Volatility 0.17
Volatility 0.19
Minimum Time to Distinguish
Year
s (L
og)
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Convergence• Market prices are driven by fear and greed - Anomalies abound • Volatility is extremely high.• Prices drive returns – Beebower, Brinson. • Market returns are negatively correlated
with GDP growth out to about five years• This violates Arrow Debreu fixed point
efficient resource allocation equilibria.• But as we move to long holding periods,
income dominates and volatility declines.• Long term returns are positively
correlated with GDP growth• In other words, short term market price
moves converge to the long-term fundamentals and allocative efficiency
• But not if we use them as indicators for short-term management actions• Such as special contributions and management techniques like LDI which are hedging
regulatory and accounting nonsenses.
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Expected ReturnsCorporate Bonds• Suppose we have tow zero coupon bonds outstanding
both have the same maturity, but they were issued with different terms and conditions
• The bond-holder claims in insolvency differ – the issue terms matter
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 150
20
40
60
80
100
120
Seatbelts and Brakes
Funding 0.1 0.05 Valuation dateRoA B RoA Fifteen Ten