Floored, but not Capped
Defined benefit retirement fund based on @Risk
Palisade Conference
June 11, 2013
Dr. Ido Kallir
The Phoenix & MTA
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Background
The pension market in Israel is unique:
• As of 2005 all pension and provident funds are private
• As of 2008 pension plans are mandatory
The market value of the private pensions is ~250 Billion GBP and highly
competitive on both yields and fees. Yet, the common investment method
remained conservative and most funds weld to “one fits all" horizon and
risk.
Following the 2008 2008 crisis decided the Phoenix –the third largest
insurance & pension group in Israel to transform it's investment method.
The new model is based on passive investment rolling MVF and Life
Cycle
The task of turning an academic model into a sound, practical system
required methods and tools that are not typically used by traditional
“active” investors
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Principles
Investment in liquid indices (index funds)
Rebalance of asset allocation
Personal pension investment portfolio, tailored
to client characteristics and preferences
Life cycle over investment period
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The 1st stage
We utilize Palisade's @Risk package in three substantial stages of our model:
1. The correlation functions to simulate missing historical returns.
2. We use Campbell & Vicieria (2006) methods by clustering monthly returns into
long (up to 84 periods) . As these periods overlap, actual correlations may
distort. Current literature does not present statistical confidence level for an
acceptable level of overlapping. We simulated a "2000 years of trade" with
numerous scenarios and receive good confidence levels
3. Each individual has an exclusive investment scheme based on his age, current
wealth and taste for risk. The Asset allocation is modified periodically, following
a sigmoid shape that is best fitted to the life cycle model. Therefore, any
projection of one's Future Value and Value at Risk can be made only with a
strong simulation. @Risk allowed us to test several distributions and apply the
best fitting one in an easy to use manner.
3 years later, the Phoenix have 1.2 B USD of new assets under
management, being the fastest growing pension scheme in Israel.
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Israeli Indices: Asset Allocation
Tel-Aviv 100
Tel Bond Shekel
Tel Bond 20
Fixed interest government
bonds
Fixed 5+ years
T-bills
CPI linked government
bonds 0-2 years
CPI linked government
bonds 2-5 years
CPI linked government
bonds 5-10 years
8%
47%
23%
14%
17%
7%
15%
9%
9%
7%
15%
13%
9%
4%
18%
5%
3%
18%
27%
Investment Horizon
32%
Foreign Indices Asset Allocation
16%
22%
10%
14%
23%
$
Investment
Grade
12%
7%
JP
EMBI
6%
10%
21%
19%
13%
16%
28%
23%
14%
5%
5%
Libor
1M
13%
US Gov
3-7
EU STOXX 50
S&P
500
15%
10%
Investment Horizon
MSCI EM
2013 Challenge
On January 1st 2013, the treasury ordered the insurance
companies to stop selling pension plans with embedded Longevity
Risk insurance. This step had cut of the most profitable segment in
the insurance industry.
These policies are less then 26% of the assets under management,
yet the insured segment is responsible for 62% of industry’s
annual net profit
Some insurance companies developed option-based financial
products. These products were discarded by the treasury for
providing a short securitization horizon and for forcing a cap on the
annual return.
#:
The challenge: Develop a long-term financial simulation
should:
1. Guarantee long term (up-to 43 years) of floored return.
2. Not impose a cap.
3. Have realistic requirements of Capital Confinement.
4. Have transparent mathematical structure so the
Treasury's risk management board will be able to
understand and approve the model.
Do it fast
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Guidelines:
1. A limited number of “building blocks”: 16 indices in total, all liquid.
2. Fees, payments and returns are all in NIS
3. For each index- a full history providing, variance, correlation and
stress factors
4. A predefined investment scheme: we know how much we will
hold in each index in each future period
5. A modest guarantee: 3% nominal
Guarantee should be identical for all - the annual fees differ.
Therefore a different scheme should be set for:
• Different age groups – with different horizons
• The rate of initial deposit vs. annual deposit (different durations)
• Capping salary growth
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Expected fees
@risk allows us to build a specific program for each cluster
We find that the life cycle mechanism and the long investment horizons
permits fees that are significantly lower then quotes from investment
banks (flat for age and deposits at ~0.8%).
When simulating the fees, we find significant correlation between:
time to retirement and annual fee (-)
Initial deposit and fee(+)
Salary (deposits) and fee (+)
Net fees for fixed compensation
#Time to retirement
#43 years
Net fee (99%)
#Net fee (99.8%)
Net fees for one-time endownment
#Time to retirement
#43 years
Net fee (99%)
#et fee (99.8%)