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The Pension Crisis
Ryan ALM, Inc. - The Solutions Company
1-888-RyanALM
www.ryanalm.com
Index
Returns
YTD 2011
Estimated
Weights
Liabilities :
Market (Tsy STRIPS)
FAS 158 (AA Corporates)
PPA
(3 Segment)
PPA
(Spot Rates)
GASB /ASOP (8% ROA)
33.77 %
19.58
14.56
18.93
8.16
100 %
Assets :
Ryan Cash
Lehman (Barclay)Aggregate
S&P 500
MSCI EAFE Int’l
0.31 %
7.85
2.10
-11.68
5%
30
60
5
3.27 %
100 %
Asset Allocation Model
Assets – Liabilities
Market
FAS 158
PPA (3 Segment)
PPA (Spot Rates)
GASB/ASOP (8% ROA)
(Copyright Ryan ALM, Inc. 2011 …All Rights R
- 30.50%
- 16.31
- 11.29
- 15.66
- 4.89
Ryan ALM, Inc.
The Solutions Company
1- 888-Ryan-ALM
www.RyanALM.com
2
Total Returns
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
Assets
-2.50
-5.40
-11.41
20.04
8.92
4.43
12.25
6.82
-24.47
19.43
11.89
3.27
Liabilities
25.96
3.08
19.47
1.96
9.35
8.87
0.81
11.76
33.93
-19.52
10.13
33.77
-28.46
-8.48
-30.89
18.08
-0.43
-4.44
11.44
-4.94
-58.40
38.95
1.76
-30.50
-37.60
-73.40
-60.08
-66.13
-76.75
-64.60
-78.38
-181.57
-106.94
-115.67
-195.73
Difference:
Annual
Cumulative
Ryan ALM, Inc.
The Solutions Company
1- 888-Ryan-ALM
www.RyanALM.com
3
Pension Deficits
(Estimated)
Private Plans
- $ 477 billion
Public Plans
- $ 3.4 trillion
Sources : Credit Suisse
Prof. Robert Marx Novy, Joshua Rauh
4
4
Ryan ALM, Inc.
The Solutions Company
1- 888-Ryan-ALM
www.RyanALM.com
5
Ryan ALM, Inc.
The Solutions Company
1- 888-Ryan-ALM
www.RyanALM.com
6
Actuarial Gain/Loss
___________________
Actual Return on Assets - ROA Forecast
____________________________________
Average Life of Pension (Duration)
Actuarial Gain/Loss = Goes directly to EPS
Since 12/31/99 = Heavy hit to EPS
Ryan ALM, Inc.
The Solutions Company
1- 888-Ryan-ALM
www.RyanALM.com
7
Ryan ALM, Inc.
The Solutions Company
1- 888-Ryan-ALM
www.RyanALM.com
8
Ryan ALM, Inc.
The Solutions Company
1- 888-Ryan-ALM
www.RyanALM.com
9
10
10
NYCERS Actuarial Report
_______________________
“The financial objective of the New York City Employees
Retirement System is to fund members’ retirement benefits during
their active service and to establish employer normal contribution
rates that, expressed as a percentage of active member annualized
covered payroll, would remain approximately level over the future
working lifetimes of those active members and together with
members’ contributions and investment income, would ultimately
be sufficient to accumulate assets to pay benefits when due.”
Ryan ALM, Inc.
The Solutions Company
1- 888-Ryan-ALM
www.RyanALM.com
11
12
12
Problem : Liability Valuation
_________________________
Single Discount Rate
Not market interest rates
(GASB, ASOP = ROA, PPA = 2 year weighted average)
Present Value calculated annually/triennially
(Months delinquent)
Liability Term Structure not transparent
(Short, Intermediate, Long, Very Long)
Ryan ALM, Inc.
The Solutions Company
1- 888-Ryan-ALM
www.RyanALM.com
13
Problem : ROA (Return On Asset)
______________________________
FASB = Offset to Pension Cost (Actuarial G/L)
GASB = Discount Rate on Liabilities
Significantly undervalues liabilities
ROA = 8%
Long Treasury = 3%
Yield Difference = 5%
Yield Difference x Duration
= PV $ Difference
5%
x 10-15 years = 50% to 75% error
Used as Hurdle Rate for assets
Asset Allocation models used to validate ROA
Ryan ALM, Inc.
The Solutions Company
1- 888-Ryan-ALM
www.RyanALM.com
14
ROA and Contributions
____________________________________________________________
ROA = Growth rate used to calculate Contributions (ONLY value)
Contribution = Asset $ Growth – Liability $ Growth (if negative)
Example: Funded Ratio = 60% (40% Deficit)
Year 1
Year 2
Year 3
Year 4
Year 5
Year 6
Assets
$60.00
64.80
69.98
75.58
81.63
88.16
Growth Rate = 8% ROA
$ Growth
Liabilities $ Growth
$ 4.80
$100.00
$ 8.00
5.18
108.00
8.64
5.60
116.64
9.33
6.05
125.97
10.07
6.53
136.05
10.88
7.05
146.93
11.72
Contribution
$ Cost % Increase
$ 3.20
3.46
8.13%
3.73
16.56
4.02
25.63
4.36
36.25
4.67
45.94
Note: Requires an ROA = 13.33% to not increase Contribution costs
Assets > Liability growth by 5.33% per year (Level Contributions)
15
ROA and Contributions
____________________________________________________________
ROA = Growth rate used to calculate Contributions (ONLY value)
Contribution = Asset $ Growth – Liability $ Growth (if negative)
Example: Funded Ratio = 140% (40% Surplus)
Year 1
Year 2
Year 3
Year 4
Year 5
Year 6
Assets
$100.00
108.00
116.64
125.97
136.05
146.93
Growth Rate = 8% ROA
$ Growth
Liabilities $ Growth
$ 8.00
$ 71.43
$ 5.71
8.64
77.14
6.18
9.33
83.32
6.66
10.07
89.98
7.20
10.88
97.18
7.77
11.72
104.95
8.40
Contribution
$ Cost % Increase
$ NA
NA
NA
NA
NA
NA
Note: Requires an ROA = 5.72% for NO Contribution costs
Assets < Liability growth by -2.28% per year (NO Contribution)
Surplus Strategy: Immunize… Asset Growth = Liability Growth (NO Contribution)
16
Ryan ALM, Inc.
Assets vs. Liabilities Funding Ratio
(Asset Allocation (30% Bonds/60% Equity/5% Int'l/5% Cash)
12/31/1988 - 12/31/2011
180.0
156.5
160.0
140.0
120.0
100.0
80.0
60.0
65.0
55.8
40.0
20.0
0.0
88
89
90
91
92
93
94
95
96
97
98
99
00
01
02
Ryan ALM, Inc.
The Solutions Company
1- 888-Ryan-ALM
www.RyanALM.com
03
04
05
06
07
08
09
10
11
17
18
18
Custom Liability Index (CLI)
_______________________________
Create a set of Economic Books in harmony with SoA directive
Based on Market Value
Built as a Liability Index series
Provide a Proper Benchmark for the Asset side to function efficiently
Asset Allocation
Asset Management
Performance Measurement
Ryan ALM, Inc.
The Solutions Company
1- 888-Ryan-ALM
www.RyanALM.com
19
Asset Allocation
________________
Based on “Funded Ratio” (Assets/Liabilities)
Separate Assets into Beta Assets and Alpha Assets
Requires Custom Liability Index to Measure MV of Liabilities
Large Deficit = Different Asset Allocation than Small Deficit
Should be Responsive (Dynamic or Tactical)
Ryan ALM, Inc.
The Solutions Company
1- 888-Ryan-ALM
www.RyanALM.com
20
True Alpha
__________
Requires CLI to Measure Liability Growth (Returns)
Actual Return of Alpha Portfolios
- Actual Return of Liabilities
-----------------------------------------True Alpha
Ryan ALM, Inc.
The Solutions Company
1- 888-Ryan-ALM
www.RyanALM.com
5.00%
- 5.00%
-------10.00%
21
Liability Beta Portfolio
___________________
Matches Return of Objective
Pension Objective = Liability Driven
Beta = Asset / Liability Matched Portfolio
Liability Beta = Liability Index Fund
Requires Custom Liability Index
Ryan ALM, Inc.
The Solutions Company
1- 888-Ryan-ALM
www.RyanALM.com
22
Contributions
____________
Contributions = Asset growth – Liability growth (if negative)
Contributions = used to fund Liabilities
Current Assets fund net Liabilities
Enhances Funded Ratio
Ryan ALM, Inc.
The Solutions Company
1- 888-Ryan-ALM
www.RyanALM.com
23
Asset Allocation
_____________
a.
b.
c.
d.
e.
f.
Market Value of Assets
Market Value of Liabilities
Funded Ratio
Contributions (present value)
Net Liabilities
Net Funded Ratio
$ 560,000,000
$ 1,000,000,000
%
56.00
$ 200,000,000
$ 800,000,000
%
70.00
Net Deficit
---------------------------- = Annual Target Alpha
Duration of Liabilities
30%
------------ = 2.5% Annual Target Alpha
12 years
Ryan ALM, Inc.
The Solutions Company
1- 888-Ryan-ALM
www.RyanALM.com
24
Asset Allocation
_____________
g. Annual Target Alpha = 2.5%
h. YTM of Custom Liability Index (CLI) = 3.0%
i. ROA of Alpha assets = 7.00%
Annual Target Alpha / (ROA – YTM of CLI) = Allocation to Alpha assets
2.5% / (7.00% - 3.00%) = 2.5% / 4.00% = 62.5% Alpha Allocation
100% - Alpha Allocation = Beta Allocation = 37.5%
Ryan ALM, Inc.
The Solutions Company
1- 888-Ryan-ALM
www.RyanALM.com
25
Ryan ALM, Inc.
The Solutions Company
1- 888-Ryan-ALM
www.RyanALM.com
26
Solution: Portable Alpha
___________________________
Transfer (Port) Excess Returns above Objective Index
from
to
Alpha Portfolio(s)
Beta Portfolio
Requires Custom Liability Index = Liability Objective
Beta Portfolio = matches and funds Liabilities
Secures Victory! Reduces Funded Ratio Volatility!
Ryan ALM, Inc.
The Solutions Company
1- 888-Ryan-ALM
www.RyanALM.com
27
Portable Alpha
(Benefits)
___________
As Portable Alpha Transfers Excess Returns above Liability Index
Beta Portfolio grows and grows… creating 4 Major Benefits :
1. Reduces Contribution Costs (Fully Funds Liabilities)
2. Reduces Interest Rate Risks (Hedges Liabilities)
3.
4.
Increases Funded Ratio (Client Objective)
Increases Certainty of Meeting Objective
Ryan ALM, Inc.
The Solutions Company
1- 888-Ryan-ALM
www.RyanALM.com
28
Solution: Rates Go Up (5 Years)
_______________________________
Liabilities:
Interest Rates go up (+80 bps per year)
30-yr U.S. Treasury = 3.00% >> 7.00%
Growth Rate
= ( 5.00%) Annual
Note: Liabilities behave like long bonds
Assets
Liabilities
Alpha (Annual)
------- Annual Growth Rate ------5%
6%
7%
8%
- 5%
-5%
- 5%
- 5%
10%
11%
12%
13%
Funding Ratio = 50%
89%
94%
98%
103%
60%
101%
109%
115%
120%
ns Company
1- 888-Ryan-ALM
www.RyanALM.com
29
Solution: Liability Alpha
_____________________
Focus:
Funded Ratio not the ROA
Asset Growth > Liability Growth
Example:
Funded Ratio = 60%
Asset Growth = 6% Liability Growth = - 5%
Assets outgrow Liabilities by 11% per year (Alpha)
Start
Year 1
Year 2
Year 3
Year 4
Year 5
Assets
$ 60.00
$ 63.60
$ 67.42
$ 71.46
$ 75.75
$ 80.29
Liabilities
$ 100.00
$ 95.00
$ 90.25
$ 85.74
$ 81.45
$ 77.38
Funded Ratio Contribution
60.00%
$3.20
66.95%
$2.41
74.70%
$1.64
83.34%
$1.03
93.00%
$0.43
103.76%
NA
Note: Contribution calculated on Asset/Liability Growth = 8% (ROA)
30
Performance Measurement
_______________________
Compares Assets vs. Objective
Objective = Custom Liability Index
Requires CLI to Measure Performance vs. Liabilities
Requires CLI to measure RISK and ALPHA
Ryan ALM, Inc.
The Solutions Company
1- 888-Ryan-ALM
www.RyanALM.com
31
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32
Ryan ALM, Inc.
The Solutions Company
1- 888-Ryan-ALM
www.RyanALM.com
33
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