Joined-Up Pensions Policy in the UK: An Asset-Libility Model for Simultaneously Determining the Asset Allocation and Contribution Rate
The trustees of funded defined benefit pension schemes must make two vital and inter-related decisions - setting the asset allocation and the contribution rate. While these decisions are usually taken separately, it is argued that they are intimately related and should be taken jointly. The objective of funded pension schemes is taken to be the minimization of both the mean and the variance of the contribution rate, where the asset allocation decision is designed to achieve this objective. This is done by splitting the problem into two main steps. First, the Markowitz mean-variance model is generalised to include three types of pension scheme liabilities (actives, deferreds and pensioners), and this model is used to generate the efficient set of asset allocations. Second, for each point on the risk-return efficient set of the asset-liability portfolio model, the mathematical model of Haberman (1992) is used to compute the corresponding mean and variance of the contribution rate and funding ratio. Since the Haberman model assumes that the discount rate for computing the present value of liabilities equals the investment return, it is generalised to avoid this restriction. This generalisation removes the trade-off between contribution rate risk and funding ratio risk for a fixed spread period. Pension schemes need to choose a spread period, and it is shown how this can be set to minimise the variance of the contribution rate. Finally, using the result that the funding ratio follows an inverted gamma distribution, shortfall risk and expected tail loss are computed for funding below the minimum funding requirement, and funding above the taxation limit. This model is then applied to one of the largest UK pension schemes - the Universities Superannuation Scheme
|Date of creation:||Sep 2005|
|Date of revision:|
|Publication status:||Forthcoming in Handbook of Asset and Liability Management, edited by Stavros A. Zenios and William T. Ziemba, North Holland Handbooks in Finance, Elsevier Science B.V., Volume 2.|
|Contact details of provider:|| Postal: |
Phone: +44 (0) 118 378 8226
Fax: +44 (0) 118 975 0236
Web page: http://www.henley.reading.ac.uk/
More information through EDIRC
References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- John L. G. Board & Charles M. S. Sutcliffe, 1994. "Estimation Methods in Portfolio Selection and the Effectiveness of Short Sales Restrictions: UK Evidence," Management Science, INFORMS, vol. 40(4), pages 516-534, April.
- Haberman, S., 1994. "Autoregressive rates of return and the variability of pension contributions and fund levels for a defined benefit pension scheme," Insurance: Mathematics and Economics, Elsevier, vol. 14(3), pages 219-240, July.
- Haberman, Steven, 1997. "Stochastic investment returns and contribution rate risk in a defined benefit pension scheme," Insurance: Mathematics and Economics, Elsevier, vol. 19(2), pages 127-139, April.
- Ederington, Louis H, 1979. "The Hedging Performance of the New Futures Markets," Journal of Finance, American Finance Association, vol. 34(1), pages 157-70, March.
- Kingsland, Louis, 1982. " Projecting the Financial Condition of a Pension Plan Using Simulation Analysis," Journal of Finance, American Finance Association, vol. 37(2), pages 577-84, May.
- Haberman, Steven & Lam, Yuk Patrick & Wong, 1997. "Moving average rates of return and the variability of pension contributions and fund levels for a defined benefit pension scheme," Insurance: Mathematics and Economics, Elsevier, vol. 20(2), pages 115-135, September.
- Nijman, T.E. & Swinkels, L.A.P., 2003. "Strategic and Tactical Allocation to Commodities for Retirement Savings Schemes," Discussion Paper 2003-20, Tilburg University, Center for Economic Research.
- Tepper, Irwin, 1974. "Optimal Financial Strategies for Trusteed Pension Plans," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 9(03), pages 357-376, June.
- Hakansson, Nils H, 1971. "On Optimal Myopic Portfolio Policies, With and Without Serial Correlation of Yields," The Journal of Business, University of Chicago Press, vol. 44(3), pages 324-34, July.
- Chang, Shih-Chieh & Chen, Chiang-Chu, 2002. "Allocating unfunded liability in pension valuation under uncertainty," Insurance: Mathematics and Economics, Elsevier, vol. 30(3), pages 371-387, June.
- Hakansson, Nils H, 1970. "Optimal Investment and Consumption Strategies Under Risk for a Class of Utility Functions," Econometrica, Econometric Society, vol. 38(5), pages 587-607, September.
- Haberman, Steven & Butt, Zoltan & Megaloudi, Chryssoula, 2000. "Contribution and solvency risk in a defined benefit pension scheme," Insurance: Mathematics and Economics, Elsevier, vol. 27(2), pages 237-259, October.
- Haberman, Steven, 1993. "Pension funding with time delays and autoregressive rates of investment return," Insurance: Mathematics and Economics, Elsevier, vol. 13(1), pages 45-56, September.
- Kouwenberg, Roy, 2001. "Scenario generation and stochastic programming models for asset liability management," European Journal of Operational Research, Elsevier, vol. 134(2), pages 279-292, October.
- Rudolf, Markus & Ziemba, William T., 2004. "Intertemporal surplus management," Journal of Economic Dynamics and Control, Elsevier, vol. 28(5), pages 975-990, February.
- Sutcliffe, Charles, 2005. "The cult of the equity for pension funds: should it get the boot?," Journal of Pension Economics and Finance, Cambridge University Press, vol. 4(01), pages 57-85, March.
- Zimbidis, Alexandros & Haberman, Steven, 1993. "Delay, feedback and variability of pension contributions and fund levels," Insurance: Mathematics and Economics, Elsevier, vol. 13(3), pages 271-285, December.
- Frankfurter, George M. & Hill, Joanne M., 1981. "A Normative Approach to Pension Fund Management," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 16(04), pages 533-555, November.
- Blake, David & Lehmann, Bruce N & Timmermann, Allan, 1999. "Asset Allocation Dynamics and Pension Fund Performance," The Journal of Business, University of Chicago Press, vol. 72(4), pages 429-61, October.
- Haberman, Steven, 1992. "Pension funding with time delays : A stochastic approach," Insurance: Mathematics and Economics, Elsevier, vol. 11(3), pages 179-189, October.
- Dufresne, Daniel, 1989. "Stability of pension systems when rates of return are random," Insurance: Mathematics and Economics, Elsevier, vol. 8(1), pages 71-76, March.
When requesting a correction, please mention this item's handle: RePEc:rdg:icmadp:icma-dp2005-11. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Ed Quick)
If references are entirely missing, you can add them using this form.