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The purpose of this file is to document papers, articles, newsletters and the like available in digital form whose topic concerns pension finance or is useful background to understanding pension finance, or economics from the finance point of view. The abstract from the original, or where it had a short synopsis, is provided to help the user choose appropriate readings. It is hoped this material will serve to augment the Pension Actuary's Guide to Financial Economics with additional material for study by those with an interest in the field generally or its application to pension The symposium tab is the list of papers presented at the Society of "Great Controversy" symposium held in June, 2003 at Vancouver. The General tab lists papers collected from various sources. They are listed in order of publication date. In a few cases the papers are drafts with circulation. Respect the rights of the author by limiting the use of these personal education. The user can sort the records differently or search for author, topic, etc. to locate material of interest. The SOA Website tab is the list of articles available in the "Pension Resources" area of the website. At the top of the worksheet is the direct which can be used to jump directly to the Pension Finance Resources home page. Or, if the link doesn't work, try copying the cell contents to your address. Some of the papers are referenced under more than one topic. SOA web links are duplicates to files listed under the Symposium or Send comments, suggestions or corrections to: email@example.com Code Description AC Accounting AM Assumptions/Methods AS Actuarial Standards BE Behavioral Economics DE Design FE Financial Economics FF Full Funding IM Immunization IN Investments MF Minimum Funding MV Market Value PF Pension Finance PG PBGC RK Risk TR Traditional DB view Title Author Publisher Date Filename Print Size Pages Kbytes 1/n (The) Pension Heath Windcliff North American Actuarial Journal Jul-04 http://www.soa.org/library/journals/north-american-actuarial- 14 511 Investment Puzzle Phelim P. Boyle journal/2004/july/naaj0403_3.pdf Accounting/Actuarial Jeremy Gold Pension Research Council Nov-05 http://www.soa.org/library/journals/north-american-actuarial- 39 304 Bias Enables Equity journal/2005/july/naaj0903-1.pdf Investment by Defined Benefit Pension Plans Actuaries discuss the Jon Exley The Actuary [US] Nov-03 http://www.soa.org/library/newsletters/the-actuary/2000- 27 1470 principles of financial Paul Gewirtz 09/2003/november/act0311.pdf economics of pension Dimitry Mindlin accounting Mark Ruloff Adding an Annuity to Watson Wyatt Worldwide Jun-07 http://watsonwyatt.com/us/research/whitepapers/wprender.asp?id=2007- 12 326 Improve Defiined US-0070 Contribution Plan Options Adequate Funding for Michael M. C. Sze The Pension Forum Vol 9, No 1 Jun-96 http://www.soa.org/library/newsletters/pension- 6 2340 a Pension Plan forum/1996/june/pfn9606.pdf Agency Problem Auburn University Jun-05 http://www.auburn.edu/%7Ejohnspm/gloss/agency_problem 2 41 An Actuary Looks at Richard Q. Wendt Risks and Rewards Feb-99 http://www.soa.org/library/newsletters/risks-and- 2 513 Financial Insurance rewards/1999/march/rrn9903.pdf Title Author Publisher Date Filename Print Size Pages Kbytes Are Stocks "Too Ron Muhlenkamp Muhlenkamp & Company, Inc. Jul-94 http://www.soa.org/files/pdf/pen-1994-stocks-high-muhlenkamp.pdf 2 21 High"? Asset-Liability Society of Actuaries Aug-98 http://www.soa.org/library/professional-actuarial-specialty- 24 233 Professional Specialty guides/professional-actuarial-specialty- Guide guides/1998/august/spg9808alm.pdf Assumed Rates of Jeremy Gold Pension Research Council Sep-00 http://rider.wharton.upenn.edu/~prc/PRC/WP/wp2001-6.pdf 52 153 Discount for Working Paper [Draft] Valuations of Publicly Sponsored Defined Benefit Plans Behavioral Economics Sendhil International Encyclopedia of the Social and Nov-01 http://www.soa.org/files/pdf/pen-mullainathan-thaler.pdf 12 133 Mullainathan, Behavioral Sciences Richard H. Thaler Behavioral Finance Douglas A. George Risks and Rewards, Issue 43 Oct-03 http://www.soa.org/library/newsletters/risks-and- 4 971 rewards/2003/october/rrn0310.pdf Title Author Publisher Date Filename Print Size Pages Kbytes Bond market Chet Ragavan Merrill Lynch Apr-05 9 102 implications of the defined-benefit pension reform proposals Case (The) Against Lawrence N. Bader Pension Section News Feb, 2003 Feb-03 http://www.soa.org/library/newsletters/pension-section- 3 449 Stock in Corporate news/2003/february/psn0302.pdf Pension Plans Case (The) against Lawrence N. Bader Financial Analysts Journal Feb-07 http://www.cfapubs.org/doi/abs/10.2469/faj.v63.n1.4407 8 402 Stock in Public Jeremy Gold Vol. 63 No. 1 Pension Funds Cashing In: Watson Wyatt Worldwide Nov-05 3 189 Do Aggressive Funding Policies Lead to Higher Credit Ratings? Cognitive Dissonance John Shuttleworth Risks and Rewards, Issue 40 Oct-02 http://www.soa.org/library/newsletters/risks-and- 2 488 rewards/2002/october/rrn0210.pdf letter response by Edward Friend Title Author Publisher Date Filename Print Size Pages Kbytes Comprehensive (A) Eric Klieber Eric Klieber Sep-03 7 42 Defined Benefit Pension Plan Reform Proposal Conceptual Paul W. McCrossan Risks and Rewards, Issue 47 Aug-05 http://soa.soa.org/library/newsletters/risks-and- 7 1614 Framework - rewards/2005/august/rrn0508.pdf Thoughts Corporate Pension William F. Sharpe Journal of Financial Economics Jan-76 11 837 Funding Policy Cross (The) Section of Gabriel Hawawini Wharton School May-98 http://books.google.com/books?hl=en&lr=&id=cDuyJ5tjOxoC&oi=fnd 52 577 Common Stock Donald B. Keim &pg=PA3&dq=%22Hawawini%22+%22The+Cross+Section+of+Com Defined Benefit Seth Ruthen PIMCO Feb-05 mon+Stock+Returns:+A+Review+of+...%22+&ots=8yC9P96LJZ&sig 6 256 Pension Plans’ Interest Rate Exposure at Record High Discounting Pension Lawrence N. Bader Risks and Rewards Jun-94 http://www.soa.org/library/newsletters/pension-section- 2 3510 Liabilities under the news/1994/june/psn9406.pdf` New SEC Rules Title Author Publisher Date Filename Print Size Pages Kbytes Does An Actuarial Ethan E. Kra Society of Actuaries Jun-01 http://www.soa.org/library/proceedings/record-of-the-society-of- 30 240 Bias Lead To Equity Zvi Bodie actuaries/2000-09/2001/january/RSA01V27N137PD.PDF Investment? Jeremy Gold Draft Editorial Eric Klieber Eric Klieber Sep-03 4 61 Durational (Select & Ron Iverson The Pension Forum Vol. 15, No. 1 Dec-04 http://www.soa.org/library/newsletters/the-pension- 6 967 Ultimate) Discount Heidi Rackley forum/2004/december/pfn0412.pdf Rates for FAS 87 & Steve Alpert 106 Valuations Ethan Kra Earnings Daniel Bergstresser May-04 50 293 Manipulation and Mihir A. Desai Managerial Joshua Rauh Investment Decisions: Evidence from Sponsored Pension Plans Economics (The) of Andrew L. Turner Russell Research Commentary Dec-04 48 705 Defined Benefit Pensions and the Rationality of Pension Funding Strategies Title Author Publisher Date Filename Print Size Pages Kbytes Equity Duration – David M. Blitzer Standard & Poors Jan-05 http://som.gmu.edu/sba/MBA703/010605_equity_duration.pdf 5 245 Updated Duration of Srikant Dash the S&P 500 Equity Risk Premium Martin L. Leibowitz CFA Institute Nov-01 http://www.econ.ucsb.edu/~mehra/aimr.pdf 122 2075 Forum (chr.) [prior to 2004, known as AIMR: Association for plus 19 other Investment Management and Research] participants Robert Arnott, John Campbell, Peng Chen, Bradford Cornell, William Goetzmann, Brett Hammond, Campbell Equity Risk Premium: Harvey, Roger Richard A. Derrig North American Actuarial Journal Vol 8, No. 1 Jan-04 http://www.soa.org/library/journals/north-american-actuarial- 32 528 Expectations Great Elisha D. Orr journal/2004/january/naaj0401-4.pdf and Small Evaluating the Long- Manuel Ammann The Geneva Papers on Risk And Insurance Vol 25, No. Jul-00 http://en.scientificcommons.org/5985 15 514 Term Risk of Equity Heinz Zimmermann 3 Investment in a Portfolio Insurance Framework Title Author Publisher Date Filename Print Size Pages Kbytes Evolving Pension Richard H. unpublished Aug-03 5 45 Actuarial Science Herchenroether Final Report of the Shiraz Y. M. Canadian Institute of Actuaries Jan-03 http://www.soa.org/files/pdf/pen-2003-final-report.pdf 19 69 Task Force on Bharmal Pension Funding Jean Demers Bernard Dussault Malcolm P. Hamilton Karen L. Lockridge William M. Loucks Gerald F. Schnurr Financial Economics Tim Gordon Society of Actuaries Jun-03 http://www.soa.org/library/monographs/retirement-systems/the-great- 28 232 and Pension Stuart Jarvis controversy/2004/june/m-rs04-1-17.pdf Actuaries: The U.K. Experience Financial Economics Richard Q. Wendt Risks and Rewards, Issue 43 Oct-03 http://www.soa.org/library/newsletters/risks-and- 1 971 for Pension Plans rewards/2003/october/rrn0310.pdf Financial Economics: Kenneth Buffin Commentary : Apr-07 http://www.buffinpartners.com/Commentary_2007_04.pdf 1 57 A Wake-up Call Buffin Partners, Inc. Title Author Publisher Date Filename Print Size Pages Kbytes Financial Economics: Shane Whelan The Actuary [UK] Dec-02 http://www.soa.org/files/pdf/pen-act-2002-whelan.pdf 2 66 Actuaries' Contributions Fixing the Pension Edward E Burrows Pension Forum Vol. 16 No. 2 Apr-05 http://www.soa.org/library/monographs/retirement-systems/the-great- 21 172 Plan Funding Rules controversy/2004/june/m-rs04-1-23.pdf Foundations of Information The Royal Swedish Academy of Sciences Dec-02 http://www.nobel.se/economics/laureates/2002/ecoadv02.pdf 25 688 Behavioral and Department Experimental No individual cited. Economics: Daniel Kahneman and Vernon Smith Framework (A) for Christopher M. Bone The Pension Forum Vol 9, No 1 Jun-96 http://www.soa.org/library/newsletters/pension- 10 2340 Establishing forum/1996/june/pfn9606.pdf Corporate Retirement Funding Policy Funding defined David Morton The Actuary [UK] Mar-05 http://www.soa.org/files/pdf/pen-act-2005-morton.pdf 1 38 benefit pension schemes Title Author Publisher Date Filename Print Size Pages Kbytes Getting the Models Richard J. Herring Wharton School of the University of Pennsylvania Jun-07 http://knowledge.wharton.upenn.edu/article.cfm?articleid=1763 3 169 Right': How to Value (roundtable host) Hard-to-Price Assets Group Variable Tom Lowman Bolton Partners Mar-04 15 133 Annuity Pension Plan: An Optional Plan Design/Legislative Proposal in Response to Financial Economics Challenge to DB Plans Herbert Simon Byron Spice Pittsburgh Post-Gazette Feb-01 http://www.post-gazette.com/regionstate/20001016simon2.asp 8 36 Interview & Obituary Hindsight Mark Ruloff Winkelvoss Jul-04 http://www.soa.org/files/pdf/pen-2004-ruloff.pdf 9 60 How Much Money are Ron Muhlenkamp Muhlenkamp & Company, Inc. Nov-05 http://www.soa.org/files/pdf/pen-2005-theory-muhlenkamp.pdf 12 429 You Willing to Lose for a Theory? How to Stop the Jeremy Gold Feb-03 http://www.soa.org/library/newsletters/pension-section- 2 112 Insanity news/2003/june/psn0306.pdf Title Author Publisher Date Filename Print Size Pages Kbytes Impact (The) of Fair Jeremy Gold Risks and Rewards, Issue 40 Oct-02 http://www.soa.org/library/newsletters/risks-and- 1 488 Value Accounting on rewards/2002/october/rrn0210.pdf the “Normal” Rate Curve—A Speculation Impact (The) of Stephen Brown Sep-04 http://www.soa.org/files/pdf/pen-2004-brown-impact.pdf 41 253 Pension Assumptions on Firm Value Improving 401(k) William G. Gale Issue Brief from Center for Retirement Research at Dec-04 http://crr.bc.edu/briefs/improving_401_k_investment_performance.htm 8 66 Investment Return J. Mark Iwry Boston College, l Alicia H. Munnell number 26 Richard H. Thaler Is it Time to David Bianco UBS Investment Research Mar-05 10 155 Immunize? Issue Debt to Fund Gordon Latter Merrill Lynch Aug-05 9 309 Plan Deficits and Michelle Charles "Pensions & Endowments" Capitalize on the Pension-Debt- Jensen and Meckling Jacques Thépot Université Louis Pasteur Apr-06 http://papers.ssrn.com/sol3/papers.cfm?abstract_id=899521 13 207 30 years after: A game theoretic view Title Author Publisher Date Filename Print Size Pages Kbytes Judgment under Amos Tversky Science, New Series, Sep-74 http://www.sciencemag.org/cgi/search?volume=185&firstpage=&andor 9 2231 Uncertainty: Daniel Kahneman Vol 185 Issue 4157 exactfulltext=and&andorexacttitleabs=and&journal_search_volume_go Heuristics and Biases .x=14&journal_search_volume_go.y=4 Knowledge, Wisdom Philip Booth Contingencies, reprinted from Oct-97 3 2803 or Understanding The Actuary [UK] Loser's (The) Game Charles Ellis Financial Analysts Journal Aug-75 6 458 Making Financial Neil Brougham [UK] The Actuary May-04 http://www.soa.org/files/pdf/pen-act-2004-brougham.pdf 1 24 Economic Sense of the Future Making Investment Zvi Bodie Draft article Jan-07 http://papers.ssrn.com/sol3/papers.cfm?abstract_id=900005 15 417 Choices as Simple as Jonathan Treussard Possible: An Analysis of Target Date Retirement Funds Market (A) is Needed Bernard Dumas, Financial Times Jul-05 4 98 in Pension Claims INSEAD Ian Edwards, INSEAD Andrew Smithers, Smithers & Co Title Author Publisher Date Filename Print Size Pages Kbytes Merton Miller Rene M. Stulz The New Palgrave Dictionary Apr-06 9 51 Modern (A) Jon Exley [Asset and Liability Management Tools - Chapter 2] May-06 19 1364 Perspective on Institutional Investment Policy Modern Valuation Stuart Jarvis The Staple Inn Actuarial Society Feb-01 http://www.sias.org.uk/siaspapers/listofpapers/view_paper?id=Modern 57 1225 Techniques Frances Southall Valuations Elliot Varnell Morris Review of the Sir Derek Morris Her Majesty's Treasury [UK] Mar-05 168 694 Actuarial Profession Nature (The) of Risk Mellon Investment Update Mar-06 2 452 New York City Story Nicholas Dunbar Life & Pensions Magazine Jun-06 http://www.life- 5 103 pensions.com/public/showPage.html?validate=0&page=lp_login2&url =%2Fpublic%2FshowPage.html%3Fpage%3D319815 Next (The) Savings David Zion Credit Suisse/First Boston Jan-05 25 333 and Loan Crisis? Bill Carcache Title Author Publisher Date Filename Print Size Pages Kbytes Noisy (The) Market' Jeremy J. Siegel Wall Street Journal 6/14/2006 http://online.wsj.com/article/SB115025119289879729.html 5 39 Hypothesis Not Such a Great Shane Whelan The Actuary [US] Dec-06 http://www.soa.org/news-and-publications/publications/magazines/the- 6 48 Controversy: actuary-magazine/december-2006/pub-not-such-a-great- Actuarial Science and controversy.aspx Financial Economics Off-Balance-Sheet David Zion Bill Credit Suisse/First Boston Jun-05 8 144 Activity Back in the Carcache Spotlight On the Risk of Stocks Zvi Bodie Financial Analysts Journal Jun-95 http://www.cfapubs.org/toc/faj/1995/51/3 3 53 in the Long Run Overview: Olivia Mitchell Pension Research Council Sep-03 16 101 Developments in Risk Kent Smetters Management for Retirement Security Pension Actuary's Gordon Enderle Joint AAA/SOA Task Force on Financial Economics Oct-06 http://www.soa.org/files/pdf/actuary-journal-final.pdf 449 Guide to Financial Jeremy Gold and the Actuarial Model Economics Gordon Latter Michael Peskin Pension Deficits: An Lawrence N Bader Financial Analysts Journal Jun-04 http://www.cfapubs.org/toc/faj/2004/60/3 7 839 Unnecessary Evil Title Author Publisher Date Filename Print Size Pages Kbytes Pension Design and Olivia Mitchell Pension Research Council Jul-04 41 188 Structure Stephen Utkus Chap. 1: Lessons from Behavioral Finance for Pension Funding: A Arnold F. Shapiro Society of Actuaries Jul-05 http://www.soa.org/library/monographs/retirement-systems/the-future- 34 306 Historical Perspective of-pension-plan-funding-and-disclosure- monograph/2005/december/shapiro.pdf Pension Reform Jay Cooper Merrill Lynch Apr-05 2 80 Spells $200B Fixed Income Shift Pension Valuation Eric J. Klieber Contingencies Oct-02 http://www.contingencies.org/sepoct02/pensionvalu.pdf 5 113 Needs More Disclosure, Not a New Formula Pensions and Capital John Ralfe Society of Actuaries Jun-03 http://www.soa.org/library/monographs/retirement-systems/the-great- 21 204 Structure: Cliff Speed controversy/2004/june/m-rs04-1-03.pdf Why Hold Equities in Jon Palin the Pension Fund? Primer (A) in S. F. Whelan B. A. J. Jul-02 http://www.actuaries.org.uk/files/pdf/library/bowie.pdf 39 414 Financial Economics D. C. Bowie A. J. Hibbert Title Author Publisher Date Filename Print Size Pages Kbytes Primer (A) on Yanni Partners Measuring Up Oct-06 4 764 Portable Alpha Vol. 18 No. 4 Principles (The) of Jack L. Treynor Journal of Finance May-77 http://www.afajof.org/journal/jstabstract.asp?ref=9305 12 757 Corporate Pension Finance Prospect Theory: Daniel Kahneman Econometrica, Vol 47 Issue 2 Mar-79 31 2890 An Analysis of Amos Tversky Decision under Risk Psychology and Luke N. Girard Risks and Rewards Feb-99 http://www.soa.org/library/newsletters/risks-and- 2 513 Financial Markets: rewards/1999/march/rrn9903.pdf Richard H. Thaler Addresses the Investment Section Puzzling (The) State Michael C. Jensen Social Science Research Network (SSRN) Aug-05 http://papers.ssrn.com/sol3/papers.cfm?abstract_id=783604 20 908 of Low-Integrity Relations Between Managers and Capital Rationale (The) of the Karl Borch The American Economic Review Jun-74 http://econpapers.repec.org/article/aeaaecrev/v_3A64_3Ay_3A1974_3 3 323 Mean-Standard Vol. 64 No. 3 Ai_3A3_3Ap_3A428-30.htm Deviation Analysis: Comment Title Author Publisher Date Filename Print Size Pages Kbytes Rationale (The) of the S. C. Tsiang The American Economic Review Jul-74 http://econpapers.repec.org/article/aeaaecrev/v_3A64_3Ay_3A1974_3 9 1158 Mean-Standard Vol. 64 No. 3 Ai_3A3_3Ap_3A442-50.htm Deviation Analysis: Reply and Errata for Original Article Reaffirming Pension Dimitry Mindlin Pension Forum Vol. 16 No. 2 Apr-05 http://www.soa.org/library/newsletters/the-pension- 21 150 Actuarial Science forum/2005/april/pfn0504.pdf Reforming the David W. Wilcox Division of Research and Statistics Mar-06 http://www.soa.org/files/pdf/pen-2006-wilcox-reform.pdf 61 485 Defined-Benefit Federal Reserve Board Pension System in the United States [Preliminary and incomplete draft] Reinventing Pension Lawrence N. Bader The Pension Forum Vol. 15, No. 1 Jan-03 http://www.soa.org/library/newsletters/pension- 34 1785 Actuarial Science Jeremy Gold forum/2003/january/pfn0301.pdf (including discussions) Title Author Publisher Date Filename Print Size Pages Kbytes Rethinking Pension Ronald J. Ryan, THE JOURNAL OF PORTFOLIO MANAGEMENT Jul-02 9 500 Liabilities and Asset Frank J. Fabozzi Allocation Rise (The) of Liability Yanni Partners Measuring Up Jan-07 4 434 Driven Investing Vol. 19 No. 1 Risk (The) of Raymond Murphy Pension Section News Sep, 2006 Sep-06 http://www.soa.org/library/newsletters/pension-section- 3 931 Declining Market Cap news/2006/september/PSN0609.pdf with Large Pension Obligations Risk Transfer in Jeremy Gold Pension Research Council Oct-02 25 143 Public Pension Plans Draft chapter for The Pension Challenge: Risk Transfers and Retirement Income Security. Shareholder (The) - Jeremy Gold Pension Research Council Dec-00 http://users.erols.com/jeremygold/papers.html 101 293 Optimal Design of Working Paper [Draft] Cash Balance Plans Statement on George G. Benston Financial Economists Roundtable Dec-04 http://fic.wharton.upenn.edu/fic/Policy%20page/fer2004.pdf 10 70 “CORPORATE Dennis E. Logue PENSION FUND Elroy Dimson ACCOUNTING” Jeremy Siegel Title Author Publisher Date Filename Print Size Pages Kbytes Statement on K.J. Arrow, R. AEI-Brookings Joint Center May-07 http://papers.ssrn.com/sol3/papers.cfm?abstract_id=984584 8 121 Prediction Markets Forsythe, M. Gorham, R. Hahn, R. Hanson, D. Kahneman, J.O. Ledyard, S. Levmore, R. Litan, P. Milgrom, F.D. Nelson, G.R. Neumann, M. Stocks are Still an Ottaviani, C.R. Plott, Wall Street Journal Jeremy Siegel Jul-02 1 171 Oasis Stocks Not For the Raymond Fazzi Financial Advisors Magazine Jan-04 http://www.financialadvisormagazine.com/past_issues.php?id_content 11 22 Long Run =3&idArticle=350&idPastIssue=79 Stop Thief! Tim Bond Barclays Capital Research Jan-06 6 148 Successful Defined Mark Ruloff Jun-04 http://www.soa.org/files/pdf/pen-2004-ruloff-bonds.pdf 3 60 Benefit Plans Cost Less with Bonds Title Author Publisher Date Filename Print Size Pages Kbytes Tax (The) Fischer Black Financial Analysts Journal Aug-80 http://papers.ssrn.com/sol3/papers.cfm?abstract_id=921678 9 667 Consequences of Long-Run Pension Policy Taxation and Irwin Tepper Journal of Finance Mar-81 http://www.afajof.org/journal/jstabstract.asp?ref=9839 13 764 Corporate Pension Policy The Cost of Capital, Franco Modigliani American Economic Review Jun-58 http://books.google.com/books?hl=en&lr=&id=CIni3oHnprEC&oi=fnd 38 2051 Corporation Finance Merton H. Miller &pg=PA3&dq=%22Modigliani%22+%22The+Cost+of+Capital,+Corp and the Theory of oration+Finance+and+the+Theory+...%22+&ots=yqhCurxuJl&sig=lwa NR1t6aOTiXjxLM9J0oEsfZE0 Investment The U.S. Pension The Committee on Investment of Employee Benefit Mar-04 100 1923 Crisis: Evaluation and Assets CIEBA Analysis of Emerging Defined Benefit Pension Issues Treatment of Pension Lawrence N. Bader AIMR May-03 http://www.cfapubs.org/toc/faj/2003/59/3#PERSPECTIVES 6 199 Plans in a Corporate Valuation Title Author Publisher Date Filename Print Size Pages Kbytes UBS Investment Stephen Cooper UBS Q-Series Sep-03 61 688 Research David Bianco Pension Fund Asset Allocation Understanding Equity Richard Q. Wendt Risks and Rewards, Issue 38, Special Insert Feb-02 http://www.soa.org/library/newsletters/risks-and- 42 1536 Risk Premium rewards/2002/february/rrn0202.pdf Understanding the Holger Hofling The Pension Forum Vol 15, No 1 Dec-04 http://www.soa.org/library/newsletters/the-pension- 34 1027 Corporate Bond Yield Rudiger Kiessel forum/2004/december/pfn0412.pdf Curve Gunther Loffler Valuation of Pension Richard Q. Wendt The Pension Forum Vol 15, No 1 Dec-04 http://www.soa.org/library/newsletters/the-pension- 13 1027 Obligations with forum/2004/december/pfn0412.pdf Lump Sums Value (The) of John Pemberton The Staple Inn Actuarial Society Feb-98 http://www.actuaries.org.uk/files/pdf/library/SIAS-1998/values.pdf 40 125 Actuarial Values Title Author Publisher Date Filename Print Size Pages Kbytes Valuing Companies, Lawrence N. Bader Contingencies Oct-02 http://www.contingencies.org/sepoct02/pensionplans.pdf 5 129 Valuing Pension Eric Klieber Plans Welfare (The) of Henry G. Manne Wall Street Journal 6/13/2006 http://online.wsj.com/article/SB115015714883578393.html 2 71 American Investors What are Corporate Jeremy I. Bulow Quarterly Journal of Economics Aug-82 http://links.jstor.org/sici?sici=0033- 18 1292 Pension Liabilities? vol 97, no 3 5533%28198208%2997%3A3%3C435%3AWACPL%3E2.0.CO%3B 2-6&origin=repec What is Risk (Part II) Ron Muhlenkamp Muhlenkamp & Company, Inc. Jul-03 http://www.soa.org/files/pdf/pen-2003-risk-02-muhlenkamp.pdf 8 283 What is Risk? Ron Muhlenkamp Muhlenkamp & Company, Inc. Jul-03 http://www.soa.org/files/pdf/pen-2003-risk-muhlenkamp.pdf 8 181 What Pension Scheme Robert Clarkson The Actuary [UK] Jul-06 http://www.the-actuary.org.uk/pdfs/06_10_05.pdf 2 76 Deficits 2 Title Author Publisher Date Filename Print Size Pages Kbytes What’s next?—DB Jeremy Gold The Actuary [US] Oct-03 http://www.soa.org/library/newsletters/the-actuary/2000- 19 1182 plans for the long run 09/2003/october/act0310.pdf Yikes! How to Think Alicia H. Munnell Center for Retirement Research Jan-05 http://crr.bc.edu/briefs/yikes_how_to_think_about_risk_.html 8 59 about Risk? Steven A. Sass Issue in Brief No. 27 Mauricio Soto Title Author Publisher Date Filename Print Size Pages Kbytes Title Subject(s) abstract 1/n (The) Pension BE, IN This paper examines the so-called 1/n investment puzzle that has been observed in defined Investment Puzzle contribution plans whereby some participants divide their contributions equally among the available asset classes. It has been argued that this is a very naive strategy since it contradicts the fundamental tenets of modern portfolio theory. We use simple arguments to show that this behavior is perhaps less naive than it at first appears. It is well known that the optimal portfolio weights in a mean-variance setting are extremely sensitive to estimation errors, especially those in Accounting/Actuarial Although pension finance theory says most defined benefit pension error, the 1/n rule has some AC, PF the expected returns. We show that when we account for estimation plans sponsored by publicly Bias Enables Equity traded corporations should invest entirely in fixed income, 60% of assets are invested in equities. Investment by The existing theory makes a strong – but often unstated – assumption of transparency, implying Defined Benefit that investors view the pension plan as a financial subsidiary of the operating parent and value it Pension Plans Actuaries discuss the Financial economics, I explain the to actuarial science, calls into question some to how investors PF, AC as a market portfolio. when appliedequity choice made by managers as a reaction basic principles. principles of financial Many actuarial principles are based on understanding of the stock market and pension plans with economics of pension which financial economists would disagree. To get a more comprehensive understanding of the accounting principles that play an integral role with financial economics, The Actuary spoke to four actuaries who are subject matter experts in their field: Adding an Annuity to Three structural flaws make defined contribution (DC) plans less efficient vehicles for delivering DE, TR, IN Improve Defiined retirement financial security than traditional defined benefit (DB) plans. Contribution Plan This article examines the benefits associated with expanding DC plan investment options to Options include annuities. Adequate Funding for MF In setting the funding policy, the fact that the assets being accumulated are earmarked to cover a Pension Plan pension obligations must be recognized. Thus, both the ultimate goal and the interim measure must involve an asset plan, a liability plan, and a contribution plan that are fully integrated with each other. To set up a funding policy that only includes a liability and contribution plan is to lose sight of half of a balance sheet. To set up asset and liability plans that are independent of each other is not enough because of the impact of asset and liability performance on each other. Agency Problem PF, BE Also sometimes referred to as the principal-agent problem. The difficult but extremely important and recurrent organizational design problem of how organizations can structure incentives so that people (“agents”) who are placed in control over resources that are not their own with a contractual obligation to use these resources in the interests of some other person or group of people actually will perform this obligation as promised — instead of using their delegated authority over other people's resources to feather their own nests at the expense of those whose interests they are supposed to be serving (their “principals”). Enforcing such contracts will involve transaction costs (often referred to as agency costs), and these costs may sometimes be An Actuary Looks at PF, IN The cost of financial guarantees to investors and policy holders is examined using option pricing Financial Insurance methods of Black-Scholes. Traditional actuarial methods are not a good match to analyze these guarantees. Title Subject(s) abstract Are Stocks "Too IN, MV The models that seek to determine fair value for stocks use corporate earnings and a capitalization High"? rate (such as a price/earning ratio) to arrive at "fair value". Nearly all such models use interest rates to set the capitalization rate. Current interest rates are assumed to be fair, as if there were no emotions in the bond market. Interest rates themselves are never viewed as "too high" or "too low." For the past 10 years [1984-1993] stocks have been viewed as "too high," in relation to interest rates. In reality, interest rates have been too high. Asset-Liability IN, MV This Specialty Guide is a background reading reference for the practice of asset-liability Professional Specialty management (ALM). It is being published to offer guidance not only to actuaries seeking to gain Guide knowledge on ALM as it relates primarily to life and health insurance, but also to practitioners in the property and casualty insurance and pensions fields. ALM means different things to different people. It can mean duration and convexity matching, immunization, optimization, stochastic modeling, performance management and measurement, risk management, and so on. These different notions of ALM occur in part due to differences by practice area (for example, pension fund management versus life insurance product development) and in part due to differences in training, such as Casualty Actuarial Society (CAS) versus Chartered Financial Analyst (CFA). Assumed Rates of PF, MF This paper uses arbitrage principles to show that the use of expected returns including equity Discount for premia is biased in favor of early generations at the expense of later generations, a wealth transfer Valuations of Publicly disguised as risk diversification over time. It is shown that unbiased results can be developed, with Sponsored Defined no wealth transfers between generations, by assuming risk-free rates of return independently of the Benefit Plans actual asset mix. Because cost computations anticipate equity premia, governments are likely to offer their employees pension benefits and valuable options (Skim funds) at less than their risk-adjusted cost, Behavioral Economics BE Behavioral Economics is the combination of psychology and economics that investigates what happens in markets in which some of the agents display human limitations and complications. We begin with a preliminary question about relevance. Does some combination of market forces, learning and evolution render these human qualities irrelevant? No. Because of limits of arbitrage less than perfect agents survive and influence market outcomes. We then discuss three important ways in which humans deviate from the standard economic model. Bounded rationality reflects the limited cognitive abilities that constrain human problem solving. Bounded willpower captures the fact that people sometimes make choices that are not in their long-run interest. Bounded self- interest incorporates the comforting fact that humans are often willing to sacrifice their own interests to help others. We then illustrate how these concepts can be applied in two settings: finance and savings. Financial markets have greater arbitrage opportunities than other markets, so behavioral factors might be thought to be less important here, but we show that even here the Behavioral Finance BE .. some observers argue that the empirical data do not support the Efficient Markets Hypothesis. They claim that there are anomalies in price movements that cannot be explained through EMH. Because of these perceived shortcomings, a new approach to explaining financial markets has recently emerged known as behavioral finance. Title Subject(s) abstract Bond market IN, MF, The Bush administration’s proposal to reform Social Security has received enormous attention implications of the PG lately. Lost in the ensuing debate over the crisis (or lack thereof) faced by the Social Security defined-benefit system, however, is a set of new proposals put forth by the administration to fix problems facing pension reform corporate defined-benefit (DB) plans. proposals The administration’s reform proposal, along with several other initiatives that are currently being debated by the Financial Accounting Standards Board (FASB), the U.S. Treasury and the credit rating agencies, has important implications for fixed income markets. This paper highlights some of the issues raised by these various reform proposals and their financial implications for the fixed income market, especially in the long end of the yield curve. Case (The) Against PF, IN This article focuses on the real economics rather than GAAP accounting. For this purpose, we Stock in Corporate assume a transparent financial system, in which shareholders have full information about Pension Plans corporate pension funds and recognize that they experience the risks and rewards of these funds. Needless to say, today’s system falls well short of that standard, but it is advancing rapidly in that direction, as the accounting profession progresses toward a market value paradigm and the financial community improves its understanding of pension plans. Case (The) against PF, IN In two of the earliest papers in pension finance, Black (1980) and Tepper (1981) showed that Stock in Public shifting corporate pension plan investments from equities to bonds can add value for shareholders Pension Funds through a tax arbitrage. Many observers (e.g., Sutcliffe 2004) believe that tax arguments for bond investment in corporate plans are irrelevant to governmental pension funds. Nonetheless, we show that in a transparent financial environment, shifting governmental (public) pension fund investments from equities to bonds adds value for local taxpayers through a federal tax arbitrage. We also observe that equity investment by governmental plans involves many risks in addition to market risks. Public plan sponsors should prepare for changes that will occur as greater transparency lowers the obstacles to an all-bond strategy. Cashing In: IN, PF This article takes a fresh look at the relationship between pension deficits and the credit ratings of Do Aggressive sponsoring firms. Using data from Fortune 1000 pension sponsors over the past three years, we Funding Policies Lead find a notable positive relationship between higher pension deficits and lower credit ratings. Since to Higher Credit lower debt ratings generally drive up the cost of borrowing, this relationship suggests that Ratings? leveraged firms may be able to reduce overall costs by diverting available cash flow to shore up their pension plans. Indeed, the analysis clearly indicates that some firms have already moved Cognitive Dissonance PF [The essay on page 26] ran in the June 2002 issue of The Actuary. Ed Friend has submitted a response to this article by John Shuttleworth. Ed suggested that we reprint the original article and his response. The Actuary is published by the Staple Inn Actuarial Society and is the official publication of the actuarial profession in e United Kingdom. Title Subject(s) abstract Comprehensive (A) MF, FF, ERISA introduced a wide variety of reforms - minimum participation and vesting standards, Defined Benefit DE, PG minimum funding standards and tighter restrictions on tax-deductible contributions, limits on Pension Plan Reform benefits and plan termination insurance. Since the passage of ERISA, most restrictions from the Proposal original law have been tightened by subsequent legislation. With nearly thirty years of experience under ERISA behind us, it seems clear that, at least with respect to defined benefit plans, the cure has nearly killed the patient. The number of defined benefit plans and the percentage of US workers participating in defined benefit plans have both decreased dramatically, many remaining sponsors are freezing or terminating their plans, and the plan termination insurance program is Conceptual AC, BE, This is an excerpt from a longer address to the International Accounting Standards Board on Framework - RK guiding principles. As the IASB and the European Commission work out application of a “fair Thoughts value option” and continue to debate standards for portfolio hedging, these principles affect actuarial practice and risk management. ALM practitioners are familiar with the debate: how efficiently do insurance contract-holders and pension plan members exercise their options? Why are deposits automatically classed as liabilities? Which assumptions lead to useful information and sound management decisions, and why? Mr. McCrossan is a member of Eckler Partners, an affiliate of Milliman Global. The unabridged Corporate Pension PF, IN What policy should a corporation adopt concerning the funding of a defined-benefit pension plan Funding Policy and the investment of the assets held in trust for the plan? Until recently, pension plans did not have to be insured, and some risk could be borne by intended beneficiaries. Federal legislation has now mandated such coverage. This paper analyzes corporate policy under three conditions which correspond, roughly , to the earlier situation ('uninsured' loans), the current situation ('partially insured' loans), and the situation required by law to be implemented in the future ('completely insured' plans). We show that if insurance premiums are set correctly, corporate policy in this area may not matter; otherwise the optimal policy may simply be that which maximizes the difference between the value of the insurance and its cost. Cross (The) Section of FE, IN A growing number of empirical studies suggest that betas of common stocks do not adequately Common Stock explain cross-sectional differences in stock returns. Instead, a number of other variables (e.g., Defined Benefit PF Three secular trends have combined to leave U.S. defined benefit pension plans more exposed to Pension Plans’ an unwanted decline in interest rates than at any time in at least the last 50 years. Interest Rate Two of these trends, a 25-year secular decline in interest rates and a long-term shift away from Exposure at Record fixed income by pension plans, are well known. The third trend, a continuing shift in the High composition of pension plans’ fixed income allocations, has received less attention but has served to magnify the risk to pension plans and increase the likelihood that corporate sponsors will need to contribute new cash to their pension plans in the event of a decline in interest rates. PIMCO estimates that the combination of these three secular trends has left the average defined benefit pension plan unhedged on more than 90% of its interest rate exposure. Discounting Pension PF, MV This article is a condensation of "Introducing the Salomon Brothers [now Citigroup] Pension Liabilities under the Discount Curve and Pension Liability Index" New SEC Rules Title Subject(s) abstract Does An Actuarial PF, IN, Summary: A controversial alternative to ERISA/FASB actuarial cost methods and assumptions is Bias Lead To Equity AC presented as a challenge from the discipline of financial economics. Investment? 1. It is argued that economic assumptions prescribed by ERISA and the FASB are financially biased in a fashion that favors equity investments. This is detrimental to shareholders, risky to the PBGC, and of ambiguous benefit to plan participants. A comparison is made between existing methods/assumptions and alternatives that are, in the language of finance, "transparent." FASB's current "fair value" paradigm follows the transparent financial model. 2. The combination of transparent actuarial cost methods, unbiased actuarial economic assumptions and the Internal Revenue Code Imply that, in the future, U.S.-defined benefit plans will be invested entirely in fixed income. This will reduce the risk exposure of the PBGC, provide tax benefits to shareholders, and provide participants with a more certain measure of their benefit Draft Editorial AC A common put-down today is to call something "so twentieth century." Of the accounting profession, it can legitimately be said it's "so fifteenth century." It's time for accountants to leap ahead six centuries to provide the information needed by investors of the twenty-first century. Durational (Select & AC, PF Issues come with the application of a "yield curve" to calculation of actuarial present values. Ultimate) Discount Common mistakes are corrected. Yield curves and their application are explained. Rates for FAS 87 & 106 Valuations Earnings AC Managers appear to manipulate firm earnings when they characterize pension assets to capital Manipulation and markets and alter investment decisions to justify, and capitalize on, these manipulations. We Managerial construct a measure of the sensitivity of reported earnings to the assumed long-term rate of return Investment Decisions: on pension assets. Managers are more aggressive with assumed long-term rates of return when Evidence from their assumptions have a greater impact on reported earnings. Managers also increase assumed Sponsored Pension rates of return as they prepare to acquire other firms and as they exercise stock options, further Plans confirming the opportunistic nature of these increases. Decisions about assumed rates of return, in turn, influence asset allocation within pension plans. Instrumental variables results suggest that a 25 basis point increase in the assumed rate of return is associated with a 5% increase in equity allocation. Taken together, these results suggest that earnings manipulation arising from managerial motivations influences significant managerial investment decisions. Economics (The) of PF, IN Pension finance has attracted the attention of a small and particularly impressive group of Defined Benefit academicians and practitioners. Over the last twenty years, the recommendations of this group of Pensions and the thinkers have run counter to prevailing practice and conventional wisdom. For the most part, their Rationality of Pension recommendations have been ignored. This paper is about those ideas, their essential relevance to Funding Strategies shareholders, workers, and society, and why it is time to embrace them. Economic analysis reveals that: the markets should (and the empirical evidence suggests they do) regard pension liabilities as corporate debt (to be valued at an appropriate corporate debt rate) and pension assets should be valued at market; in the absence of tax effects, pension investment policy is irrelevant; and in many countries such as the US, the UK, and Canada, tax arbitrage possibilities favor holding debt Title Subject(s) abstract Equity Duration – FE, IM, INAkin to the well-known concept of bond duration, equity duration measures the sensitivity of Updated Duration of equities to interest rates. Although research on this subject is more recent and the concept is rarely the S&P 500 used in practice, we believe equity duration is of significant importance in immunization, risk management, and asset allocation. Equity Risk Premium RK, IN Leibowitz, "Our goal here today is to foster a very candid discussion of the many facets of the Forum equity risk premium. Generally, the risk premium is thought of as the incremental return of certain equity market components relative to certain fixed-income components." from Roger Ibbotson summary: "First, we see a need for clarification of what we mean by the equity risk premium: I think all of us in this room see it as an expectation, not a realization; if we look at realizations, it’s to help us understand expectations. ... The second issue is the use of “arithmetic” versus “geometric.” Every time we make a forecast, we should say whether the forecast is arithmetic or geometric and which risk-free rate we are using—U.S. T-bills, the long bond, or TIPS. Third, we need to distinguish between yields and returns. … Fourth, we should Equity Risk Premium: IN,RK The historical the forecast for the stock market are talking about a short pricing horizon. always specifyrealized ERPhorizon—whether weappears to be at odds withor a longtheory … Expectations Great parameters for risk aversion. Since 1985, there has been a constant stream of research, each of and Small which reviews theories of estimating market returns, examines historical data periods, or both. Those ERP value estimates vary widely from about _1% to about 9%, based on a geometric or arithmetic averaging, short or long horizons, short- or long-run expectations, unconditional or conditional distributions, domestic or international data, data periods, and real or nominal returns. This paper examines the principal strains of the recent research on the ERP and catalogues the empirical values of the ERP implied by that research. In addition, the paper supplies several time series analyses of the standard Ibbotson Associates 1926–2002 ERP data using short Treasuries for the risk-free rate. Recommendations for ERP values to use in common actuarial valuation Evaluating the Long- PF, IN The impact of the time horizon upon the risk of equity investments is still a controversial issue. In Term Risk of Equity this paper, we analyse long-term risk in a portfolio insurance framework based on option pricing Investment in a theory. The insurance strategies are implemented alternatively with a portfolio of stocks and put Portfolio Insurance options or bonds and call options. The risk of stock holdings is measured by the permissible Framework realtive stock position in the replicating portfolio for an exogenous floor function. Our findings indicate that there is no general conclusion as to the long-term risk of stocks; the risk can only be determined for specific floor functions. Because the utility function is implicit in any floor specification, we argue that the assumption of preference-free determination of risk with the help of option-pricing theory, as recently suggested in the literature, is a fallacy. Moreover, the Title Subject(s) abstract Evolving Pension PF, BE, Continual study, evolution if you will, benefits actuarial science. Some have proposed we adopt Actuarial Science TR the principles of the neo-classical financial economics model to reinvent -- that is replace -- the pension actuarial methods and practices we have traditionally used. But the pension field, indeed all of actuarial science, is as much about human psychology as it is about probability functions. As such, a broader economics model is necessary. Fortunately, the behavioral economics field of study provides that broader view. The experimental economics field adds the tool to investigate the human dimension and yield a predictability to our choices. Behavioral and experimental economics improve the usefulness of economics in understanding our financial world. The 2002 Nobel prize in economics recognized Daniel Kahneman and Vernon L. Smith for their work in these fields. Let's evolve, not reinvent, and use all the tools of economic study, not just the rigidly Final Report of the MF, FF The task force believes that we need to address the following key philosophical question: Task Force on Pension Funding “What role should the profession play in the reporting and certification of pension plan funding? Is it only to provide expertise and an acceptable process for measuring the level of funding achieved compared to given objectives? Or is it to provide a professional opinion about the efficacy of funding by establishing bounds outside of which it is not prepared to lend its Accepted Actuarial Practice (AAP) imprimatur?” Financial Economics PF, AS There has been strong resistance within the U.K. actuarial profession against taking on board the and Pension lessons of financial economics. Nevertheless, the majority of the largest U.K. actuarial firms have Actuaries: significantly modified their standard approaches to actuarial valuations to take account of The U.K. Experience criticisms based on financial economics. In the meantime, the failure to come to terms with basic lessons from financial economics has caused the U.K. actuarial profession to lose credibility with key players in the United Kingdom. The U.K. actuarial profession has still not come to a single view on financial economics, and the major divisions that remain continue to hamstring its policy Financial Economics FE, PF [After the Great Pension Controversy Symposium in Vancouver] many of my actuarial colleagues for Pension Plans who did not attend have asked, "Exactly what is financial economics and what does it have to do with pension plans?" Financial Economics: FE In 1998 The Actuarial Foundation published a 669-page textbook, Financial Economics with A Wake-up Call Applications to Investments, Insurance and Pensions that its editor described as suitable for a two semester course at the early graduate school level. The title page with the imprimatur of The Actuarial Foundation included the words Preparing for tomorrow’s possibilities . That tomorrow may perhaps now have arrived, some nine years later, with the publication of Pension Actuary’s Guide to Financial Economics prepared by the Joint American Academy of Actuaries and Society of Actuaries Task Fo rce on Financial Economics and the Actuarial Model. Title Subject(s) abstract Financial Economics: FE Hans Bühlmann posed a riddle a few years ago. ‘Looking back’, he said, ‘it is difficult to Actuaries' understand why the approaches and solutions developed for today’s financial sector, which are Contributions clearly orientated towards mathematics, or to be more precise towards probability theory, did not originate from the breeding ground of actuarial thinking’. A recent paper in the BAJ (Vol 8, Part I) hints at a disturbing reason. The paper, ‘A Primer in Financial Economics’, takes a few detours in mapping out the terrain of financial economics that shows that actuaries anticipated important insights in financial economics, but failed to develop their ideas or disseminate them to a broader Fixing the Pension MF Recent events suggest that it’s time to reexamine existing pension plan funding rules and consider Plan Funding Rules changes. This is a discussion of how the current rules came into being, their shortcomings, and possible replacing rules. Foundations of BE Human decision-making deviates in one way or another from the standard assumptions of the Behavioral and rationalistic paradigm in economics. If such deviations from rationality and self-interest were Experimental small and purely idiosyncratic, they would on average cancel out, and economic theory would not Economics: Daniel be too wide off the mark when predicting outcomes for large aggregates of agents. Following the Kahneman and lead of Vernon Smith, early studies of alternative market mechanisms by experimental economists Vernon Smith can be viewed as tests of the hypothesis of idiosyncratic deviations 2 from standard economic theory. If deviations from rationality and self-interest were systematic, however, this would call for a revision of economic theory itself. Following the lead of Daniel Kahneman and the late Amos Tversky, early studies of human decision-making by cognitive psychologists can be seen as testing hypotheses of systematic deviations from rationality. Framework (A) for MF This paper recommends the following four criteria for measuring the adequacy of proposed Establishing funding policies. Corporate Retirement I. Management Review and Commitment. Funding Policy II. Adequacy of Plan Assets/Benefit Security. In effect, this criterion requires that, should a pension plan (or plans) be terminated, retirees would be secure in their pensions and active employees would find an equity in the fund assets commensurate with their accrued pensions for service rendered through the date of plan termination. III. Reasonable Stability in and Understanding of Anticipated Contribution Patterns. IV. Adoption of a Rational and Systematic Actuarial Method. Funding defined PF, AS, The paper, ‘Funding defined benefit pension schemes’, which was produced by Charles Cowling, benefit pension MF Tim Gordon, and Cliff Speed, and the discussion on the night serve to highlight the difference in schemes opinion that exists in the debate on how the funding target of defined benefit (DB) pension schemes should be derived. The debate centered around the appropriateness of what some might call traditional pension scheme funding techniques, which take advance credit for expected future investment return, and techniques which do not, e.g. funding targets which are related to scheme solvency, as proposed by the authors. Title Subject(s) abstract Getting the Models MV, BE What are things worth? It's a devilish problem in the business world, where companies need to Right': How to Value account for the fast-changing values of complex financial instruments -- from insurance policies to Hard-to-Price Assets employee stock options to exotic derivatives -- for which there is no ready sales history. Yet accounting standards are tightening, requiring that businesses justify valuations rather than simply use their best guess or original purchase price, as they did in the past. So firms are turning to ever more complicated financial models that attempt to deduce values using an array of indicators. Group Variable MF, PF This is a proposal to change the law on defined benefit (DB) plan design in response to the Annuity Pension Plan: challenges facing DB plans. The proposed design would tie benefits to funding levels. Doing so An Optional Plan puts participants at risk so something must be offered: benefit indexation (e.g. a COLA). My Design/Legislative intent is to find a balance between the needs of participants, plan sponsors and the government Proposal in Response (e.g. the PBGC). This plan design is intended only to be an option to current plan designs: it is to Financial not intended to replace existing defined benefit plan designs. Economics Challenge An advocate of just one or two parts of this triangle would likely make modifications to this to DB Plans design. Some possible “advocacy modifications” I have indicated as options to various key features of my core proposal. Herbert Simon BE A look back on a lifetime of academic work in human cognition. Interview & Obituary Hindsight MF, FF, A plan sponsor asked me a very interesting question. He noted that if we looked back at where we IM were 10 years ago, we would find that we set out anticipating a certain level of expected return on the pension portfolio. Had we gone to sleep and woke up 10 years later (now), we might ask how our portfolio did. We would be told that our portfolio return was higher than we anticipated. We would be happy and think we were in great shape. However, we would be surprised to later learn that we were in terrible shape and we were experiencing the pension “perfect storm”. How did this happen? I took a sample case we commonly use to take a look at this. I ran some projections, but based on starting in 1994. I first ran the projections based on what one might have expected, and then reflected the actual historical experience to see what would have happened. I then examine one alternative, and looked at the experience under that as well. How Much Money are IN Risk adjusted returns. You Willing to Lose for a Theory? How to Stop the MF At the 2002 Enrolled Actuaries Meeting, Donald Segal and Tonya Manning asked ERISA Insanity authorities to “Stop the Insanity.” In the authors’ response to comments on our article “Reinventing Pension Actuarial Science,” Larry Bader and I have said that funding rules require societal, or political, judgments. In this article, I try to identify and thereby confine, the public’s interest in defined benefit plan funding. Thus, for the time being, I put aside the pursuit of a new theory of pension actuarial science in favor of a practical proposal to Stop the Insanity. Title Subject(s) abstract Impact (The) of Fair AC, MV, I speculate that the worldwide promulgation of fair value accounting standards will make the Value Accounting on IN normal shape of the rate curve downward sloping. Upward sloping curves will be the occasional the “Normal” Rate exception rather than the rule. Curve—A Why do I so speculate? I hypothesize that fair value accounting will alter perceived risk, which, in Speculation turn, will alter both supply and demand along the duration dimension. Impact (The) of AC I examine the association between disclosed financial accounting data and firm value, while Pension Assumptions incorporating the effect of managerial discretion in reporting those data. I focus on the on Firm Value assumptions used to compute a firm's pension liability. I find that firm values are consistent with analysts being aware of the likely influence of reporting incentives on managers' choices of assumptions. Analysts appear to be aware of the incentives associated with contracting considerations and where they infer that such incentives have induced managers to choose obligation-reducing assumptions, they treat $1 of reported obligation as if it were an obligation of more than $1. These findings suggest that analysts recognize managers' use of assumptions that are not justified by the firm's operating environment and that they discount the effect of those Improving 401(k) BE, IN Investment Return Is it Time to IN, IM Demand for LT Corporate Bonds will Promote Issuance Immunize? We think it more likely now, with the flattening yield curve and narrowing credit spreads, that this strong demand for long duration corporate bonds may eventually be met by supply. A flattening yield curve and contracting corporate bond spreads make it more difficult for managers to justify a preference for short-term borrowing and will likely entice them to strongly consider releveraging the balance sheet to take advantage of a higher interest tax shield, make opportunistic share repurchases and acquisitions to drive EPS growth. Issue Debt to Fund AC, PF We put forth the financial merits of corporations issuing unsecured debt and using the proceeds to Plan Deficits and fund their defined benefit (DB) pension plan deficit. Capitalize on the Pension-Debt- Jensen and Meckling FE This paper is aimed at exhibiting the underlying game structure of Jensen and Meckling (1976) 30 years after: A equity model with agency cost. Beside the simplification of the proofs, this approach highlights game theoretic view the strategic interaction between the owner-manager and the minority shareholders. Analytical characterization of the equilibrium size of the firm with agency cost is found and the monitoring expenses are rigorously introduced. Title Subject(s) abstract Judgment under BE Many decisions are based on beliefs concerning the likelihood of uncertain events such as the Uncertainty: outcome of an election, the guilt of a defendant, or the future value of the dollar. These beliefs are Heuristics and Biases usually expressed in statements such as "I think that ...," "chances are ..." "it is unlikely that ...," and so forth. Occasionally, beliefs concerning uncertain events are expressed in numerical form as odds or subjective probabilities. What determines such beliefs? How do people assess the probability of an uncertain event or the value of an uncertain quantity? This article shows that people rely on a limited number of heuristic principles which reduce the complex task of assessing probabilities and predicting values to simpler judgmental operations. In general, these heuristics are quite useful, but sometimes they lead to severe and systematic errors. Knowledge, Wisdom BE, FE ESSAY or Understanding Loser's (The) Game IN This article presents information for investment managers on how to win the money management game. The author's experience with very bright and articulate investment managers is that their skills at analysis and logical extrapolation are very good, often superb, but that their brilliance in extending logical extrapolation draws their own attention far away from the sometimes erroneous basic assumptions upon which their schemes are based. Major errors in reasoning and exposition are rarely found in the logical development of this analysis, but instead lie within the premise itself. To win the game, a few specific things should be considered. First, the manager should be sure that he is playing his own game, he should know his policies very well and should play according to them all the time. Second point is to keep things simple i.e. make fewer and perhaps better investment decisions and simplify the professional investment management problem. And Making Financial FE FINANCIAL ECONOMICS IS DEVELOPING at a blistering pace: the instruments, the Economic Sense of technology, the applications, the size of the market – even the jargon. Many actuaries, especially the Future those who qualified ‘in the last century’, have had no grounding in this now fundamental subject which is standard material for current students. Making Investment IN, RK Many participants in self-directed retirement plans (401k, IRA, etc.) do not know enough about Choices as Simple as investing to choose rationally among alternatives. Others may know enough, but find it unpleasant Possible: or too time-consuming. Target-date funds (TDFs), also known as life-cycle funds, are being An Analysis of Target offered as a simple solution to their dilemma. A TDF is a “fund of funds” diversified across Date Retirement stocks, bonds, and cash with the feature that the proportion invested in stocks is automatically Funds reduced as time passes. Empirical evidence suggests that a simple TDF strategy would be an improvement over the choices currently made by many uninformed plan participants. This paper explores one way to achieve an even greater improvement. Market (A) is Needed PG Pension claims could and should be traded. This would increase welfare by reducing in Pension Claims beneficiaries’ risks and give sponsors an incentive to fund schemes properly. Title Subject(s) abstract Merton Miller FE Merton Miller was at the center of the transformation of academic finance from a descriptive field to a science. His principal contribution to this transformation was the introduction of arbitrage arguments which underlie most theoretical contributions in finance and remain central to the way financial economists analyze finance problems to this day. These arbitrage arguments underlie his and Franco Modigliani's famous irrelevance propositions. Modern (A) PF, This chapter explores the modern thinking behind asset and liability modeling for the Perspective on IN,AC quintessential "long-term institutions", namely defined benefit pension schemes and life insurance Institutional funds. The conclusion found here is that, although long-term institutions have developed their Investment Policy own unique methods of asset and liability management, in reality the management principles should be the same as those applying to other financial institutions (such as banks), or indeed to the Treasury function of non-financial institutions (such as industrial companies). The ramifications of this conclusion extend well beyond asset and liability modeling alone, and have profound implications for unified accounting, regulation and supervision of all institutions, as well as for the roles of actuaries, accountants, analysts and professional risk managers. Modern Valuation FE, PF This paper describes techniques for valuing cashflows generated within a stochastic projection Techniques model on a market consistent basis. Traditionally actuaries value cashflows using deterministic calculations or projection of the cashflows stochastically and discounting at a risk-adjusted raate. We advocate using deflators to value cashflows. Deflators are consistent with economic principles and, where the model is calibrated to the market, wiill produce market-consistent valuations. Morris Review of the AS In March 2004 the Government asked Sir Derek Morris to undertake a wide-ranging independent Actuarial Profession review of the actuarial profession. The background to the review was Lord Penrose's Inquiry into the Equitable Life, which highlighted a number of issues and concerns with the actuarial profession. The review has focused on three main areas: the extent of choice and competition in the market for actuarial services, the current regulatory framework for members of the actuarial profession, and the role and future institutional status of the Government Actuary's Department Nature (The) of Risk BE, RK Those in behavioral finance and psychology who study decision making have long known that risk appetite varies considerably among individuals. It generally has been the theory that people will accept larger risks to avoid losses than to achieve gains, even when the choices are New York City Story IN, IM The man responsible for determining the liabilities of New York City's public sector pension system wants to move to market-based valuation, but the move may be controversial. Next (The) Savings AC, PG With that as the backdrop, we, along with many investors, have lots of questions for the PBGC, and Loan Crisis? including: Are we facing the next savings and loan crisis? What are the biggest flaws in the pension system today? For how many more years can the PBGC continue to pay pension benefits? Could we see pension plans start shifting asset allocations toward fixed income? Where does the PBGC stand in line in a bankruptcy? Title Subject(s) abstract Noisy (The) Market' BE If you are a fan of indexing, as I and so many other investors are, you are no longer trapped in Hypothesis capitalization-weighted indexes which overweight overvalued stocks and underweight undervalued stocks. Devotees of value investing who are searching for a simple, low-cost indexed portfolio in which to hold their stocks need wait no longer. Fundamentally weighted indexes are Not Such a Great FE, TR Tension is often observed between the theoretical and the applied branches of a science. While the Controversy: subject of study is the same, the theoretician and practitioner have differing motivations, take Actuarial Science and different approaches and judge from different aesthetics. One is deductive and the other inductive. Financial Economics The theoretician seeks simplifying and unifying models while the experimenter or practitioner values models with high fidelity to the underlying data generating process. Off-Balance-Sheet AC, MV Yesterday, the SEC released its long-awaited report on off-balance-sheet activity to Congress and Activity Back in the the President as required by Sarbanes-Oxley. In the report, over 100 SEC staffers dug through the Spotlight filings for a sample of 200 companies, including the 100 largest companies by market cap as of December 31, 2003. The report focused on a range of topics with potential off-balance-sheet implications, including leases, pensions, other postretirement employee benefits (OPEB), contingent liabilities, derivatives, contractual obligations, and special purpose entities, among On the Risk of Stocks PF, IN This paper examines the proposition that investing in common stocks is less risky the longer an in the Long Run investor plans to hold them. If the proposition were true, then the cost of insuring against earning less than the risk-free rate of interest should decline as the length of the investment horizon increases. The paper shows that the opposite is true even if stock returns are “mean-reverting” in the long run. The case for young people investing more heavily in stocks than old people cannot therefore rest solely on the long-run properties of stock returns. For guarantors of money-fixed annuities, the proposition that stocks in their portfolio are a better hedge the longer the maturity of Overview: DE, TR, We offer a brief analysis of why the traditional DB pension plan appears to be abandoned in favor Developments in Risk RK of DC plans. We also discuss some key risks that both DC and DB plans convey upon plan Management for members, and we highlight some of the ways recommended by contributors to this volume, for Retirement Security managing these retirement risks. Pension Actuary's PF, TR Guide to Financial Economics Pension Deficits: An PF, FF In this article, we began with considering an economy without governmental guarantees for Unnecessary Evil pension funding. We found that transparency should lead to voluntary full funding. Otherwise, employers and employees would have inefficient compensation contracts that exposed employees to risk that they could not diversify. We then introduced a guarantee program and found that it reversed the main incentive for full funding. We noted that insufficient funding, however, enables weak or irresponsible plan sponsors to dip into the pockets of other sponsors—and perhaps of taxpayers. So, the government that includes a guarantee program must require plan sponsors to fund their plans; that is, it must compel behavior that would occur naturally in an unregulated, Title Subject(s) abstract Pension Design and BE Structure Chap. 1: Lessons from Behavioral Finance for Pension Funding: A PF An important prerequisite for insights into the future of pension plan funding is a sense of its Historical Perspective history. This includes not only the history of traditional topics like actuarial cost methods and assumptions, and the history of past inquiries into the dynamic and stochastic nature of pension costs, but also the perceptions and concerns of pension actuaries of the past. The purpose of this paper is to present this historical perspective. Pension Reform IN, MF The Bush administration’s pension reform proposal could prompt more than $200 billion in assets Spells $200B Fixed to switch from equity to fixed income. That’s one conclusion as actuaries, plan sponsors and Income Shift analysts have weighed in this week on the possible effects of the proposal. Pension Valuation TR, AC Revamping the methodology for taking defined benefit pension plans into account in corporate Needs More valuations addresses only a symptom of the underlying problems. The price-earnings multiple is Disclosure, Not a itself a deeply flawed methodology for valuing companies. Bader notes that "[t]he price-earnings New Formula (P/E) multiple is the most familiar valuation tool. . . . " But he offers no other reason for making the use of this tool the centerpiece of his analysis. Pensions and Capital PF This paper considers the pension plan as part of the capital structure of the sponsoring employer. Structure: This enables lessons from financial theory concerning capital structure to be used to answer the Why Hold Equities in question "what assets should a pension fund hold?". The standard Modigliani-Miller framework is the Pension Fund? expanded on to consider the implications of corporate tax. This leads to the conclusion that bond investment for pension plans has tangible advantages over holding risky assets (e.g. equities). The paper considers a case study of the pension plan of The Boots Company, a UK pharmacy retailer with a pension fund of around £2.3bn ($3.5bn), where these ideas were put into practice. Finally the paper discusses the value released to shareholders and the extra security members of the pension fund have derived from putting theory into practice. Primer (A) in FE This paper is divided into three parts. Taken together, the three parts intend to provide the reader Financial Economics with an overview of the first 101 years of financial economics, with particular attention on those developments that are of special interest to actuaries. In Section 1, S.F. Whelan attempts to capture the flavour of the subject and, in particular, to give an overview or road map of this discipline, highlighting actuarial input. In Section 2, D.C. Bowie gives a concise and self- contained overview of the Modigliani and Miller insights (or MM Theorems, as they are often known). In Section 3, A.J. Hibbert considers the novel option pricing method proposed by Black, Merton, and Scholes. These two insights are highlights of this new science, and, in both cases, Title Subject(s) abstract Primer (A) on PF, IN Within the past few years two broad themes have had significant impact on many institutional Portable Alpha investment portfolios. First with forward-looking capital market assumptions for equity and fixed income returns lower than past performance, institutional investors area increasingly turning to alternative investments such as hedge funds and real estate to create an efficient portfolio. Second, fiduciaries have increased their focus on controlling the management fees and tracking error of their efficient traditional asset class allocations through passive investment strategies. Can portable alphas address both of these themes simultaneously? Principles (The) of PF The key to understanding the financial implications of corporate pension plans … is the economic Corporate Pension value of claims on a pension plan. Beneficiaries have regarded their claims as a bona fide Finance retirement fund. On the other hand, sponsoring companies, their actuaries, their accountants, their creditors, and their stockholders have regarded pension claims lightly. Thus corporate pension plans have traditionally had a "something for nothing" aspect about them, whereby their value to beneficiaries seemed to exceed the financial burden imposed on the sponsoring company. What Prospect Theory: BE This paper presents a critique of expected utility theory as a descriptive model of decision making An Analysis of under risk, and develops an alternative model, called prospect theory. Choices among risky Decision under Risk prospects exhibit several pervasive effects that are inconsistent with the basic tenets of utility theory. In particular, people underweight outcomes that are merely probable in comparison with outcomes that are obtained with certainty. This tendency, called the certainty effect contributes to risk aversion in choices involving sure gains and to risk seeking in choices involving sure losses. In addition, people generally discard components that are shared by all prospects under consideration. This tendency, called the isolation effect, leads to inconsistent preferences when the same choice is presented in different forms. An alternative theory of choice is developed, in which value is assigned to gains and losses rather than to final assets and in which probabilities are replaced by decision weights. The value function is normally concave for gains, commonly Psychology and BE Thaler challenges financial axioms of rational expectations and expected utility maximization Financial Markets: using the results from the study of human decision making. These include paradoxes (to rational Richard H. Thaler theory) known by short hand names such as "overconfidence," "anchoring and adjustment," Addresses the "mental accounting," and "framing." Investment Section Puzzling (The) State AC Jensen of Harvard Business School condemns "managing earnings" as a form of lying. This is an of Low-Integrity example of the agency problem: How to recognize and control the problems arising when the Relations Between interests of managers are not aligned with those of shareholders. Managers and Capital Rationale (The) of the IN, FE Portfolio analysis based on mean and variance was introduced by Harry Markowitz (1953) more Mean-Standard than 20 years ago. This method of analysis has become extremely popular, partly through Deviation Analysis: Markowitz's own book (1959), and also through the work of James Tobin. The method has been Comment severely criticized, and I am among the critics who have argued that mean-variance analysis must be seen as a n intellectual exercise, useful only if it leads to insight into the real problems of Title Subject(s) abstract Rationale (The) of the IN, FE Rebuttal of Borch' article with the same main title Mean-Standard Deviation Analysis: Reply and Errata for Original Article Reaffirming Pension TR, PF The pension actuarial community has been in the process of revisiting the fundamental principles Actuarial Science of pension actuarial science. Bader  and Bader-Gold  have raised important questions about the validity of the actuarial pension model. They have urged the profession to undertake a major revision of the model in light of financial economics. The works of Bader and Gold, as well as several other actuaries and economists, have become the subject of numerous discussions. The paper of Bader and Gold  offers a comprehensive list of grievances that the financial economics community has had with various methodologies utilized by the pension actuarial community. The negative role of ERISA enactment, numerous shortcomings of statement FAS87, the importance of understanding of financial economics – these and several others points are very well taken. However, the paper contains several declarations that should be disputed. The Reforming the DE, PF actuarial pension model certainly needs further development, but it needs no reinvention. DB pensions should remain as one of the compensation tools available to workers and Defined-Benefit management as they work out the value-maximizing means of delivering compensation to Pension System in the workers. The paper derives the implications of attaching an important caveat to the use of DB United States pensions—namely, that if workers are to be promised annuities by their employers and if [Preliminary and taxpayers are to be interposed as third-party guarantors of those annuities, then the pension incomplete draft] promise should be essentially free of risk. In the course of bargaining with their employers, workers should of course be careful not to demand too high a fraction of their overall compensation in the form of such risk-free annuities, taking account of whatever Social Security benefits to which they might become entitled. Equity-related compensation and own-firm-risk- related compensation may be complementary elements of the compensation toolbox, but other vehicles aside from DB plans are available for the purpose of giving workers exposure to those forms of risk. The salient common feature of those other forms of compensation is that they all Reinventing Pension PF The 1974 passage of ERISA halted the evolution of the actuarial pension model. This frozen Actuarial Science model was unable to incorporate the emerging science of financial economics, which in turn (including revealed fundamental flaws in the model. Contrary to the teachings of financial economics, the discussions) actuarial pension model anticipates expected outcomes without reflecting the price of risk. It then camouflages the risky distribution of outcomes by various smoothings and amortizations. The flawed pension model has caused widespread, though rarely recognized, damage to pension plan stakeholders. This paper illustrates the flaws and the injuries they cause. To protect the pension system and the vitality of our profession, we urge pension actuaries to reexamine and redesign the model. The new model must incorporate the market value paradigm and reporting transparency that is rapidly becoming a worldwide minimum standard in finance. Title Subject(s) abstract Rethinking Pension PF, IN The purpose of this article is threefold. First, we discuss the recent performance of defined-benefit Liabilities and Asset corporate pension plans (in 2000 and 2001) and the implications for future corporate earnings. Allocation Second, we address the issues associated with measuring pension liabilities. Finally, we suggest solutions for dealing with the problem of measuring pension liabilities. Rise (The) of Liability PF, IN, IMTraditionally, defined benefit pension plan sponsors have managed their plan's investment Driven Investing portfolios from an asset-only perspective, monitoring the value of plan assets while giving insufficient consideration to the risks and economic sensitivities of the liabilities. Risk (The) of PF Upcoming funding and accounting regulations will limit the ability of pension plan sponsors to Declining Market Cap smooth the recognition of investment gains and losses, resulting in better transparency, but more with Large Pension volatility. More cost volatility will make short-term budgets harder to manage, and large healthy Obligations companies will need to find a way to either bear or mitigate the risk. Companies that have experienced a decline in market capitalization, but still retain large pension obligations, will not be as able to withstand the cost of a sharp decline in funded status. This article will focus on the pension risk from the standpoint of different companies. Specifically, we’ll examine risk based on the relative size of the pension obligation to the market capitalization of the plan sponsor. Risk Transfer in PF, AC Actuaries and sponsors of public sector defined benefit pension plans agree that each generation Public Pension Plans of taxpayers should bear its fair share of the long term plan cost. Actuarial methods and assumptions are designed to equate expected costs across generations. This paper uses arbitrage principles to show that equating expected costs unfairly lowers risk-adjusted costs for early generations and raises them for later generations. The use of expected rather than risk-adjusted returns on risky assets leads to sub-optimal asset allocations, granting of valuable options (skim funds), and costly financing strategies such as Pension Obligation Bonds. Shareholder (The) - PF, DE In 1980 and 1981, Fischer Black and Irwin Tepper showed that shareholders would gain if Optimal Design of corporate defined benefit pension assets were invested in taxable fixed income securities instead Cash Balance Plans of equities. This paper extends this analysis into the cash balance plan arena, concluding that additional shareholder gains arise when plan liabilities mimic equities. A numerical example demonstrates that the present value of riskless gains to shareholders can exceed the entire after-tax value of plan assets. Lack of transparency in actuarial methods and assumptions is shown to Statement on PF, MF, Commentary on  Discount rate for liabilities,  Funding of PBGC guarantees,  Valuation “CORPORATE AC of assets and  Smoothing of deficits PENSION FUND ACCOUNTING” Title Subject(s) abstract Statement on AM, BE Prediction markets are markets for contracts that yield payments based on the outcome of an Prediction Markets uncertain future event, such as a presidential election. Using these markets as forecasting tools could substantially improve decision making in the private and public sectors. We argue that U.S. regulators should lower barriers to the creation and design of prediction markets by creating a safe harbor for certain types of small stakes markets. We believe our proposed change has the potential to stimulate innovation in the design and use of prediction markets throughout the economy, and in the process to provide information that will benefit the private sector and government alike. Stocks are Still an IN, RK What about underestimated pensions costs? Bears maintain that the market decline confirms that Oasis the return estimates used by most firms on their pension portfolios are far too high. But there is good news and bad news in the market decline. Yes, the value of the pension portfolios has fallen. As ridiculous as a 12% return estimate was at the market peak in March 2000, a 6% to 7% return estimate is far too low from current stock market values, which I believe will approach, if not exceed, the 7%-plus inflation that has been realized over all long-term periods. Stocks Not For the IN, RK The underpinning of Bodie’s investment philosophy is that stocks are far riskier than advisors are Long Run leading their clients to believe. Too many portfolios, he says, are built on the fundamental belief that over the long run stocks are almost a sure bet. This view holds that if your investment horizon is ten years or more, stocks are a safe investment play and a better investment than bonds. Stop Thief! IN, IM Successful Defined MF, PF, Recent meetings on financial economics have promoted the idea of an all bond asset allocation. Benefit Plans Cost IN Financial economics calls us to take a corporate-centric, rather than plan-centric approach to Less with Bonds pension asset allocation selection. However, we can also learn about the risk of investing in stocks by using some traditional actuarial tools, like measuring the “probability of ruin”. It is commonly known that actuarial liabilities and normal costs are lower using a discount rate based on higher equity returns as compared to lower bond returns. However, if we factor in the probability of ruin (which we learned during our actuarial exams, but rarely use with pension trust funds), we will find that a plan than avoids ruin costs less with a large bond asset allocation. Title Subject(s) abstract Tax (The) PF, MF Because they are worth more when times are good and less when times are bad, common stocks in Consequences of the pension fund add to the sponsoring firm's leverage. They cause contributions to a pension Long-Run Pension fund to be high just when the firm can least afford to pay them. Conversely, bonds in the pension Policy fund will make it easier for the firm to avoid default on its own bonds when times are bad all over: The more bonds a pension fund buys, the more the firm can borrow. The tax treatment accorded the pension fund differs notably from that accorded the firm. Some have argued that a firm can capitalize on the difference by accelerating the funding of its pension plan. The benefits of full funding are wasted, however, unless the added contributions to the fund are invested in bonds; higher pension contributions now mean lower contributions later, hence higher taxes later. The benefits come from earning, after taxes, the pretax interest rate on the Taxation and PF This paper focuses on the impact of taxes on optimal corporate pension policy. The analysis is Corporate Pension based upon an integration of corporate and individual shareholder considerations. The major Policy conclusions are that a company should fully fund its pension plans and should invest the pension The Cost of Capital, FE What is the "cost of capital" to a firm in a world in which funds are used to acquire assets whose Corporation Finance yields are uncertain; nada in which capital can be obtained by many different media, ranging from and the Theory of pure debt instruments, representing money-fixed claims, to pure equity issues, giving holders only Investment the right to a pro-rata share in the uncertain venture? This questions has vexed at least three classes of economists:(1) the corporation finance specialist concerned with the techniques of financing firms so as to ensure their survival and growth; (22) the managerial economist concerned with capital budgeting; and (3) the economic theorist concerned with explaining The U.S. Pension IN, DE This report, therefore, attempts to provide some of the actual data needed to analyze the potential Crisis: Evaluation and effects of these emerging pension issues properly. It also serves as a reminder that our nation Analysis of Emerging boasts a sound, long-term national retirement strategy based on a foundation of core benefits Defined Benefit (Social Security and DB pension plans) and flexible benefits (personal savings and defined Pension Issues contribution [DC] plans). It is the ratio and health of those two types of retirement programs that allow us to achieve our long-term corporate and societal goals. Treatment of Pension PF, AC, Pension plans may not quite fit Churchill’s “mystery wrapped in an enigma,” but probably no Plans in a Corporate MF other financial activity spanning such a broad spectrum of U.S. business is so little understood Valuation outside the small world of its practitioners. • Corporate pension contributions are governed by the Byzantine rules of the Employee Retirement Income Security Act of 1974 and the U.S. Internal Revenue Code. These rules aim to protect the participants and the Pension Benefit Guaranty Corporation (PBGC) while limiting tax- deductible contributions. • The financial reporting for pension plans is governed by an entirely different set of complex rules set forth primarily in Statement of Financial Accounting Standards No. 87. The resulting expense figures conceal market risk and are irrelevant in assessing the value of the pension plans’ sponsors. Until recently, few analysts paid special attention to pension plans. Title Subject(s) abstract UBS Investment PF, IN In this report we seek to answer the question of whether a valid case can be made for a zero-equity Research investment strategy by company-sponsored, defined-benefit pension schemes. We analyse the Pension Fund Asset financial economics of pension provision and examine the common belief that significant equity Allocation investment adds to shareholder value. This report is NOT about whether equities are currently under or overvalued, nor whether equities will or will not deliver a certain return in the future. Also, the case against equity investment by corporate pension schemes by no means suggests a zero equity allocation by individual investors or public sector schemes. . Understanding Equity RK, FE, Several recent books and articles have addressed the issue of expected equity returns, with a range Risk Premium IN of opinions—from dourly pessimistic to irrationally optimistic. This article attempts to answer the following questions: • What is equity risk premium? • How should equity risk premium be measured? • Does a constant risk premium provide the best model? • What are reasonable expectations for the future? Understanding the FE, MV This paper discusses the construction of the corporate bond yield curve and possible applications Corporate Bond Yield to pension valuation. The first part addresses the mathematical theory and tools needed to extract Curve the yield curve from corporate bond data and the issues that arise in contrast to the Treasury yield curve. Next, specific problems concerning the construction of the curve are explored, for example, the number of bonds available, the quality at different durations, etc. In the last part questions arising when applying the yield curve to pension valuation are discussed. Valuation of Pension FE, MV, This paper will discuss the valuation of lump sums for both funding and FAS 87 valuations, Obligations with DE particularly the selection of appropriate discount rates. Because of the complexity of the Lump Sums requirements for setting discount rates for FAS 87, most of the discussion is with respect to FAS 87. Since the mathematical calculations required for exact calculation of lump-sum values may be incompatible with some actuarial valuation systems, the last part of the paper discusses some approaches for approximating the detailed calculations with simplified approaches. This paper shows that reasonable approximations exist to the theoretically correct methodology for valuing Value (The) of FE Should we value an asset at an amount calculated using actuarial discounted cash flows, or at its Actuarial Values current market price? Much hinges on this question - the possible answers dictate quite distinct programmes for the development and practice of the valuation of long-term business, and the theory and practice of the associated investment management. Title Subject(s) abstract Valuing Companies, PF, AC, Deciding what a company is worth is fundamental to the work of executives, investors, and Valuing Pension MV lenders. Corporate valuations are needed for mergers, acquisitions, sales, spin-offs, initial public Plans offerings, leveraged buyouts, bankruptcies, and investment and lending decisions. For a publicly traded company, a market valuation is readily available, but even then an interested party may want an independent judgment of value. Relying on FAS 87, though, can distort the valuation of companies whose defined benefit pension plans are significant in relation to their overall business. Reliance on reported pension costs, however, can produce errors. Although FAS 87 has drawn much controversy and criticism, its real or alleged defects aren’t the problem here. Rather, folding a conventional pension cost into corporate earnings hinders rather than helps in understanding corporate value. The danger lies in conflating two very different types of earning or expenses—those generated by conventional business operations and those arising from financial Welfare (The) of BE Behavioral finance, a developing field of academic research that emphasizes investor irrationality American Investors (and ignorance) and the inefficiency of markets, has been hailed by defenders of the SEC as offering a solid economic rationalization for our vast scheme of federal securities regulations. Even apart from the obvious implications for the regulatory system of ignorance and irrationality on the part of regulators, a closer examination of the logic of behavioral finance leaves little for the pro-regulation crowd to crow about. What are Corporate PF, AC Analyses of corporate pension plans often make unstated assumptions about an implicit labor Pension Liabilities? contract. An example of the effect of such an assumption is that many mistakenly believe that if a worker’s benefits are tied to final salary, he is protected against inflation until retirement. Also, the value of a worker’s claims is often considered to be independent of the status of the firm’s pension fund. These “implicit contract” assumptions are examined and questioned. The implications of analyzed pension liabilities in a manner consistent with the analysis of other What is Risk (Part II) IN Much has been written about the “riskiness” of stocks and the safety of bonds. But the data seems to focus on only the recent history, a time of falling interest rates and capital gains in bonds. Our discussion has a more long-term focus. What is Risk? IN When people seek investment advice, the first response from professionals is usually “How much risk can you take?” The ensuing discussion is then governed by the concept of “risk.” In today’s financial world, however, the definition of risk used by professional financial planners and stockbrokers has become completely divorced from the definition used by most people. What Pension Scheme BE Almost every day we read about the serious crisis in final salary pension schemes that has been Deficits largely brought about by the move to the methodology of FRS17 (and its European twin IAS19), in which the yield on long-dated AA corporate bonds is the specified discount rate for liabilities, and assets are taken at market value without any smoothing adjustment. The adverse consequences of this move to FRS17 area numerous and acute: [also includes letter replies] Title Subject(s) abstract What’s next?—DB PF, DEIn light of the global demand for financial transparency, we need to wean ourselves and our plans for the long run clients from the seductive (but illusory) and addictive advantages of Defined Benefit (DB) plans without weaning them away from DB plans. We must abandon reliance on the “free lunches” that appear to be served up by DB plans and focus instead on substantive virtues. Along the way we will need an endorsement by society (better rules) and we will have to exert our creativity and The Yikes! How to Think PF, RK, IN same issue keeps reappearing. How to deal with the risk associated with equity investments about Risk? when evaluating the financial health of retirement systems? Some experts argue that retirement plans holding equities can make smaller funding contributions than those invested primarily in bonds. After all, stocks yield 7 percent, after inflation, and bonds only 3 percent. Nonsense, say others. The higher expected returns on equities reflect their greater risk. Any serious financial evaluation of retirement arrangements must “risk-adjust” these returns. After accounting for risk, the contribution needed today to fund future pension obligations is the same regardless of whether Title Subject(s) abstract Title comment Significance Grade Entry 1/n (The) Pension 18 Investment Puzzle Accounting/Actuarial 65 Bias Enables Equity Investment by Defined Benefit Pension Plans Actuaries discuss the 81 principles of financial economics of pension accounting Adding an Annuity to Kiosks and phone centers can only help participants when better options are available. 119 Improve Defiined Contribution Plan Discusses liability driven investing (LDI). Options Adequate Funding for 86 a Pension Plan Agency Problem 47 An Actuary Looks at 90 Financial Insurance Title comment Significance Grade Entry Are Stocks "Too Use of "prevailing interest rates" in discounting cash flows assumes those rates provide an accurate A 6 High"? yardstick. But the bond market is subject to emotions just as are equity and other markets. Ron demonstrates that relative value signals using prevailing interest rates were wrong for 20 years and that the signals would have been correct if instead of market rates the discounting was based on long term "bond" rates of inflation plus 3% real return. Asset-Liability 92 Professional Specialty Guide Assumed Rates of Example of analysis using pension finance concepts, which are explained in the paper. Early draft. 78 Discount for Perhaps a later version exists. Valuations of Publicly Sponsored Defined Benefit Plans Behavioral Economics It says something interesting about the field of economics that there is a sub-field called behavioral C A 25 economics. Surely all of economics is meant to be about the behavior of economic agents, be they firms or consumers, suppliers or demanders, bankers or farmers. Behavioral Finance An introduction to behavioral concepts. 68 Title comment Significance Grade Entry Bond market Example of analyst work product based on pension finance. Impact of pension finance on new C 14 implications of the directions for Congress, FASB, Credit rating agencies and investors. defined-benefit pension reform proposals Case (The) Against 88 Stock in Corporate Pension Plans Case (The) against 107 Stock in Public Pension Funds Cashing In: 76 Do Aggressive Funding Policies Lead to Higher Credit Ratings? Cognitive Dissonance For actuaries who dismiss the Great Controversy as mere academic musings not worthy of a response, A B 28 Shuttleworth declares traditional actuarial science is based on "untruths" and that actuaries who do not follow the tenets of financial economics are "wrong-headed." Wall street analysts, for example, view traditional pension methods this way and tend to dismiss measurements which are not based on future cash flows discounted with a yield curve. Title comment Significance Grade Entry Comprehensive (A) Identifies and addresses solutions for the "perverse unintended consequences" of Erisa. A useful B 8 Defined Benefit template to compare to actual reform. Pension Plan Reform Proposal Conceptual 63 Framework - Thoughts Corporate Pension 93 Funding Policy Cross (The) Section of More evidence of the incompleteness of the rational functions of the financial economics models. 115 Common Stock Defined Benefit An example of analysis based on financial economic theory. The conclusion is that relative volatility 57 Pension Plans’ in liability and asset values to change in interest rate is dangerously mismatched. Interest Rate Exposure at Record High Discounting Pension 89 Liabilities under the New SEC Rules Title comment Significance Grade Entry Does An Actuarial B+ 46 Bias Lead To Equity Investment? Draft Editorial This draft essay might be titled "Reinventing Accounting" as it critiques the use of current financial B+ 7 statements by analysts. Durational (Select & 64 Ultimate) Discount Rates for FAS 87 & 106 Valuations Earnings B 41 A study to measure the impact of the agency problem related to pension accounting. This paper is a follow up to the Coronado and Sharpe (2003) paper. Manipulation and Managerial Investment Decisions: Evidence from Sponsored Pension Plans Economics (The) of It is interesting that this particular paper cannot be found in Russell's web pages. 73 Defined Benefit Pensions and the Rationality of Pension Funding Strategies Title comment Significance Grade Entry Equity Duration – Duration, or sensitivity of price to interest rate fluctuation, of equities is ignored largely because of 105 Updated Duration of the difficulty of not having a final maturity date or known dividend payments. This realization poses the S&P 500 the question, "what difficult to deal with issues are ignored in a bond duration calculation?" One example, fluctuating credit quality. Equity Risk Premium A transcription of a conference of well known economists, statisticians and investment professionals. B B 29 Forum Summary comments on pages 108 through 113 provide much information from this conference. Also a good bibliography at the end. A "theoretical foundations" essay by Richard Thaler presents the Behavioral Economics view of the equity risk premium at pages 2 through 7. Equity Risk Premium: 116 Expectations Great and Small Evaluating the Long- 60 Term Risk of Equity Investment in a Portfolio Insurance Framework Title comment Significance Grade Entry Evolving Pension B 21 Actuarial Science Final Report of the 49 Task Force on Pension Funding Financial Economics Vancouver Great Controversy B 12 and Pension Current Actuarial Practice in Light of Financial Economics Symposium Actuaries: The U.K. Experience Financial Economics 69 for Pension Plans Financial Economics: B A 108 A Wake-up Call Title comment Significance Grade Entry Financial Economics: The theoretical developments were made but not disseminated beyond the insular province of the A 112 Actuaries' actuarial community. When later rediscovered by non-actuarial mathematicians the connection to Contributions real world problem solving was no longer apparent. Theoretical developments continued unchallenged by real data ultimately leading to the presumptive dismissal ("reinventing") of traditional actuarial methods and models. In hindsight this condemns the self administered educational system chosen by the actuarial organizations over maintaining an applied science niche within the mathematics departments of the higher educational academy. Fixing the Pension B- 1 Plan Funding Rules Foundations of 2002 Nobel Laureates in Economics A+ B 27 Behavioral and Experimental Rational utility functions are modified to take into account Prospect Theory of behavioral economics Economics: Daniel on page 17. Also, a good source of citations of important papers. Kahneman and Vernon Smith Framework (A) for 87 Establishing Corporate Retirement Funding Policy Funding defined Can traditional DB plans exist if solvency is measured using pension finance? 15 benefit pension schemes Title comment Significance Grade Entry Getting the Models Experimental Economics at work. B A 118 Right': How to Value Hard-to-Price Assets Group Variable Included at the end of the essay are several points of view or questions posed by people who read the 72 Annuity Pension Plan: article. Some of these are responded to by Lowman. An Optional Plan Design/Legislative Proposal in Response to Financial Economics Challenge to DB Plans Herbert Simon A 52 Interview & Obituary Hindsight 51 How Much Money are 35 You Willing to Lose for a Theory? How to Stop the Practical comments on the public policy issues of pension funding. 70 Insanity Title comment Significance Grade Entry Impact (The) of Fair 62 Value Accounting on the “Normal” Rate Curve—A Speculation Impact (The) of 66 Pension Assumptions on Firm Value Improving 401(k) 34 Investment Return Is it Time to Example of analyst work product based on pension finance. C 9 Immunize? Issue Debt to Fund An example of the practical application of financial economic theory. A 39 Plan Deficits and Capitalize on the Pension-Debt- Jensen and Meckling Agency costs 102 30 years after: A game theoretic view Title comment Significance Grade Entry Judgment under Key paper A+ 30 Uncertainty: Heuristics and Biases Knowledge, Wisdom 33 or Understanding Loser's (The) Game 100 Making Financial Continuing education via Certificate in Practical Financial Economics, or CPFE, obtained after 75 Economic Sense of twelve units of study material. the Future Making Investment 106 Choices as Simple as Possible: An Analysis of Target Date Retirement Funds Market (A) is Needed I find the opening paragraph in this article to be misleading in the extreme. I believe the proper 17 in Pension Claims reference in the footnote should be to PBGC's Pension Insurance Data Book (2003). It does indeed point out that underfunding is rampant -- WITHIN THE SUBSET of plans which made claims against the PBGC! Well, duh. These 3,277 plans (through 2003) amount to a tiny fraction of the more than 160,000 plan terminations since 1974. Title comment Significance Grade Entry Merton Miller 54 Modern (A) A 48 Perspective on Institutional Investment Policy Modern Valuation If you want the theory and formulas, this is your paper. The "examples" are sketches and outlines of 120 Techniques considerations, not practical applications. Morris Review of the Comprehensive review of the actuarial profession in the United Kingdom. 10 Actuarial Profession Nature (The) of Risk 53 New York City Story 19 Next (The) Savings Interview with Brad Belt. Total 22 pages. 44 and Loan Crisis? Title comment Significance Grade Entry Noisy (The) Market' C A 22 Hypothesis Not Such a Great Practical validity of theoretical ideas of finance is discussed, followed by illustration of the problems A 111 Controversy: of complexity in modeling real world systems. Actuarial Science and Financial Economics Off-Balance-Sheet 45 Activity Back in the Spotlight On the Risk of Stocks A+ C 24 in the Long Run Overview: The opening chapter of The Pension Challenge, Risk Transfers and Retirement Income Security. B A 40 Developments in Risk Management for Retirement Security Pension Actuary's Replace this file with pdf version after released by SOA A B+ 20 Guide to Financial Economics Pension Deficits: An B+ 2 Unnecessary Evil Title comment Significance Grade Entry Pension Design and A good example of the application of behavioral concepts to plan design. 32 Structure Chap. 1: Lessons from Behavioral Finance for Pension Funding: A 95 Historical Perspective Pension Reform Example of analyst work product based on pension finance. C 13 Spells $200B Fixed Income Shift Pension Valuation 83 Needs More Disclosure, Not a New Formula Pensions and Capital A 11 Structure: Why Hold Equities in the Pension Fund? Primer (A) in Most historical reviews start with academic papers from the 1950s. This one points to 1900. A 38 Financial Economics Title comment Significance Grade Entry Primer (A) on Lower nominal capital market assumptions do not necessarily mean lower real returns. Although the B 110 Portable Alpha current fashion (or fascination ) with fixed income may be leading to lower real returns as prices are bid higher. Principles (The) of 94 Corporate Pension Finance Prospect Theory: Key paper A+ 31 An Analysis of Decision under Risk Psychology and 91 Financial Markets: Richard H. Thaler Addresses the Investment Section Puzzling (The) State B C 37 of Low-Integrity Relations Between Managers and Capital Rationale (The) of the Skewness in Borch' discussion could be contained in the behavioral terms added to the rational utility functions. 113 Mean-Standard Deviation Analysis: Comment Title comment Significance Grade Entry Rationale (The) of the 114 Mean-Standard Deviation Analysis: Reply and Errata for Original Article Reaffirming Pension The separation of pension actuarial science and its methodology from FASB, Erisa, IRS, and other A 3 Actuarial Science (misinterpretations is clarifying. Reforming the Three axioms are stated in the introduction: (1) the pension promise should be essentially free of risk; 77 Defined-Benefit (2) taxpayers should be fully compensated for bearing any residual risk; and (3) healthy sponsors Pension System in the should not have to subsidize unhealthy ones . United States [Preliminary and incomplete draft] Reinventing Pension A+ B+ 26 Actuarial Science (including discussions) Title comment Significance Grade Entry Rethinking Pension 58 Liabilities and Asset Allocation Rise (The) of Liability B 109 Driven Investing Risk (The) of 99 Declining Market Cap with Large Pension Obligations Risk Transfer in 59 Public Pension Plans Shareholder (The) - Example of analysis using pension finance concepts, which are explained in the paper. Early draft. 79 Optimal Design of Perhaps a later version exists. Cash Balance Plans Statement on 50 “CORPORATE PENSION FUND ACCOUNTING” Title comment Significance Grade Entry Statement on Experimental Economics at work. 117 Prediction Markets Stocks are Still an 67 Oasis Stocks Not For the 43 Long Run Stop Thief! 36 Successful Defined 71 Benefit Plans Cost Less with Bonds Title comment Significance Grade Entry Tax (The) 96 Consequences of Long-Run Pension Policy Taxation and 98 Corporate Pension Policy The Cost of Capital, 97 Corporation Finance and the Theory of Investment The U.S. Pension Unintended consequences of pension finance? B 42 Crisis: Evaluation and Analysis of Emerging Defined Benefit Pension Issues Treatment of Pension 56 Plans in a Corporate Valuation Title comment Significance Grade Entry UBS Investment 74 Research Pension Fund Asset Allocation Understanding Equity To discuss equity risk premium, common understanding of defined terms is essential. This article 61 Risk Premium makes that clear and presents the commonly used definitions. Understanding the 84 Corporate Bond Yield Curve Valuation of Pension 85 Obligations with Lump Sums Value (The) of 55 Actuarial Values Title comment Significance Grade Entry Valuing Companies, 82 Valuing Pension Plans Welfare (The) of Very readable. C A+ 23 American Investors What are Corporate A criticism of "projected benefit" and "ongoing plan" assumptions, often implicit, in pension liability 103 Pension Liabilities? valuation What is Risk (Part II) Muhlenkamp defines "risk" as the probability of losing purchasing power. This essay questions A- 5 whether one year periods are appropriate to measure volatility. It proposes fundamental reason why equity returns exceed bond (or any other) investment class which is unrelated to statistical variances. What is Risk? Muhlenkamp defines "risk" as the probability of losing purchasing power. Statistics are used because B 4 they are available, not necessarily because they are informative. Outside of short term or specifically, time diversification allows fundamental trends to override short term volatility. Investment diversity depends on spreading investments over several enterprises, not over security classes. What Pension Scheme 101 Deficits Title comment Significance Grade Entry What’s next?—DB 80 plans for the long run Yikes! How to Think " … most people have little ability to manage the risk … in equities …" 104 about Risk? The essay comments on private account proposals for Social Security. This statement implies most people can better manage the risks involved with fixed income investments. Title comment Significance Grade Entry The Great Controversy Symposium - June, 2003 - Vancouver abstract Title Author Subject(s) filename (all are .pdf) Pension Funds - A Jon Exley PF openingremarks_1 Classical financial theory offers a normative prescription for pension fund asset allocation that rejects the widely adopted Company Manager's Shyam Mehta portfolio selection theory favoured by practitioners in favour of close asset and liability matching. In this paper we search for View Andrew Smith positive theory to explain actual observed behaviour. We question whether the classical theory can accommo date this actual observed behaviour by allowing only for issues affecting the principals (pension scheme members and sponsoring company shareholders) and conclude that it is unlikely that a full explanation can be obtained by this analysis alone. Instead we propose that the roles of agents and the interests of corporate insiders need to be considered in order to explain observed behaviour. We argue that the agents involved may themselves be behaving quite rationally in terms of their own welfare and this provides a simple explanation for actual behaviour without rejecting the underlying principles of classical theory. The reporting of the Isabel Gordon AC openingremarks_2 This paper compares the development of the reporting for pension commitments by the sponsoring employer in Australia to defined benefit cost in the US and the UK. In Australia, there are no measurement rules concerning the calculation of the periodic cost to the defined the sponsor's books in an benefit fund (DBF) provided by the sponsor. By contrast, in the USA and UK accounting standards on this topic were unregulated setting: introduced in 1987, and an international accounting standard first promulgated in 1983. The flexibility of accounting Australia compared to treatment in Australia permits managerial discretion when determining the contribution expense to the DBF. The development the USA & UK of reporting for commitments in defined benefit funds by the sponsor in Australia is compared to the USA and the UK. This lack of regulation of the defined benefit fund expense in Australia permits the modelling of the contribution expense to determine if management exploit this flexibility of accounting treatment. An assessment of the interrelationship between the actuarial valuation and the role of the sponsor for Australian DBFs can also be gleaned. Pensions and Capital John Ralfe IN, PF openingremarks_3 This paper considers the pension plan as part of the capital structure of the sponsoring employer. This enables lessons from Structure Cliff Speed financial theory concerning capital structure to be used to answer the question "wha t assets should a pension fund hold? ”. Why hold Equities in the The standard Modigliani-Miller framework is expanded on to consider the implications of corporate tax. This leads to the Pension Fund? conclusion that bond investment for pension plans has tangible advantages over holding risky assets (e.g. equities). The paper considers a case study of the pension plan of The Boots Company, a UK pharmacy retailer with a pension fund of around £2.3bn ($3.5bn), where these ideas were put into practice. Finally the paper discusses the value released to shareholders and the extra security members of the pension fund have derived from putting theory into practice. The Influence of the Semyen Spivak openingremarks_4 Enron case brings up the issue that has long worried pension and benefits experts: a retirement plan hugely dependent on the Financial Status of the Ravil Akhtyamov health of the company that provides it. Enron’s own stock accounted for more than 60 percent of the assets in the $2,1 billion Pension Plan Sponsor to defined contribution 401 (k) plan in 2001. It is widely known that some companies have even higher levels, creating even the Solvency of the worse scenario should these companies fail. Occupational pension funds investing pension reserves in securities of their own Pension Fund companies are now the most common in other countries, including Russia. Pension plans used to invest the bulk of equity assets in the own company’s stock, representing a worrying concentration of risk for beneficiaries. Our purpose is to establish the right balance between interests of the company and requirements of risk management. Hence, we need to create the default probabilities model in conditions of rising uncertainty and volatility in the world financial markets. Letting Financial Mark Ruloff AC, MF solvencymeasures_1 Economics Drive the Development of Transparent Accounting link accounting & and Contributions contributions The Great Controversy Symposium - June, 2003 - Vancouver abstract Title Author Subject(s) filename (all are .pdf) Desirable Funding Level Carole Turcotte MF solvencymeasures_2 of Defined Benefit Anne Fortin Pension Plans reversion Pension Funds: A Roland van Gaalen MF solvencymeasures_3 Funding Adequacy Rule Suppose that after a downturn in the financial markets, pension funds have funding ratios in the neighborhood of 100%, all with a Flexible cushion reserves having been more or less exhausted. ... if financial market conditions improve, what level should the funding Mismatch Reserve ratios reach before any assets can be released, at least from a solvency perspective? ... [any such level] is neither a constant of nature nor an immutable truth of reason, but follows from a particular method. Moreover, it depends equally critically on the terms of the average pension plan and the fund’s asset allocation as well as a number of assumptions and other choices. In this article, it is argued that it would be reasonable to permit the minimum solvency cushion that is required on top of the 100% funding ratio to vary as driven by market conditions between a floor of zero and an upper boundary. ... Moreover, a method is suggested for determining the upper boundary by means of a rule, that is, a fixed formula. To complete the circle, the solvency protection system could be incorporated in the pension promise. The ABO the PBO and Zvi Bodie PF investment_1 The incentive to immunize the ABO is strongest when the plan is fully funded. If the plan is overfunded, it makes sense to Pension Investment invest in equities and pursue a kind of portfolio insurance strategy known as contingent immunization. If the plan is very Strategy underfunded and the sponsor is in financial distress, it may be optimal to exploit the put provided by PBGC insurance through a high-risk investment strategy. Tax, regulatory, and other considerations have in the past created strong incentives to overfund the pension plan. Recent changes in accounting rules and tax law are likely to reinforce the use of fixed income immunization strategies and reduce pension fund investment in equities. Hedging Pension Plan Jon Palin IN, PF investment_2 This paper explores practical methods to hedge the fair value of pension scheme liabilities against changes in market Funding Ratio Cliff Speed conditions. The bond like nature of defined-benefit pension liabilities enables hedge portfolios to be constructed. We consider how to find hedge portfolios for simple liabilities that are either fixed in monetary terms or linked to the consumer price index and also more complex benefits containing options. After discussing the difficulties of hedging we propose a new algorithm and apply it to practical problems. Alternative Investments Laurens Swinkels IN, PF investment_3 Market valuation of assets and liabilities plays a central role in new International accounting standards. This means that the and the Solvency dutch pension fund Industry, which has historcially been dominated by actuarial valuation Techniques, has to incorporate Requirements for valuation techniques from financial Economics. The proposed new financial assessment framework in the Netherlands sets Defined Benefit Pension three requirements based on market valuation of assets and Liabilities: (a) minimum funding requirement, (b) solvency Schemes requirement, and (c) continuity requirement. We examine the use of alternative investments for Pension funds facing these three requirements. Prudent investments in Commodities might provide liability hedging opportunities decreasing the Probability of pension fund insolvency. We are skeptical about the use of Other alternative asset classes for improvement of the speculative or Liability hedging part of the pension fund portfolio Periodic Cost of Larry Bader AC periodicVC cost of employee benefits to accounting periods. The periodic cost may be derived from the end-of-period liabilities that are Employee Benefits Jeremy Gold recognized; the likely liability candidates, using U.S. nomenclature, are the Vested Benefit Obligation (VBO), the Accumulated Benefit Obligation ( ABO ) and the Projected Benefit Obligation ( PBO ). Our analysis follows two parallel tracks. The first challenges us to justify certain benefit designs that may be identified by the large accounting conflicts they engender. The second asks us to recognize that these same accounting conflicts may lead to public misunderstandings and societal reaction. The Great Controversy Symposium - June, 2003 - Vancouver abstract Title Author Subject(s) filename (all are .pdf) F.E. and Actuarial Tony Day MF valuation_employerchoices_2 This paper examines concepts from both financial economics and actuarial science as applied to defined benefit schemes Practices using a simple discounted cash flow framework as a reference point. The general finding is that many standard modes of actuarial thought are, in fact, indefensible when examined with the tools and techniques of financial economics. The call for revision of actuarial training and practices is credible and necessary. However, the paper also touches upon areas where a heavy-handed application of finance theory could be misguided due to limitations in the simple financial economic models presented. It concludes that financial economics should be carefully integrated into actuarial thought rather than appended to existing actuarial theory or inserted as a wholesale replacement. Pension Funding without Robert McCrory MF valuation_employerchoices_3 My goals for this paper are quite modest: Liabilities vital aspects of defined benefit pension plans that are often omitted from our actuarial models: Future new entrants and stochastic variability of asset returns and inflation. calculations do not arise naturally and are not needed. experimentation – rather than analytically with simplified mathematical models. The mathematical models we typically use are too abstract and leave out too much. Discount Rate Revisited Dimitry Mindlin AC valuation_employerchoices_4 In this paper we will: 1. define major types of pension commitments and valuations; 2. analyze basic actuarial assumptions; 3. discuss measurements of pension commitments; 4. introduce a new type of liabilities; 5. clarify the source of “the great controversy”. A Lifecycle Analysis of David McCarthy DE benefitadequacy_1 This paper employs a lifecycle model from the consumption-savings literature to examine the tradeoffs between defined DB benefit and defined contribution pension plans. We examine the effects of varying risk aversion, varying initial income and financial wealth, and varying wage processes (that may be correlated with returns on the risky asset). The model illustrates two economic functions performed by defined benefit plans. Firstly, DB plans pool individual wage risks. This allows older workers to buy a wagelinked security that increases their exposure to wage risks. Secondly, they create a group annuities market that reduces the cost of adverse selection. Financial Economics and Brian Rosenblum DE benefitadequacy_2 While examining the expected replacement ratio does illustrate some of the implications of a plan design on participants, this the Retirement Plan process is incomplete in its treatment of risk. In fact, it makes the assumption that the participant does not place any value, Design Model positive or negative, on risk. Unfortunately, this premise violates a basic principle of financial economics, that a risk-averse investor assigns a lower value to a financial arrangement where risk is present compared to one that is absent of risk. [The] analysis suggests a method of incorporating utility theory into the evaluation of plan designs, thus keeping the model more in accord with the basic principles of financial economics. The market value of risk, utility theory, and decreasing risk tolerance with age are all concepts which are virtually ignored in traditional plan design models, yet are quantified and shown to be quite significant in financial economic models. By using a model that captures these elements, the actuary can better measure the adequacy as well as the relative value of different retirement plan designs. The Great Controversy Symposium - June, 2003 - Vancouver abstract Title Author Subject(s) filename (all are .pdf) A Bayesian Model for Armand Yambao DE benefitadequacy_3 During the prosperous economic times of the 90’s, employees preferred defined contribution plans where high investment Developing an Optimal returns were directly added to their accounts. On the other hand, many employers who sponsored defined benefit plans Mix of DC and DB enjoyed contribution holidays and pension income from the accounting of their pension plans. However, during the tough economy in recent years, employers were surprised by large required cash contributions for their defined benefit plans. Also, employees suddenly realized that the benefit from their defined contribution accounts might not be sufficient for their retirement. … A common objective for an employer is to have predictability in cash contributions for the retirement plans. From the employee’s perspective, an objective is to have a sufficient retirement benefit. … A Bayesian Model is used to develop an optimal mix of defined benefit and defined contribution plans that achieves both of these objectives. Pension Funds and the Jon Exley PF valuation_1 The paper considers the impact of UK defined benefit pension scheme funding and investment on the UK economy. It UK Economy suggests that many conventional theories are based on incomplete or inconsistent economics…. The conclusion of the paper is that the most significant impact of pension funds on the UK economy relates to the costs imposed by extreme mismatching between their financial assets and liabilities. We argue that such risks can, in essence, “crowd-out” entrepreneurial risk by increasing the cost of capital. We assert that the UK economy would gain from greater focus on the matching of the substantial assets and liabilities associated with pension funds F.E. and Pensions Timothy Gordon PF valuation_2 There has been strong resistance within the UK Actuarial Profession against taking on board the lessons of financial Actuaries - The UK Stuart Jarvis economics. Nevertheless, the majority of the largest UK actuarial firms have significantly modified their standard approaches Experience to actuarial valuations to take account of criticisms based on financial economics. In the meantime, the failure to come to terms with basic lessons from financial economics has caused the UK Actuarial Profession to lose credibility with key players in the UK. The UK Actuarial Profession has still not come to a single view on financial economics and the major divisions that remain continue to hamstring its policy development. Sources and Eric Klieber RK valuation_3 price. This price would take into account the future utility of the item and changes in price with time and use, which would all Measurement of Risk in be known with certainty. Risk complicates matters immensely by making future utility and price changes unknown. Capitalist DB economies use the market to set prices, based on the tacit consensus of market participants regarding what the future holds and how that future will affect an item's current value. Individuals are free to place their own value on any item in the marketplace and to make buy/sell decisions based on any difference between the value they set and the market value. Skill in setting value determines an individual's success in the market. A Forward-Looking Douglas Andrews MF valuation_assumptions_1 The paper shows an approach whereby future asset returns and liabilities are modelled taking into account the probability of Asset - Smoothing various returns. The paper develop s an asset smoothing approach that uses an expected return on the asset mix, and averages Method both historical and projected asset values. Key Items To Be Covered The Great Controversy Symposium - June, 2003 - Vancouver abstract Title Author Subject(s) filename (all are .pdf) Fixing the Pension Plan Edward Burrows MF valuation_assumptions_2 … the original ERISA funding rules mimicked, very closely, the funding techniques that responsible employers had followed Funding Rules voluntarily in the years before ERISA. So, the brave new world of ERISA was born, and we all sat back to see how the new funding rules would work. It turns out that sometimes they worked – and sometimes they didn’t. When they didn’t work, the reasons for failure quickly became so obvious that many planners were chagrined they hadn’t anticipated the failures. The original rules were designed to reach target funding levels gradually and relatively painlessly over a long period. So far, so good. So long as the sponsor remained healthy over this period of gradual buildup, employees would be fully protected – without any help from the Pension Benefit Guaranty Corporation (the PBGC). Measuring Terminable Jeffrey Petertil FE, AC valuation_assumptions_3 The actuarial model used to measure retiree health benefits has proven to be of limited usefulness in understanding the Post-Retirement obligations associated with the benefits. A major failing has been to disregard the financial uncertainty that is implicit in a Obligations plan sponsor’s unilateral ability to change, or even terminate, the obligation to pay for the benefits. … This paper examines a number of ways the actuarial model can be refined to take into account the plan sponsor’s legal right to terminate the plan. After discussing the current model and its drawbacks, this paper will introduce three of those refinements and briefly discuss how each would fit with the usual actuarial model. One modification leans more heavily on financial economics than the others, but in the sense that each attempts to quantify a risk previously not quantified, each may be of interest to this forum. The paper will then turn to how the measurement results of these refined models would compare with those of the current model, the likely effect on behavior of interested parties if the refined model were to be adopted, and likely objections to adopting the refinements. Finally, the paper will comment on some aspects of The Great Pension Controversy. A Reevaluation of ASOP Frank Todisco AS valuation_assumptions_4 27, post Enron This paper calls for a reconsideration of ASOP 27 in the wake of the scandals that began with Enron and have rocked the world of finance. Financial professionals have been under scrutiny, and actuaries have not been spared. The profession is being questioned not just about its financial models, but also about its ethics. … The paper critiques two aspects of ASOP 27: the actuary’s obligation with respect to employer-selected FAS 87 assumptions, and the concept of the “best-estimate range.” ASOP 2 had required the actuary to disclose any disagreement with employer-selected assumptions. … [and the paper] argues for a return to the ASOP 2 standard. ASOP 27 also introduced the “best-estimate range.” Continued reliance on this construction could prove dangerous to the profession: it is a contradiction in terms, it is arbitrarily wide, and it permits the selection of aggressive assumptions. The paper argues for a tighter standard, perhaps based on the different approach taken in ASOP 35. Did Pension Plan Julia Coronado AC, IN debate_2 During the 1990s the assets of corporate defined-benefit (DB) pension plans ballooned as a result of the booming stock Accounting Contribute Steven Sharpe market. Because of accounting rules for DB plans put in place in 1986, this robust growth provided a substantial, although to a Stock Market stealthy, boost to the profits reported by sponsoring corporations. In particular, the extraordinary returns earned on pension Bubble assets flowed to the bottom line on corporate income statements through lower net pension cost accruals included in general corporate expenses. These developments may have misled many investors about the value of corporate equities, because pension cost accruals provide a fairly convoluted signal of the underlying value of net pension assets, in two ways.
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