"tim (moved to sweden)" wrote
Equity returns, salary increases and inflation rates *are* all closely linked - that's the point. [They vary, but generally always in line with one another.]
Hence, the liabilities are **not matched** very well at all by the "
**fixed** total return from Fixed Interest portfolio "...
"john boyle" wrote
But that's not possible!
The usual way is to use the *difference* between future assumed investment return and future assumed salary increases -- and similarly the *difference* between future assumed investment return and future assumed inflation increases.
That's because equity returns tend to be 'real' - and hence move with the level of salary increases / inflation.
But if you are "locked-in" to a particular fixed return on gilts, that wouldn't be possible...
In message , Tim writes
Eh? Oh yes it is!
It is perfectly possible to perform a review in exactly the same way as any other statutory actuarial review of a pension.!!
So, you seem to be saying that every statutory actuarial review of a pension fund is impossible?
"john boyle" wrote
Oh, no it isn't!!
"john boyle" wrote
Of course - but it is *not* possible to allow for future salary & inflation increases "... in exactly the same way as any other statutory actuarial review of a pension ...", when the underlying future investment returns are
*FIXED* and not *REAL*. [Because the usual method uses the *differences* in rates which don't change much, even when absolute values do change -- but this won't be the case when the future investment return is *fixed*.]"john boyle" wrote
Not at all. See above.
Example:
Suppose we had assumed future investment returns to be (say) 7% pa, future salary increases to be (say) 5% pa, and future inflation to be (say) 3% pa.
Now, it doesn't matter if the actual rates come out (in the future) at 11% (investment), 9% (salaries) and 7% (inflation) -- because the differences are still the same, so the assets value & liabilities value will still bear the same relationship with each other (they will both have increased from our forecasts at roughly 4% pa).
*But* if the actual rates come out at 7% (investment), 9% (salaries) and 7% (inflation), and the assets started off at 100% of the liabilities, then the assets won't be sufficient any longer to cover the liabilities (the assets will be 4% short for each year at 7/9/7).Do you see?
In message , Tim writes
Yes. The words 'Eggs suck & grandmother etc.," come to mind.
The nature of asset backed investments is exactly as you describe, but it certainly IS possible to deduce that fixed interest securities are the correct asset class for a fund if that fund is sufficiently in surplus. With a fund closed to new members (as I think the Boots scheme is, but I could be wrong) then this is even easier. *Every* triennial actuarial review of a pension fund makes certain assumptions and will predict a minimum return needed to ensure that the fund can fulfil its future liabilities based on a certain set of assumptions. It is perfectly possible for this to provide a 'critical yield' that is sufficiently low for it to be achieved from Fixed Interest securities.
"john boyle" wrote
There is no one "correct" asset class. But the point I have been trying to make, is that to reduce risk, it is best to "match" the assets to the liabilities - eg if liabilities are *fixed*, then invest in *fixed* assets; or if liabilities are linked to inflation, then invest in real assets (index-linked gilts might be best then, if you can get enough of them!).
If you are 100% invested in Fixed Interest, and inflation / salary increases suddenly shoot upwards increasing your liabilities, then you can soon have problems.
"john boyle" wrote
I don't think it is; altho' AIUI, eligibility for entry is quite strict - must join scheme before age 25 or within 2 years of joining company - so a GPP (now Stakeholder) was set up to accept employees not eligible to join the main scheme.
But then, even "closed" funds can have liabilities linked to salary - for current (already joined) active members.
"john boyle" wrote
That "critical yield" will still depend on future salary increases & inflation. For example, it may be "3% over inflation". Investing in real assets should be more likely to cover that required yield - if inflation rises (increasing the required "critical yield") then the value of the assets should increase too, to compensate.
But if you have "real" liabilities (linked to inflation & salary increases) and you invest 100% in Fixed Interest (say yielding a fixed 7% pa) - then you need to be sure that inflation won't exceed, say, 3%. In other words, you are gambling that your opinion of the future is right.... [As I said before, Boots have been lucky...]
In message , Tim writes
I can smell eggs being sucked again.......
Thats true.
Well i think you are questioning the validity of every actuarial valuation of a pension fund.
As it happens, I think they are a load of overpriced crap, but they do it none the less!
"john boyle" wrote
Well I'm not at all (as I said before).
What I'm actually questioning, is the validity of investing in assets which are a **very poor match** to the liabilities. And pointing out that this strategy is a *gamble*, and that Boots have (so far) been *lucky*.
In message , Tim writes
Good. We have tidied up my original point then, i.e. that is it at least 'possible' but just not a good idea because of the risk. This is different from being 'impossible' which was your original assertion.
"john boyle" wrote
Talking about the decision to invest 100% Fixed Interest, yes.
"john boyle" wrote
Ah, but what I said was "impossible", was your assertion that they could allow for unknown future salary increases and inflation "... in exactly the same way as any other statutory actuarial review of a pension ". I still hold by this.
The common method (when investing in real assets) would be to do a deterministic valuation using assumptions for these economic factors where the *differences* are the important factors, not the absolute values. [It doesn't matter if each assumption was 4% out, because the end result will be roughly the same.]
However, when you have *fixed* assets and *real* liabilities (like with Boots), then this method would not be appropriate (and any actuary using it should be shot!) -- you'd seriously need to do it stochastically, which is a whole different ball-game...
"Tim" wrote
John, are you still sucking those eggs? [No reply yet?]
In message , Tim writes
I didnt think your last post begged a reply!
"john boyle" wrote
Does that mean you agree with me now? ;-)
In message , Tim writes
NO, you seem to be just saying the same thing over and over again.
As I have already said, are you 'rubbishing' every Actuarial Pension Fund Review ?
With regard to Boots, I think their fund was closed to new members and its main liabilities related to pensions in payment and, in line with most occupation defined benefit schemes, I would expect there to be an upper limit on annual increases.
"john boyle" wrote
Oh dear...
"john boyle" wrote
That's because I haven't changed my mind!
"john boyle" wrote
As I've already replied several times, "NO" -- I am most definitely *not*! But I *am* saying:- (A) The usual method used, when assets held are matched to liabilities, is a **deterministic** approach; (B) It's IMPOSSIBLE to (properly) use a **deterministic** approach when assets & liabilities don't match -- such as with *real* liabilities and *fixed* assets; (C) I believe you need a **stochastic** approach in that case (when assets & liabilities don't match).
However, *you* seemed to think that (B) is POSSIBLE -- how so?
"john boyle" wrote
I am fairly sure there are still salary-related liabilities (even if it is only from current actives; but I also believe there are still a flow of a few new entrants - I don't think it's fully closed, as I said before).
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