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  #161  
Old 08-22-2016, 10:02 AM
Dr T Non-Fan Dr T Non-Fan is offline
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Originally Posted by Jeremy Gold View Post
I don't recognize this: "What the assets are is not a concern of the liability side. It is the asset side's job to meet the discount rate used by the liability side."

It is possible that I said it but also possible that you have paraphrased something. Can you source the quote?
I said it was "in effect," meaning I interpret the use of the risk-free rate as the separation of the valuation of the liability versus the assets chosen to cover it.
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  #162  
Old 08-22-2016, 08:56 PM
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Originally Posted by Jeremy Gold View Post
Although there are some cases where liability discount rates should be lower, this is not universal. If the liability uncertainty is correlated with market assets that earn a risk premium, so should the liability discount rate reflect a risk premium. Example, a liability denominated in units of the S&P 500 should include a discount for the S&P 500 risk premium. If liabilities were correlated with a negative beta security (e.g., gold stocks in some time periods), then the negative risk premium on gold stocks would attach to the liability.

The most interesting case, and the one I think you are referring to, is where there is white noise (zero beta). In effect, the liability has attached to it a risk that cannot be hedged. In that case the value of the liability increases because you would have to pay someone to accept your unhedgeable risk. If that same white noise were attached to an asset, the value of the asset decreases, again because any buyer of the asset would be stuck with the unhedgeable risk.
Reinsurers actually trade in what are hoped to be your white noise risks. But they manage that operation based on taking measures to put upper bounds on exposures and to keep the relative scales of their exposures and their surplus at manageable levels. They also assist with risk selection, hopefully making that risk more white.

You can't just talk about the market for unhedgeable risks. You have to demonstrate that one can be created. So what does a reinsurance market for pension finance look like, supposing that the ceding entity retains some risk based on their capacity to vary future contributions and possibly renegotiate benefit accruals (and on rare occasions accrued benefits)? As you ratchet the ceded risk from 0 to everything, leaving risk selection advice in place at any level, how does the picture change?

Furthermore, what examples are there of insurance markets where it's viewed as prudent to fully insure all risks rather than having some risk retention?
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  #163  
Old 08-23-2016, 07:58 PM
DiscreteAndDiscreet DiscreteAndDiscreet is offline
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Reinsurers actually trade in what are hoped to be your white noise risks. But they manage that operation based on taking measures to put upper bounds on exposures and to keep the relative scales of their exposures and their surplus at manageable levels. They also assist with risk selection, hopefully making that risk more white.

You can't just talk about the market for unhedgeable risks. You have to demonstrate that one can be created. So what does a reinsurance market for pension finance look like, supposing that the ceding entity retains some risk based on their capacity to vary future contributions and possibly renegotiate benefit accruals (and on rare occasions accrued benefits)? As you ratchet the ceded risk from 0 to everything, leaving risk selection advice in place at any level, how does the picture change?

Furthermore, what examples are there of insurance markets where it's viewed as prudent to fully insure all risks rather than having some risk retention?
I apologize, I needed to write something down once so I'd have a chance to rethink it. Let me try to clarify.

You are applying a spot pricing theory that says that any transaction can be converted to a market consistent present value by tagging any contingent cash flows based on their source and either assigning them a market consistent probability of occurring and discounting at the risk free rate, or treating them as certain and discounting at the risk free rate plus a risk premium. One's own obligations are treated as certainties. You also look for market proxies for untraded contingencies.

This is a successful model for contingencies that are covered by exchange traded securities. It is not a good model for most risk markets.

Most insurance transactions are not carried out in this manner. Most risk transfers through insurance leave the insured retaining some risk. Most risk transfers through insurance take place over multiple transactions rather than as a single contractual exchange. Most risk transfers through insurance have mechanisms for either retrospective rating or just offer no rating guarantees at renewal and as such have mechanisms to fund (or credit) adverse/(favorable) experience after the fact rather than loading all possibilities into a hypothetical market consistent price up front. Most risk transfers through insurance have some form of ongoing relationship with some degree of mutualistic risk management.

Risk retention is generally efficient when it makes use of risk capacity more proximate to the origin of the risk. We see this in coinsurance provisions in commercial insurance, deductibles in personal insurance, and the popularity of self-insurance with stop-loss reinsurance in group health plans. No one tells parties in these transactions that they are mispricing risk by anticipating the expected risk premiums that can be realized within their risk capacity and making that part of their long term plans.

Looking for market traded proxies for risks is a moronic idea. You say that gold stocks have negative beta in some periods. When you say that, what you mean is that gold stocks do not exhibit reliable behavior relative to the CAPM model and that you would be foolish to try to build a risk management plan based on that relationship. The only way to manage an unhedgeable risk is to retain it if the exposure is small relative to your capacity, or if not, to transfer it at an additional cost to someone larger than you. The only things that cover this kind of risk are size, consolidation with other uncorrelated risks, and latitude for renegotiation through ongoing relationships when these mechanisms fail.

Some risks are large, highly correlated, and difficult to renegotiate, even working from the scale of society as a whole. We manage these as we can. I firmly believe that some of these problems can only be tackled by anticipating some risk premiums and working through the challenges that this presents over multiple iterations. Limiting yourself to a spot price model imposes too many limitations on the risk capacity of society as a whole.
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  #164  
Old 08-26-2016, 03:05 PM
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STEVE MALANGA
OP-ED
DISCOUNT RATES

http://www.wsj.com/articles/covering...sis-1472164758

Quote:
Covering Up the Pension Crisis
States and actuaries are trying to stifle debate about the growing shortfall in fund assets.


Plunging investment returns have sent debt soaring in state and local pension funds and prompted new financial concerns. Meanwhile, a debate has broken out about whether these pension funds are accurately measuring their obligations. Though the issues might seem arcane, the stakes are high for taxpayers who might have to bail out these funds and for public employees who rely on them for retirement.

On Aug. 1, the American Academy of Actuaries and the Society of Actuaries shut down a 14-year-old task force on pension financing when several members were about to publish a paper that found many state and local retirement systems calculate their obligations using overly optimistic future rates of return. The authors want states and municipalities to adopt new valuation standards that would make projecting the cost of future benefits more predictable.

The problem is that this change would also make many public pension funds seem far more indebted than they are under current standards. Such a change would produce more pressure on politicians to boost funding and cut benefits.

.....
Government pension funds on average estimate they will earn 7.6% a year on their portfolios, according to a survey by the National Association of State Retirement Administrators. Using that number, the funds say they are currently about $1 trillion short of the money they will need to fund pension credits that workers have already earned. But if pension systems were required to use a riskless rate, currently below 3%, the shortfall would soar to more than $3 trillion.

Government officials have long argued that they should be allowed to employ the higher number because governments don’t go out of business the way private companies do. That gives states and municipalities a much longer window to recover from bad investments.

The problem is that the arbitrary nature of the valuation standards allows elected officials to pressure pension systems to adopt overly optimistic assumptions, which can make offering new benefits to public workers seem more affordable and more attractive.

As Jeremy Gold, one author of the task-force paper, said in a September speech: “Consistent lowballing of pension costs over the past two decades has made it easy for elected officials and union representatives to agree on very valuable benefits, for very much smaller current pay concessions.”

But when pension funds fail to deliver on these lofty projections—as many across the country have in the past decade—pension debt soars. According to a July 2015 report by the Pew Charitable Trusts, since 2005 the unfunded liabilities reported by state pension systems have risen by nearly threefold from $339 billion to nearly $1 trillion thanks in part to investment shortfalls.

Some actuaries say they’ve been reluctant to speak up about optimistic valuations because they could lose their jobs. When the Montana state pension system sought to hire new actuaries in 2009, it issued guidelines stating that any firm arguing that government pension funds should adopt more conservative valuation standards “may be disqualified from further consideration.” A May 2009 editorial in Pensions & Investments noted that there had been rumors for years of similar “threats” by other pension systems to prevent firms “from expressing their reasoned positions on unsettled issues.”
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  #165  
Old 08-30-2016, 08:34 AM
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SOA plans to publish paper: https://www.soa.org/board-announceme...ion-financing/

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Originally Posted by SOA/Reynolds
SOA President's Letter on Public Pension Plan Financing
Message from Craig Reynolds

There have been a number of media articles and opinion pieces recently, including one that was published on Aug. 25 in the Wall Street Journal, concerning a paper on public pension plan financing that was a work-in-progress of a former joint task force of the SOA and the American Academy of Actuaries. Unfortunately, most of these pieces have misrepresented the viewpoints and activities of the SOA. The SOA has responded appropriately to this media attention, including a letter to the editor of the Wall Street Journal that I sent today.

Working under the auspices of both our organization and the American Academy of Actuaries, we were unable to reach an agreement with the authors on a version acceptable to all parties through our standard editing process. Nevertheless, on Thursday, Aug. 25, before the publication of the Wall Street Journal opinion piece, we informed the authors of the paper of our plans to publish the paper representing their views in the SOA’s Pension Forum publication. The publication is anticipated by the end of October and will be accompanied by discussant debate from a range of perspectives. In the interim, the SOA has agreed to the authors’ request to allow them more time to edit the paper. We expect to post an updated draft on the SOA website the week of Sept. 5.

Historically, the SOA has published a variety of articles on public plan financing, sponsored multiple symposia on the issue, and discussed this issue at numerous educational sessions at SOA meetings. It also was a major focus of the SOA-sponsored Blue Ribbon Panel on Public Pension Plan Funding (2014), which recommended, among other things, that public pension plans should include a disclosure of plan obligations at a risk-free rate. The SOA expects to continue to offer such opportunities, including a previously planned and publicized webcast on Sept. 27, 2016, on Financial Principles Applied to the Management of Public Pension Plans, where one of the authors of the paper in question and other individuals will present their views. More information about that webcast is available at https://www.soa.org/Professional-Dev...rinciples.aspx.

The authors of the paper have important ideas that are germane to the profession, and we encourage them to explore opportunities to communicate these ideas. The SOA has made – and will continue to make – such opportunities available to them and others with important contributions to make to this issue.

Sincerely,
Craig Reynolds, FSA
SOA President
AAA has its own plans: http://www.actuary.org/content/lette...nce-task-force

Quote:
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Update (Aug. 22, 2016)
The Academy remains committed to publishing objective, unbiased public policy analyses on topics of public importance. This includes appropriately reflecting the potential contributions of financial economics to the design, management and financing of public pension plans. While certain members of the PFTF decided to reject the peer review input necessary to ensure balance and objectivity, we have continued our careful consideration of the concepts in the last draft of the PFTF’s paper. The PFTF draft could not meet the Academy’s publication standards. Nonetheless, we support a robust discussion of these concepts and ideas so that both actuaries and the public may have access to them. We will shortly be publishing a paper on public pension plans that will include concepts from financial economics.
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  #166  
Old 08-30-2016, 10:49 AM
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http://www.marketwatch.com/story/con...all-2016-08-29

Quote:
Controversial pension paper will be published after all

A controversial research paper that is critical of the way pension plans estimate the future value of their assets will now be published, after the Society of Actuaries agreed to publish it as part of its Pension Forum series.

Pension plans currently set a level of expected long-term returns on investments and use that to help calculate how much needs to be contributed each year to meet future payments. The paper argues that is the wrong approach. Instead, liabilities should be discounted using default-free rates, such as those offered by Treasurys. The bottom line is that the unfunded liabilities of public pension plans are about $6 trillion, rather than $1.5 trillion, according to two of the paper’s authors.

The SOA and another professional group, the American Academy of Actuaries, earlier this month had said they wouldn’t publish the paper, which was being written by a joint task force. That decision, which also said the authors couldn’t publish it under their own names, had unleashed a storm of criticism.

SOA President Craig Reynolds, in a letter published on the organization’s website, said the paper now will be published in the SOA’s Pension Forum publication, likely by the end of October “and will be accompanied by discussant debate from a range of perspectives.”
......
The debate over how to value pension plans comes as investment returns have plunged. On Friday, the Illinois Teachers’ Retirement System cut its expected long-term rate of return to 7%, from 7.5% for the 2018 fiscal year that begins next July 1. Had that move been effective this year, it would have cost the state more than $400 million more in pension contributions. The move was opposed by the state’s governor.

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  #167  
Old 08-30-2016, 11:34 AM
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As described, the paper seems very similar to the April 2005 Pension Forum article "Pension Deficits: An Unnecessary Evil" by Lawrence Bader. I wonder if anything new will be added. Or, perhaps this is a case of trying the same thing over and over, hoping for a different result this time.
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  #168  
Old 08-30-2016, 11:49 AM
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Originally Posted by Dan Moore View Post
As described, the paper seems very similar to the April 2005 Pension Forum article "Pension Deficits: An Unnecessary Evil" by Lawrence Bader. I wonder if anything new will be added. Or, perhaps this is a case of trying the same thing over and over, hoping for a different result this time.
Perhaps the SOA was playing a long game, initially refuse to publish to drum up interested in the paper.....
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  #169  
Old 08-30-2016, 12:49 PM
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Perhaps the SOA was playing a long game, initially refuse to publish to drum up interested in the paper.....
It worked, eh?
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  #170  
Old 08-30-2016, 01:15 PM
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It worked, eh?
It did work, but I'm not convinced that it was intentional.
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