Handbook of Asset and Liability Management

Applications and Case Studies

Stavros A. Zenios, William T. Ziemba

• Publisher: North Holland
• Year: 2007
• ISBN:
  9780080548562
• Topic: Business
• Subtopic: Finance
• Index: Business

The Handbooks in Finance are intended to be a definitive source for comprehensive and accessible information in the field of finance. Each individual volume in the series presents an accurate self-contained survey of a sub-field of finance, suitable for use by finance and economics professors and lecturers, professional researchers, graduate students and as a teaching supplement. It is fitting that the series Handbooks in Finance devotes a handbook to Asset and Liability Management. Volume 2 focuses on applications and case studies in asset and liability management.The growth in knowledge about practical asset and liability modeling has followed the popularity of these models in diverse business settings. This volume portrays ALM in practice, in contrast to Volume 1, which addresses the theories and methodologies behind these models. In original articles practitioners and scholars describe and analyze models used in banking, insurance, money management, individual investor financial planning, pension funds, and social security. They put the traditional purpose of ALM, to control interest rate and liquidity risks, into rich and broad-minded frameworks. Readers interested in other business settings will find their discussions of financial institutions both instructive and revealing.* Focuses on pragmatic applications * Relevant to a variety of risk-management industries* Analyzes models used in most financial sectors

Handbook of Asset and Liability Management, Vol. 2, No. suppl (C) • 2007

ISSN: 1872-0978

doi: 10.1016/S1872-0978(06)02020-5

Chapter 20 Dynamic Asset and Liability Management for Swiss Pension Funds

Gabriel Dondi^*
Florian Herzog^*

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ETH Zurich, Measurement and Control Laboratory, 8092 Zurich, Switzerland

swissQuant Group AG, Zurich, Switzerland

E-mail address:[email protected],

E-mail address:[email protected],

Lorenz M. Schumann,

Schumann Investment Management, Zurich, Switzerland

Hans P. Geering,

ETH Zurich, Measurement and Control Laboratory, 8092 Zurich, Switzerland

Abstract

We present an asset and liability model for Swiss pension funds. This includes an asset dynamics model and an optimisation technique to solve the problem of allocating the funds considering the liabilities maturity structure. Our liability model is based on the current and projected future cash outflows of all members, taking into account: projection of the individuals’ income, probabilities of entry and exit of members, and probabilities of death and invalidity of members. For the modelling of the various probabilities, we use a life insurance mathematics approach. This results in a dynamic, stochastic description of the pension fund liabilities. The projected uncertain future cash flows are sorted by their date of payment. Payments in a certain period are summed up in liability buckets. Furthermore, we compute the obligations that arise from the current wealth of funds where future contributions are not taken into account. Similar to the liability buckets, the obligations are also summed up into obligation buckets. The buckets give a manageable description of the pension fund’s liabilities (and obligations) and their term structure. The assets are modelled from the perspective of a Swiss investor. We use a dynamic factor model with heavy tailed residuals to model stock and bond market prices. We propose an optimisation technique for the asset liability management problem where the liability buckets are matched with available wealth of the pension fund. The optimisation problem is to minimise the shortfall of bucket funding while reaching a required future surplus. The solution results in an asset allocation for each liability bucket based on its time horizon. In this way we realise the life-styling hypothesis for each individual across the entire pension fund. In a case study we apply this method to the data of a Swiss pension fund with over 3500 members and over 1 billion (10⁹) Swiss Francs of wealth.

Keywords

• asset and liability management • life insurance model • asset and liability portfolio optimisation • factor models

JEL classification

• C61 • G11 • G23

1 Introduction

Pension funds manage a significant amount of wealth. It is therefore highly relevant that they manage their wealth in a responsible way while always taking into account their very long time horizon. Asset and liability management for pension funds has several different issues. There is the traditional asset management and portfolio optimisation with the appropriate asset price models. There are also models describing the pension funds liabilities which depend on the type of pension fund. The combination of asset management with the liabilities of a pension fund leads to a true asset liability management.

1.1 Pension fund liability modelling

An important aspect of pension fund liability modelling is the way in which the pension fund members incomes are modelled. The income is central, since it defines the contributions into the pension fund. Very generally, Merton models a deterministic wage income in the framework of dynamic portfolio optimisation with consumption (Merton, 1992, Part II). Boulier, Huang and Thaillard (2001) then provide a pension fund model in continuous time with deterministic salaries. Further, pension fund related papers, such as Battocchio and Menoncin (2004), Cairns, Blake and Dowd (2000) or Bodie et al. (2004) provide stochastic models for wages, modelled with one or more Brownian motions for salary changes due to interest rate changes and company stock price changes, among others. Our model for salaries is based on Cairns (2003), where salaries are increased in relation to a cost-of-living index and an age related function.

Pension-fund models have been used in simulation tools which take into account the mortalities of pension fund members and what this ...

Table of contents

• Cover image
• Title page
• Table of Contents
• Introduction to the series
• Contents of the Handbook
• Preface
• Chapter 11 ALM in Banking
• Chapter 12 Dynamic Financial Analysis for Multinational Insurance Companies
• Chapter 13 Stochastic Programming Models for Strategic and Tactical Asset Allocation—a study from Norwegian life insurance
• Chapter 14 Design and Management of Unit-linked Life Insurance Contracts with Guarantees
• Chapter 15 The Prometeia Model for Managing Insurance Policies with Guarantees
• Chapter 16 Integrated Risk Control Using Stochastic Programming ALM Models for Money Management
• Chapter 17 Asset–Liability Management for Individual Investors
• Chapter 18 A Scenario Approach of ALM
• Chapter 19 The Russell-Yasuda Kasai, InnoALM and Related Models for pensions, insurance companies and high net worth individuals
• Chapter 20 Dynamic Asset and Liability Management for Swiss Pension Funds
• Chapter 21 Joined-Up Pensions Policy in the UK: An Asset–Liability Model for Simultaneously Determining the Asset Allocation and Contribution Rate
• Chapter 22 ALM Issues in Social Security
• Author Index
• Subject Index