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Finance - Investments Sub-forum: Non-Actuarial Personal Finance/Investing

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Old 04-09-2019, 02:18 PM
BadBunny BadBunny is offline
Join Date: May 2004
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Posts: 65
Default AL Modeling

Hi All - I am trying to build a simple AL Model based on 5 years worth of Pension Liability projections (based off of 2018 Val, rolled forward with assumptions). This is a new project that I am working on, I have not done asset liability modeling for extended time periods. Here's what I have done so far:
1. Me and one of my colleagues ran the Pension Plan liabilities based on the assumptions and we do have the 5 year projection results of liabilites and plan contributions etc.
2. We have base scenario assumptions on discount rate, salary progression, Inflation and mortality/withdrwals etc.
3. Four major asset classes - Growth (SP 500 proxy), Mid-stable (Wilshire 3000), Corporate Bonds (not sure of proxy - but working on it, possiby BBAgg) and Cash (Citi 90 days).
4. Stable contribution pattern so far in 10 years +, usually about 250k every Q.
5. Prior attempt was to re balance each Q and release 250k needed.
6. Going forward it will be about 500k, so double the prior Q contributions.

In my naive way of thinking, I was looking at the expected return from each class to have the cash each Q. And to make sure the expected return is within historical range.
I can do this for may be 3-4 Q and then it looks very messy and ugly - plus I think it may not be the best way forward.

Question - how would you do this kind of asset liability modeling in practice ?
may be an outline ? or a sample ?
is there anything I am missing as inputs ?
any thoughts ?

Much appreciated in advance !
God does not play dice except at Actuarial Examinations ( with apologies to Einstein )
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Old 04-09-2019, 03:46 PM
The_Polymath The_Polymath is offline
Join Date: Jun 2016
Posts: 3,157

You need to define your strategic asset allocation.

I will give you a basic cash management plan for ALM.

You want to keep cash on hand from the model at X min.

If at any time during the specified time horizon, cash falls below X, you sell assets in a specific proportion (call this A) in order to fund the shortfall, and get your cash position back up to X.

If the cashflows get beyond say Y (where Y > X), you would then buy assets in a specific proportion (call this B), in order to bring your cash position down to Y again.

As you can see, in this simple model, you are keeping cash in the X - Y range for liquidity purposes, and then using strategic asset allocation (A and B) to maintain that cash position, while maximising your investments (and ultimately staying reasonably well matched).
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Old 04-09-2019, 04:39 PM
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Kenny Kenny is offline
Join Date: Jan 2003
Posts: 8,220

For someone that is interested in beefing up basic knowledge of this topic, does anyone have a suggested reading list? I am particularly interested in the applications related to pensions (like the OP) and if there are any readings that might address potential idiosyncrasies specific to public plans (given the disparity between the standard equity heavy asset allocation vs the liabilities they back) that would be helpful as well. TIA!
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Old 04-09-2019, 05:11 PM
BadBunny BadBunny is offline
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Thanks Polymath !
The options A and B you mention will be in harmony with the IPS of the client I assume...
I have heard about treating the Benenfit and other payments from the plan as a Cash Flow and look at this from a Fixed Income perspective - any thoughts on that or am I completely off?
One last point - what about a scenario like 4Q 2018 where the market went south for about 13% ? that would be a huge sell - possibly one that client cannot recover without additional cash (fresh) into the fund?
God does not play dice except at Actuarial Examinations ( with apologies to Einstein )
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Old 04-10-2019, 03:42 PM
BadBunny BadBunny is offline
Join Date: May 2004
Location: WWW
Posts: 65

I did some reading - mostly investopidia and have following thoughts on a sort of improvement from Polymaths advice. Appreciate any comments !

1. Liability match via immunization - but I see some drawbacks on this - specifically the inability to match exactly with AA bonds and losing out on the possible upside of investing while parking the money.
2. What is there is a sudden increase of liability due to economic or other unforseen reasons - so we have CF constriants b/c of bond purchase.

Above two when considering CF method.

Is duration matching better ? since we have more options than CF scenario ?

This is my initial attempts - so would love to hear what is done in actual practice for Pension Plan specifically...

As always many thanks in advance !
God does not play dice except at Actuarial Examinations ( with apologies to Einstein )
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