Andonov: Pension fund asset allocation and liability discount rates Flashcards
DB pension funds promise retirement benefits that depend on ..
the employee’s earnings history, tenure of service and age
DB retirement systems typically pool the assets of ..
multiple generations and allow for intergenerational as well as intragenerational risk-sharing
-> can create conflict between the different stakeholders or across generations
underfunded
the value of assets is lower than the value of liabilities representing the promised pension benefits
the funding shortfall in pension fund accounting statements depends heavily on the ..
liability discount rate -> the higher the discount rate that is used, the lower the reported present value of liabilities and the stronger the pension plan’s funding position
US public pension funds follow the Government Accounting Standards Board (GASB) guidelines for discounting liabilities which allows them to base their liability discount rates on the ..
expected rate of return on their assets
US private pension funds, and Canadian and European public and private pension funds, require that their liability discount rates are based on ..
high credit quality interest rates -> their discount rates cannot be managed by modifying the allocation to risky assets
consequences of the GASB regulations for US public pension funds:
1) GASB guidelines allow public pension funds to severely understate their liabilities
2) the link between the discount rate and the expected return on assets affords US public pension funds considerable discretion to manage their liability discount rate by changing their allocation across asset classes and by choosing an expected return for individual asset classes
regulatory incentives hypothesis:
the regulatory link between the liability discount rate and the expected rate of return on assets gives US public pension funds an incentive to increase their allocation to risky assets
a 10% increase in the percentage of retired members of US public pension funds is associated with a 5.93% ..
increase in their allocation to risky assets
for all other pension funds, a 10% increase in the percentage of retired members is associated with a 1.67% ..
decrease in their allocation to risky assets
increased risk-taking enables more mature pension funds to use ..
higher discount rates
–> a 10% increase in the percentage of retired members is associated with a 75-bps increase in their discount rate
US public funds significantly increase their allocation to risky assets when interest rates ..
delice.
–> a 5% decline in the yield on ten-year treasury notes is associated with a 15% increase in their allocation to risky assets
US public funds with a higher level of underfunding per participant invest more in ..
risky assets and use higher liability discount rates
US public pension funds with a higher percentage of state-political and participant-elected trustees allocate more to ..
risky assets and use higher discount rates
what explains the allocation and discount rate choices of funds?
Differences in regulation, not country effects
what is not the key determinant of the differences in strategic asset allocation and liability discount rates?
fund type (private vs public)
liability side
number of active and retired participants, inflation protection policies, liability discount rates
asset side
strategic asset allocation
percentage allocated to risky assets
sum of strategic asset allocation weights to equity, alternative asset classes, and risky fixed income investments
non-risky assets
cash and investment grade fixed income investments
public US pension funds maintain steady discount rates around ..
7.5-8%
funding status data
actuarial value of assets, liabilities, and funding ratio from Comprehensive Annual Financial Reports (CAFR)
Board members
1) state trustees: represent state, county or city as an employer
2) plan participant trustees: represent currently employed and retired plan members
3) general public trustees: represent citizens (taxpayers)
can be 1) elected by plan members 2) appointed by governmental executive 3) serve as ex officio members by virtue of their function
average underfunding per plan member
mature US public pension funds have a greater deficit per participant