Investment

Sample presentation subtitle

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 Investment principles and pension
scheme liabilities
Risk and Return
• These are the two key concepts
• Matching the assets and the liabilities is a way of significantly
reducing the risks involved.
• What four components determine the matching strategy?
• Why is precise matching of assets to DB Schemes not
straightforward?

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 Forms and characteristics of
investments
Types of investment will differ in terms of
• Proportion of the return that are expected to arise from income
and capital growth
• The volatility of such income and capital growth
• The ease with which they can be sold at a reasonable price
• Tax on investment proceeds
Main Asset Classes
• Cash
• Bonds
What types of bonds are available in Kenya?
• Index linked bonds
• Shares (Domestic and Overseas)
• Property
• Derivatives

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 Investment Products

• It may be possible to obtain an investment product in which the

product provider determines the choice of assets
• Reasons for opting for investment products include:
– Other services
– Lower expenses
– Investment guarantees
Managed Fund
• Its a type of pooled investment vehicle; unitised
• No investment guarantees; return reflects that which is achieved
on the underlying assets
• Used by large schemes to gain exposure to specialised markets or
for index tracking

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 Investment Products

Income withdrawal / Annuity deferral

• Some products have been developed that allow the beneficiary to
receive investment income from retirement funds and defer the
purchase of a guaranteed annuity
• Such deferral may be until the individual requires:
– The security of a guaranteed lifetime income; or
– An increased level of income; or
– The price of annuities has fallen relative to the value of the fund held

With-profit arrangements
• Contributions are set which will meet a given level of benefit given
a prudent set of assumptions for investment returns.
• If investment experience is better than assumed, bonus returns are
credited to the fund benefit

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 Investment Products

Deposit Administration
• Contributions are accumulated with a mixture of guaranteed and
bonus rates of interest

Annuities
• These may be purchased to insure part or all of a pension benefit
• Can be:
– Non-profit basis – guaranteeing that the insured pension is paid
– With-profits basis – More risky

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 Assets

Stakeholders involved in the formulation of investment policy are:

• The beneficiaries
• Trustees
• Sponsor
• Investment manager
• Advisors to the sponsor/ trustees
Do poor investment returns affect the level of benefits earned by a
pensioner in a DB Scheme?
Trustees have two fundamental aims:
• Ensuring that sufficient assets are available to meet the liabilities
as they fall due; and
• Maximising the return on the fund subject to an acceptable degree
of risk

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 Assets

Risks include:
• Volatility
• Default risk
• Liquidity
– Marketability of the asset
– Asset cash flow
• Mismatching

• Which risks can be mitigated by Diversification?

• Rate of Return (Gross or Net?)

• Balancing return and risk – Funding level for DB Schemes

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Actuarial Valuations – Use of Models

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 Objectives : the use of models

Actuarial models may be used to solve many of the problems that

arise in the management of benefit provision.
Models can be developed for:
• The level and incidence of benefits
• The level and incidence of contributions
• The level and incidence of return on investments

• Combining the use of such models can help in the choice of benefit
design, method of financing and choice of assets if the benefits are
funded

• Different models are needed to achieve different objectives

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 Requirements

Inputs:
• Method
• Assumptions
• Data

Choice of Model:
• It should have a theoretical grounding in relation to the scenario
that is being used to project
• It should be practical
• Results should be capable of interpretation, verification and
communication
• The expense of running the model should be reasonable in relation
to the significance that the results can have on the decision
making process

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 Requirements

Choice of Model:
• The parameter values used in the model should be appropriate to
the particular benefits, contributions or assets that are being
modelled

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 Features of a Model

Inputs:
• Method
• Assumptions
• Data

Choice of Model:
• It should have a theoretical grounding in relation to the scenario
that is being used to project
• It should be practical
• Results should be capable of interpretation, verification and
communication
• The expense of running the model should be reasonable in relation
to the significance that the results can have on the decision
making process

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Valuation Data

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An actuarial model has three aspects, namely:
• Method
• Assumptions
• Data

Information required when determining values for future benefits or

future contributions could include:
• Documents relating to the current and past operation of the
benefit scheme;
• Information relating to the future operation of the benefit scheme;
and
• Data relating to the current position of the scheme e.g. Accounting
data, asset data and membership data

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 Information relating to the current and
past operation of the scheme
Data relating to the current and past operation of the scheme
should include:
• Detailed rules relating to the benefits to be provided from the
scheme and contributions into the scheme;
• Any booklets made available to some or all beneficiaries to
summarise their benefits and the approach taken to finance those
benefits;
• Details of any past discretionary practices; and
• Details of any previous actuarial advice.

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 Information relating to the future
operation of the scheme
This will probably result from the discussions between the actuary and
the parties most directly involved in the operation and financing of
the scheme.

Information that may arise that would be important in placing values

of assets, benefits or contributions includes:
• Views of future discretionary practices;
• Possible future changes to benefit entitlements;
• Future investment strategy;
• Planned levels of general and promotional salary progression;
• Events that may arise that will affect the sponsors’ ability to finance
the benefits;
• Events that may arise that will affect the employment and earning
prospects for the members; and
• Likely reactions to possible changes in legislation that affects the
operation of the scheme.

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 Data relating to the current position of
the Scheme
1. Accounting Data;
1. Balance sheet; and
2. Income and expenditure statement.

2. Asset Data
This may be different from the assets in the balance sheet mentioned
above if there are assets that are not permitted or are subject to
valuation restrictions imposed by the scheme rules or legislation.
• E.g. Level of self-investment allowed

3. Membership Data
Membership categories include:
• Active members
• Deferred members
• Beneficiaries

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 Quiz

1. Define the following types of schemes:

• Pension scheme
• Provident fund

2. Is it beneficial to pay pensions from the scheme or to outsource

the payment to an insurance company?

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 Data Validation
Data validation is an area in which judgement and common sense are
required:

Data checks may include:

• Reconciliation of the total number of members and changes in
membership, using previous data and accounts;
• Checks for the existence of new members;
• Comparison of the average benefits levels or of average values of
components of the benefit calculation with previous data and
accounts;
• Consistency between salary related contributions and in-payment
benefit levels indicated by membership data and corresponding
figures in the accounts;
• Consistency between investment income implied by the assets and
corresponding totals in the accounts;
• Minimum and maximum levels of benefits, their components, ages
etc; and
• Random spot checks on data for individual members.

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 Quiz

3. Mostly, early retirement pensions are reduced to reflect the fact

that the member will receive the pension over a longer period
of time. What is the difference between a pension reduced
using simple reduction and a pension reduced using compound
reduction?

4. What is the difference between a segregated fund and a

guaranteed fund?

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Valuation Assumptions

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 Introduction

There are many factors that will affect the future cashfows. However,
the majority of these factors will be unknown at the time of the
valuation so the actuary needs to make assumptions i.e predict the
future experience.

The main factors can be divided into:

• Economic factors – generally affect the amounts of investment
income, contribution income and benefit outgo;
•Demographic factors – generally affect the timing and number of
benefit payments and contribution income

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 Introduction
Assumptions needed for a valuation of a defined benefit pension
scheme might be:
Economic factors
–Discount rate
–Dividend yield
–Dividend growth
–Earnings inflation
–Price inflation
–Pension increases
•Demographic factors
–Rate of retirement in normal health
–Rate of ill health retirement
–Rates of withdrawal
–New entrants rate
–Rate of mortality before and after retirement

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 Introduction
–Proportion married
–Average age of dependants
–Dependants’ mortality
–Promotional salary scale

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 Information

•Historical data – likely to be used by the actuary in determining

assumptions about future experience;
•However, the past may not be a good indicator of the future;
•Thus current data and forecasts may also be used to enhance the
historical data and thus make it more useful

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 Extent to which the information may
be useful
•Relevance and credibility of past data
•Fluctuations
•Changes in mortality over time
•Heterogeneity
•Changes in Data recording

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 Other factors to consider when
determining the assumptions
•The need for accuracy and prudence
–Purpose of the valuation;
–Timing of cashflows
–Significance of errors
–Maturity of the scheme

•Relationship between parameters

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