Feb 19, 2012

Pension Cuts, Why?

So here we are in the 21st century of 'Pension cuts'. How could this happen and can we do something about it?

No flood of words in this blog, more staccato text and illustrations.

Let the images do their work......

Risk Management
is all about
'getting the picture'

instead of endless calculation and deliberation.

Let's start with comparing your pension with a cup of coffee......

- Most Pension agreements started in the fifties and sixties of the 20th century
- Employees were promised a nominal pension (plain coffee, so to speak)
- Any additional returns meant indexation (steamed-milk in your coffee)
- Fabulous returns in the seventies and eighties made (full) indexation possible
- The idea of 'free indexation' caught fire
- Cappuccino = Coffee + steamed-milk = Nom. Pension + Indexation, was born
- Common opinion, Science up front, started to redefine our pension concept...
- Credo: 'Pension is only pension if it's "Real Pension" (indexed)  
- The 21th century's first decade returns made it clear: no room for Indexation!
- Things (returns!) got worse; Stock markets underperformed, Low Bond rates
- Nominal Pension under pressure: Pension cuts seem inevitable

Key question: How to cut pension rights?

  1. Cut Nominal Pension and keep room for Indexation?
  2. Cut on Indexation as much as possible, before cutting Nominal Pension?

Return wrap up
Looking backwards at 10Y T. Bonds and Stocks (S&P 500) as an example, this is - in short - our 'back-up' challenge for the future :

Table 1

PeriodAverage Arith. ReturnsRisk (Standard Deviation)


PeriodAverage Compound Returns





In addition, due to implementing Market Value Principles in the nineties and later, Bonds have become more risky on the balance sheet.

To paint the dilemma of pension funds even more,
- actual artificial low interest rates (how long?)
- extremely overvalued stock market (Total Market Cap/GDP=95%)
- increasing covariance of asset classes in times of crisis
- systemic risks everywhere
- worldwide unsure economic outlook
- unregulated and non transparent hedge and debt markets
- unidentified risk in derivatives; central clearing on its way
- upcoming unsure supervisory legislation (e.g. Solvency)

make it very hard , if not impossible, to take sustainable underpinned decisions.

To illustrate the investment part of this dilemma, take a look at the next chart:

Confidence Level
As a consequence of the above development (and longevity effects) our pensions got screwed up.

In short the next chart illustrates what happened to the (1 year) confidence level of our pensions on basis of the historical returns and risks as defined in
Table 1 on basis of a 'Return Portfolio'  approach:

The above chart clearly shows that our initial cautious (Nominal+ Pension) approach in the sixties, was replaced by an (retrospective) much too optimistic (Real Pension) belief in the eighties and nineties. 

A real pension objective puts the nominal pension at risk
Even more important is to realize that - as the approach 2000-2011 shows - it's only (questionable) possible to achieve a kind of Real Pension (with a corresponding substantial (needed) return of 5% or more) by putting the Nominal Pension (extra) at risk!!!!

More in detail:

Long term view
Looking not just at '1 year return risks', but also at 3 and 10 year return risks, we may conclude the risk of underperformance is still substantial.

Therefore, the challenging question  that still remains, is:
Is it wise to put our 'nominal pension' at substantial risk to achieve a highly unsure real pension?

Mean Variance analysis in historical perspective, gives food for thought....
The 2012-2020 outlook seems tricky and is not directly showing a 'shiny future'...

Some remarks...
  • Last decade+ (2000-2011) with higher Bond than stock returns (see Table 1), shows a  major optimizing problem
  • Future approach (2012-2020) is based on the current low 10Y Bond rate of about 2% (SD=8%), which will keep low as a result of the FED's low rate strategy,  and low expected stock returns of about 4% (SD=16%). 
  • Even if the outlook returns would be slightly higher, this wouldn't change the picture..... 

Investment Management: What a fool believes
As  risk or investment manager these are challenging times. Perhaps the only truth in investment land is:  What a fool believes

But what a fool believes ... he sees
No wise man has the power to reason away
What seems ... to be
Is always better than nothing
And nothing at all keeps sending him

NB All (above) calculations, tables and charts are indicative and strongly simplified to make it possible to 'get the picture' and 'get feeling for the direction', in order to support complex decision making  without straying too far from reality..... 

Related Links:
- Gold-plated pensions lose shine (2012)
- Where Are We with Market Valuations? (2012)
- Value-at-Risk: An Overview of Analytical VaR (JPM)
- Solvency II nightmare still looms but worst-case scenario averted

Spreadsheets (Raw, download):
- Real ambition
- Risk Return

Feb 12, 2012

What became of my Pension Plan...

It's sad but a bitter reality, pension cuts are on their way....

We have to admit.., our once so ambitious pension plans got shattered.

What's left is the cartoonized view of an average pension member:

Dutch Perspective
For Dutch pension members and pensioners the situation has become (extra) paradoxical.

Top consulting firms like Mercer and Towers Watson (regularly) rank The Netherlands as one of the best pension countries ever.....

These announcements only bring little consolation......

On top of the Dutch State Treasury Agency illustrates the relative 'strong outlook' of the Netherlands in European perspective.

All this looks quite hopeful, but does it generate the necessary trust?

New Risk Management Definition
What comes to mind is: was our our pension plan based on hope or calculations we can trust? Is our (Dutch) country recovering plan based on underpinned facts and actions or is it 'pink cloud thinking'.....?

Hmmmmm...., all these reflections lead to a kind of new mathematical definition of Risk Management:

Risk Management = Trust - Hope

In other words, Risk Management is managing the difference between Hope and Trust......

Faith alone seems not enough.....

What's next?

Key question is in all this pension fuzz is of course: How could this happen?

More technical details in my next blog on Actuary-Info :

Pension Cuts, Why? 

Mean time, keep breathing, you're living a longer live......

Sources/Related Links:
- Dutch State Treasury Agency (2012)
- Global Pension Assets Study 2012

- The Melbourne Mercer Global Pension Index (2011)
- List of Top Consulting Firms 
- Is Faith Enough? 

Feb 4, 2012

World Roulette

This decade of quantum reality and quantum risk must have been foreseen by Charles Dickens:

It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness, it was the epoch of belief, it was the epoch of incredulity, it was the season of Light, it was the season of Darkness, it was the spring of hope, it was the winter of despair, we had everything before us, we had nothing before us, we were all going direct to heaven, we were all going direct the other way - in short, the period was so far like the present period, that some of its noisiest authorities insisted on its being received, for good or for evil, in the superlative degree of comparison only.

Charles Dickens,
English novelist (1812 - 1870)
, A Tale of Two Cities

Applying Dickens' wisdom to Europe: Europe will break up, Europe will survive.......    Who knows?

Let's dive a little deeper to find out what's happening.

Different interests
First of all different countries in Europe have different interests in the outcome of this debt crisis as the next charts (2010 data) of the Telegraph (nov 2011) show:

It's hard to get actual data on this subject (how about transparency?), however the 'Deutsche Bundesbank' opens up a bit, as the next table shows:

This table (3) clearly shows that Germany is increasingly funding the poor (default) positions of a number of countries.

Countries like Ireland, Greece, Portugal and Spain are in an extremely difficult and hopeless position.

Even France is 'on the wrong side' and moving in the wrong direction.....

As long as these bad performing countries are not showing any progress in getting their national finance under control and diminishing their debt, other countries like Germany, Luxembourg and The Netherlands are  throwing the money of their citizens into the bottomless pit of countries that can't take care of themselves.

As long as Europe cannot force individual member states to take appropriate measures, it's on a on a collision course and will eventually default.

For years now, Germany is putting a lot of energy and - even more - financial support in keeping Europe alive.

Despite this laudable way of acting, it's clear that if other countries don't catch up, the end of Europe is in sight.

The most horrible scenario is of course: a major (hyper)inflation in Europe.

Therefore, Germany, Luxembourg and The Netherlands would be wise to finance other countries only on basis of inflation-indexed-loans.

This way countries can't escape by means of (stimulated)  inflation.

Different types of roulette
The situation above is like a desperate German player in a casino in a lonely town.......

His European family lost a fortune that night....

In order to 'save' his family, he takes his 'responsibility' and decides to play 'double or nothing' by putting all his money on 'red' and hope for the best.

Meanwhile, his family continues to gamble on the other casino  tables, as if nothing has happened.

As Germans can calculate like no other, our Bundes-player knows he eventually can not win at roulette. But he has to play to prevent a family default.

Unfortunately, the German player doesn't realize he's not playing 'normal' European roulette, based on one green pocket.......

NO.., it's getting worse.......

Our German player is not even playing American roulette, with two green pockets and (therefore) less chance of winning.....

In fact our unlucky German friend is playing a kind of 'World roulette'..... as this inevitable European Debt Game will infect the world economy....

In 'economic practice' the situation is more risky than at the roulette table, as with roulette you can exactly calculate your probabilities, while in 'real life' you are not sure of your probabilities.

That's what Risk Management is all about, isn't it?

Keep following Europe the next months, as this story will continue.....

Next blog.... better news! 

Sources/Related Links:
- DBB:Euroland's hidden balance-of-payments crisis
- Bundesbank sinks deeper into debt saving Europe

- Bank exposure data (Bank for International Settlements, table 9D)
- Debt as percentage of GDP and total debt (Eurostat).
- ECB Stats