Happy New Year (2013)

Happy New Year to all Actuary-Info readers!!

Year of Statistics 

2013 will be "The International Year of Statistics" ("Statistics2013").

Statistics2013 is a worldwide celebration and recognition of the contributions of statistical science.
Through the combined energies of organizations worldwide, Statistics2013 will promote the importance of Statistics.

The goals of Statistics2013 include:

• increasing public awareness of the power and impact of Statistics on all aspects of society;
• nurturing Statistics as a profession, especially among young people; and
• promoting creativity and development in the sciences of Probability and Statistics

Watch the next video:
Improving Human Welfare in 2013 International Year of Statistics

Humor: Island Stocks

Original Source

Inflation or Deflation?

One of the most tricky financial phenomena is INFLATION....

A continuing inflation of an average 2% or 3% devalues pensions and erodes saving accounts on the long run.

A sudden shock of inflation, hyperinflation, vaporizes the assets as well as the debts.

It could be (the only) way out of this sustainable crisis we seem to be dealing with. The other side, credit deflation, is also a potential 'Crisis Solver Candidate' for restructuring the enormous debt in our economy.

Which one will win?  Price (hyper)inflation or credit deflation? That's the key question....

Artificial

Just like the complete arsenal of asset classes in our financial 2012 society, price inflation is not (longer) a result of natural price mechanisms directly or indirectly based on supply and demand.

Worldwide, governments and central banks (FED, ECB, etc) are trying to control inflation  to keep economies as stable as possible and to create an economic environment with growth potential, while restructuring debt step-wise on the long run to 'acceptable' levels....

Historic Price Inflation

With the above formulated insights, let's take a look at how U.S. price inflation and deflation have historically developed on the long run:

A visual analysis of this inflation graph clearly shows the hyperinflation waves (most often) are followed by a hyperdeflation avalanche. However for more than 56 years on a row now, inflation has been only positive. So the key question stays: Are we heading for a major devaluation crash or a final hyperinflation scenario after which what (?) happens????

To get (visual) sight on this question, let's take a look at the 10Y and 50Y moving averages::

At first sight, one could visually conclude that it's most likely that inflation will rise again..... On the other hand, looking 'long term' deflation seems inevitable......   But who really knows?

Detail Figures

Maybe some quantitative information gives more insight:

From this we can conclude that the average arithmetic inflation (1.38%) as well as the compound (geometric) inflation (1.13%) is modest and the standard deviation (considering the low averages) is relatively high.

This calls for a period inspection:

Or in plain numbers:

Now we have a clear view! Until 1900 the average yearly inflation was around 0%. From 1900 to 2000 we suffered from an increasing inflation, mainly due to a number of crises. As from 2000 of, we try to push inflation down, with limited success.

Hyper Risk

All these charts lead to a better view on inflation, but what about the risk of 'hyper' inflation- or deflation.

A short look at the frequency table helps us to get a picture of the inflation risk distribution:

I'll leave it up to you, to draw your conclusions from this last chart.

Mathematica

More insight and feeling about how inflation correlates with some important economic variables can be developed by playing around with the next Mathematica Applet.

To work with the applet, allow the Mathematica plugin to download (it's safe).

This year (2012) inflation come out will be somewhere around 2.1%.

One of my next blogs will allow you to Mathemetica(lly)  'play' with inflation (including the 2012 inflation outcome), so you'll be able to grasp inflation finally.

Finally: Keep Cool!
Until then....., keep cool while watching the inflation balloon rise until it will (not) burst !!! , as researchers in a "Bursting balloons and anxious faces study"  concluded that a person is willingly to take more risk when a watching friend suppresses facial expressions of anxiety. "Such a finding has obvious implications for the interpersonal emotion regulation of advisors or counselors intervening in real world decision making situations". 

Links

- Excel Spreadsheet with inflation data and charts

- Inflation Wikipedia

- Study Bursting balloons and anxious faces

What's your Risk Intelligence Quotient?

One of the main problems in risk management is that we (oblivious) overestimate our risk knowledge.

Example
If for example financial institutional boards have to define a risk-return strategy, they may overestimate the probability that the historic return level of a certain asset class will also be the expected future return level.
Or they might simply overestimate the quality of their investment advisor.... ;-)

To define an optimal asset mix on basis of a risk-return strategy, it takes more than just estimating future returns and/or risks of certain asset classes.

To make these kind of high-impact decisions it's important to train board members on knowledge of economic schools and theories and also on the relationship between economic developments and financial parameters like unemployment, inflation, GDP-growth, specific asset class return and risk parameters, linear and non-linear effects, and so on......

But more than that, it's important that board members - as they have learned all this - become aware of the fact that the more they know about risk and uncertainty, the more they'll realize that the outcome or certainty of a future development is intrinsically highly unsure. This last recognition will have significant consequences for the final choice with regard to the optimal asset mix given the risk appetite.

Risk Intelligence Test 
Eventually it all comes down to

Kowing how much you know

as Dylan Evans, author of the book "Risk Intelligence"states in the Dylan Ratigan Show

According to Dylan : 'Risk intelligence is not about solving probability puzzles; it is about how to make decisions when your knowledge is uncertain.'

Dylan Evans developed a short (5 min) Risk Intelligence Test.
See, if you can pas the test as an actuary or risk manager...
You can take the test here.
The test is also available in Dutch.



Links:
- Homepage Dylan Evans
- Dylan Evans on Twitter
- Dutch Risk Intelligence Test
- Dylan Evans: Emotional Equations (Pdf)

Solvency II or Basel III ? Model Fallacy

Managing investment models - ALM models in particular - is a professional art. One of the most tricky risk management fallacies when dealing with these models, is that they are being used for identifying so called 'bad scenarios', which are then being 'hedged away'.

To illustrate what is happening, join me in a short every day ALM thought experiment...

Before that, I must warn you... this is going to be a long, technical, but hopefully interesting Blog. I'll try to keep the discussion on 'high school level'. Stay with me, Ill promise: it actuarially pays out in the end!

ALM Thought Experiment

• Testing the asset Mix
  Suppose the board of our Insurance Company or Pension Fund is testing the current strategic asset mix with help of an ALM model in order to find out more about the future risk characteristics of the chosen portfolio.
   
• Simulation
  The ALM model runs a 'thousands of scenarios simulation', to find out under which conditions and in which scenarios the 'required return' is met and to test if results are in line with the defined risk appetite.
   
• Quantum Asset Return Space
  
  
  In order to stay as close to reality as possible, let's assume that the 'Quantum Asset Return Space' in which the asset mix has to deliver its required returns for a fixed chosen duration horizon N, consists of: 
1. 999,900 scenarios with Positive Outcomes ( POs ),
   where the asset returns weigh up to the required return) and 
2. 100 scenarios with Negative Outcomes ( NOs ),
   where the asset returns fail to weigh up to the required return.
    
Choose 'N' virtual anywhere between 1 (fraction) of a year up to 50 years, in line with your liability duration.
 


• Confidence (Base) Rate
  From the above example, we may conclude that the N-year confidence base rate of a positive scenario outcome (in short: assets meet liabilities) in reality is 99.99% and the N-year probability of a company default due to a lack of asset returns in reality is 0.01%.
   
• From Quantum Space to Reality
  
  
  As the strategic asset mix 'performs' in a quantum reality, nobody - no board member or expert - can tell which of the quantum ('potential') scenarios will come true in the next N years or (even) what the exact individual quantum scenarios are.
  
  Nevertheless, these quantum scenarios all exist in "Quantum Asset Return Space" (QARS) and only one of those quantum scenarios will finally turn out as the one and only 'return reality'.
  
  Which one...(?), we can only tell after the scenario has manifested itself after N years.
   
• Defining the ALM Model
  Now we start defining our ALM Model. As any model, our ALM model is an approach of reality (or more specific: the above defined 'quantum reality') in which we are forced to make simplifications, like: defining an 'average return', defining 'risk' as standard deviation, defining a 'normal' or other type of model as basis for drawing 'scenarios' for our ALM's simulation process.
  Therefore our ALM Model is and cannot be perfect.
  
  Now, because of the fact that our model isn't perfect, let's assume that our 'high quality' ALM Model has an overall Error Rate of 1% (ER=1%), more specific simplified defined as:
1. The model generates Negative Scenario Outcomes (NSOs) (= required return not met) with an error rate of 1%. In other words: in 1% of the cases, the model generates a positive outcome scenario when it should have generated a negative outcome scenario
    
2. The model generates Positive Scenario Outcomes (PSOs) (= required return met) with an error rate of 1%. In other words: in 1% of the cases, the model generates a negative outcome scenario when it should have generated a positive outcome scenario
    

The Key Question!

Now that we've set the our ALM model, we run it in a simulation with no matter how much runs. Here is the visual outcome:

As you may notice, the resulting ALM graph tells us more than a billion numbers....At once it's clear that one of the scenarios (the blue one) has a very negative unwanted outcome.

The investment advisor suggests to 'hedge this scenario away'. You as an actuary raise the key question:

What is the probability that a Negative Outcome (NO) scenario in the ALM model is indeed truly a negative outcome and not a false outcome due to the fact that the model is not perfect?

With this question, you hit the nail (right) on the head...

Do you know the answer? Is it 99% exactly, more or less?

Before reading further, try to answer the question and do not cheat by scrolling down.....

To help you prevent reading further by accident, I have inserted a pointful youtube movie:

Answer 

Now here is the answer: The probability that any of the NOs (Negative Outcomes) in the ALM study - and not only the very negative blue one - is a truly a NO and not a PO (Positive Outcome) and therefore false NO, is - fasten your seat belts  - 0.98%! (no misspelling here!)

Warning

So there's a 99.02% (=100%-0.98%) probability that any Negative Outcome from our model is totally wrong, Therefore one must be very cautious and careful with drawing conclusions and formulating risk management actions upon negative scenarios from ALM models in general.

Explanation

Here's the short Excel-like explanation, which is based on Bayes' Theorem.

You can download the Excel spreadsheet here.

There is MORE!

Now you might argue that the low probability (0.98%) of finding true Negative Outcomes is due to the high (99,99%) Positive Outcome rate and that 99,99% is unrealistic much higher than - for instance - the Basel III confidence level of 99,9%. Well..., you're absolutely right. As high positive outcome rates correspond one to one with high confidence levels, here are the results for other positive outcome rates that equal certain well known (future) standard confidence levels (N := 1 year):

What can we conclude from this graph?

If the relative part of positive outcomes and therefore the confidence levels rise, the probability that an identified Negative Output Scenario is true, decreases dramatically fast to zero. To put it in other words:

At high confidence levels (ALM) models can not identify negative scenarios anymore!!!

Higher Error Rates

Now keep in mind we calculated all this still with a high quality error rate of 1%. What about higher model error rates. Here's the outcome:

As expected, at higher error rates, the situation of non detectable negative scenarios gets worse as the model error rate increases......

U.S. Pension Funds

The 50% Confidence Level is added, because a lot of U.S. pension funds are in this confidence area. In this case we find - more or less regardless of the model error rate level - a substantial probability ( 80% - 90%) of finding true negative outcome scenarios. Problem here is, it's useless to define actions on individual negative scenarios. First priority should be to restructure and cut ambition in the current pension agreement, in order to realize a higher confidence level. It's useless to mop the kitchen when your house is flooded with water.....

Model Error Rate Determination

One might argue that the approach in this blog is too theoretical as it's impossible to determine the exact (future) error rate of a model. Yes, it's true that the exact model error rate is hard to determine. However, with help of backtesting the magnitude of the model error rate can be roughly estimated and that's good enough for drawing relevant conclusions.

A General Detectability Equation

The general equation for calculating the Detectability (Rate) of Negative Outcome Scenarios (DNOS) given the model error rate (ER)  and a trusted Confidence Level (CL) is:

DNOS = (1-ER) (1- CL) / ( 1- CL + 2 ER CL -ER )

Example

So a model error rate of 1%, combined with Basel III confidence level of 99.9% results in a low 9.02% [ =(1-0.01)*(1-0.999)/(1-0.999+2*0.01*0.999-0.01) ] detectability of Negative Outcome scenarios.

Detectability Rates

Here's a more complete oversight of detectability rates:

It would take (impossible?) super high quality model error rates of 0.1% or lower to regain detectability power in our (ALM) models, as is shown in the next table:

Required  Model Confidence Level

If we define the Model Confidence Level as MCL = 1 - MER, the rate of Detectability of Negative Outcome Scenarios as DR= Detectability Rate = DNOS and the CL as CL=Positive Outcome Scenarios' Confidence Level, we can calculate an visualize the required  Model Confidence Levels (MCL) as follows:

From this graph it's at a glance clear that already modest Confidence Levels (>90%) in combination with a modest Detectability Rate of 90%, leads to unrealistic required Model Confidence Rates of around 99% or more. Let's not discuss the required Model Confidence Rates for Solvency II and/or Basel II/III.

Conclusions

1. Current models lose power
   Due to the effect that (ALM) models are limited (model error rates 1%-5%) and confidence levels are increasing (above > 99%) because of more severe regulation, models significantly lose power an therefore become useless in detecting true negative outcome scenarios in a simulation. This implies that models lose their significance with respect to adequate risk management, because it's impossible to detect whether any negative outcome scenario is realistic.
    
2. Current models not Solvency II and Basel II/III proof
   From (1) we can conclude in general that - despite our sound methods -our models probably are not Solvency II and Basel II/III proof. First action to take, is to get sight on the error rate of our models in high confidence environments...
    
3. 
   New models?
   The alternative and challenge for actuaries and investment modelers is to develop new models with substantial lower model error rates (< 0.1%).
   
   Key Question: Is that possible?
   
   If you are inclined to think it is, please keep in mind that human beings have an error rate of 1% and computer programs have an error rate of about 3%.......
    

Links & Sources:

- Download this blog's Excel spreadsheet
- Wikipedia: Base Rate Fallacy

- Human Errors

Dying Age Quiz

Ever heard of Club 27? It turns out that famous pop artists have a preferred age of dying: 27.

Among this 'club', with around 50 unlucky 'members' that all died at the age of 27, are well known names like Brian Jones, Jimi Hendrix, Janis Joplin, Jim Morrison and (lately, 2011) Amy Winehouse.

There's been a lot of (actuarial) discussion whether this club 27 phenomenon is a mortality anomaly or not.

In a statistical study from BMJ (British Journal of Medicine) called "Is 27 really a dangerous age for famous musicians? Retrospective cohort study", it's shown that  there's no peak in the risk of death for famous musicians at age 27.

Club 27, or its movie,  is therefore a nice opportunity to study some interesting artists who died young, but not based on any statistical relevance.

Quiz
Not only some top musicians died young, but also some 'historical' celebrities.

Now take the next quiz to test your knowledge on the dying age of the next famous people who changed the world, each on in his/her own way:

Click here for the quiz

Links and sources:
- BMJ Statistical Study
- Dying Age Quiz of Famous People
- Death, Actuarial Science and Rock n’ Roll-the 27 Club

Pension for Contribution

People are lost if it comes down to their pension. A recent (2012) Friends Life survey found that 68% of Britons do not know the collective value of their pension funds.....

This result is in line with a Dutch 2011 survey, that concludes that 66% has no knowledge of their pension.

Pension illiteracy is clearly a worldwide phenomenon. Pensions are a 'low interest' product. Unfortunately - nowadays - in the double sense of the latter words.

As an actuary, people often ask me at a birthday party : I'm paying a 1000 bucks contribution each year for my pension, but does it pay out in the end? Can you tell me?

Unfortunately most actuaries, including myself, answer this question by telling that this is a difficult question to answer straightforward and that the pension outcome depends on topics like age, mortality, return, inflation, gender, indexation, investment scheme, asset mix, etc., etc.....

Simplifying

To make a breakthrough in this pension communication paradox, let's try to create more pension insight with a simple approach. But remember - as with everything in life - the word 'simple' implies that we can not be complete as well as consistent at the same time. After all, Kurt Gödel's incompleteness theorems clearly show that nothing in life can be both complete and consistent at the same time.

Thanks to God and Gödel, we can stay alive on this planet by simplifying everything in life to a level that our brains can comprise. We'll keep it that way in this blog as well.

How much pension Benefits for how much contribution?

First thing to do, is to give the average low pension interested person on this planet an overall hunch on what a yearly investment of a 1000 bucks(first simplification: S1)until the pension age of 65 year (S2) delivers in terms of a yearly pension as of age 65 in case of an average pension fund.

If we state 'bucks' here, we mean your local general currency. We denote 'bucks' here simply as $, or leave it out. So $ stands for €, ¥ , £ or even $ itself.

Now let's calculate for different pension contribution start ages (S3)what a yearly contribution of $ 1000 (payable in months at the beginning of each month; S4), pays back in terms of a yearly pension (payable in months at the end of each month; S5) on basis of a set of different constant return rates (S6). The calculation is on a net basis (so without costs; S7), a Dutch (2008) mortality table (S8) and without any inflation (S9), any pension indexation (S10), any contribution indexation (S11), or any tax influence (S12).

Here's the simple table we're looking for:

TABLE 1

Yearly Pension at age 65 on basis of 1000 yearly contribution
Pension Indexation=0%, Contribution Indexation=0%, Inflation: 0%
Start	Net Yearly Return Rate
Age	0%	1%	2%	3%	4%	5%	6%	7%	8%
25	2692	3669	5019	6898	9521	13192	18336	25553	35681
30	2345	3113	4134	5503	7342	9812	13133	17601	23612
35	1999	2584	3335	4304	5555	7171	9257	11949	15421
40	1654	2084	2614	3273	4092	5109	6370	7933	9867
45	1311	1610	1964	2388	2896	3502	4225	5085	6107
50	972	1163	1380	1632	1921	2254	2635	3072	3570
55	638	744	860	989	1132	1291	1465	1657	1868
60	312	355	400	448	499	554	612	674	738

In a graphical view on a logarithmic pension benefits scale, it looks something like this:

Example

To illustrate what is happening, a simple example:

When you join your pension fund at age 40 and start saving $ 1000 a year (the first of every month: $ 83.33) until your 65, you'll receive a yearly pension benefit of $ 4092 yearly ( $ 341 at the end of every month) from age 65 of, as long as you live.

From this table, we can already draw some very basic conclusions:

• To build up a substantial pension, it pays out if you start early in life
• The pension outcome is heavily dependent on the yearly return of your pension fund
• Most pension funds operate on basis of a 'general employee and/or employer contribution' instead of individual employee contributions.
  This implies that younger employees pay more than they should have paid on an individual basis and older employees less. In other words, younger employees subsidize older employees. How much more, you can derive from the tables above and by comparing the individual contributions to the general contribution level of the pension fund.

Pension Indexation

As we all want to protect our pension against inflation, let's calculate the outcome of a 'real pension' instead of a 'nominal pension'. As long term yearly inflation rates vary between 2% and 3%, we make the same calculation as above, but now the yearly pension outcome (as from age 65) will be indexed with 3% (fixed) at the end of every year and the yearly contribution paid, will also be yearly indexed with 3%.

Here's the outcome:

TABLE 2

Yearly Pension at age 65 on basis of 1000 yearly contribution
Pension Indexation=3%, Contribution Indexation=3%, Inflation: 0%
Start	Net Yearly Return Rate
Age	0%	1%	2%	3%	4%	5%	6%	7%	8%
25	3687	4914	6566	8814	11889	16112	21933	29978	41124
30	2947	3859	5051	6624	8707	11468	15138	20021	26526
35	2309	2968	3803	4872	6241	7994	10240	13119	16809
40	1760	2218	2781	3479	4344	5413	6735	8368	10382
45	1288	1590	1949	2381	2897	3515	4251	5127	6168
50	882	1066	1277	1523	1807	2134	2512	2944	3440
55	536	633	741	862	998	1149	1316	1502	1706
60	243	281	321	364	411	461	515	573	634

To get grip at the comparison between a real and a nominal pension, we express the real pension (3% Indexed Pensions and Contribution) as a percentage of the nominal pension:

TABLE 3

Yearly Pension at age 65 on basis of 1000 yearly contribution
'3% P&C-Indexed Pensions' as percentage '0% P&C-Indexed Pensions'
Start	Net Yearly Return Rate
Age	0%	1%	2%	3%	4%	5%	6%	7%	8%
25	137%	134%	131%	128%	125%	122%	120%	117%	115%
30	126%	124%	122%	120%	119%	117%	115%	114%	112%
35	116%	115%	114%	113%	112%	111%	111%	110%	109%
40	106%	106%	106%	106%	106%	106%	106%	105%	105%
45	98%	99%	99%	100%	100%	100%	101%	101%	101%
50	91%	92%	93%	93%	94%	95%	95%	96%	96%
55	84%	85%	86%	87%	88%	89%	90%	91%	91%
60	78%	79%	80%	81%	82%	83%	84%	85%	86%

From this last table we can conclude that if you start saving for your pension below the age of 40 your indexed savings weight up to the indexed pension. Above the age of 45 it is the other way around.

The above figures are the kind of figures (magnitude) you'll find on your benefits statements. You can compare in practice whether your benefit statement is in line with the above tables....

The Inflation Monster

In the last given example, pension is 3% inflation protected as from the moment of retirement.

However, if pension is not also yearly fully indexed (in this case: 3%) during the contribution period, there still is a major potential inflation erosion risk left.

In this case it's interesting to examine what the value of a 3% indexed pension in combination with a 3% indexed contribution is worth in terms of actual money, as inflation would continue at a constant 3% level each year. Here's the answer:

TABLE 4

Yearly Pension at age 65 on basis of 1000 yearly contribution
Pension Indexation=3%, Contribution Indexation=3%, Inflation: 3%
Start	Net Yearly Return Rate
Age	0%	1%	2%	3%	4%	5%	6%	7%	8%
25	1130	1507	2013	2702	3645	4939	6724	9190	12607
30	1047	1371	1795	2354	3094	4076	5380	7115	9427
35	951	1223	1567	2007	2571	3293	4219	5405	6925
40	841	1059	1328	1662	2075	2586	3217	3997	4959
45	713	880	1079	1318	1604	1946	2354	2839	3415
50	566	684	820	977	1160	1370	1612	1890	2208
55	399	471	552	642	742	855	979	1117	1269
60	210	242	277	314	355	398	445	494	547

What we notice is a substantial inflation erosion effect as the pension fund participants get younger.

Let's zoom in on an example to see what we can achieve with these tables.

Example

• From table 2 we can conclude that - at a 4% return rate - a 40 year old starting pension fund member, with a $ 1000 dollar yearly 3% indexed contribution will reach a 3% yearly indexed pension of $ 4344 yearly at age 65.
• From table 4 we can subsequently conclude that, based on an inflation rate of 3%, this $ 4344 pension has a 'real' value of $ 2075, if it's expressed in the value money had when the participant was 40 years old (so, at the start).
• From table 4 we can also conclude that in order to 'compensate' inflation erosion for this pension member, the pension fund has to achieve a return of around 7.4%.
  This follows from simple linear interpolation:
  7,4% = 7% + 1% * (4344-3997)/(4959-3997)

I'll leave other examples to your own imagination.

The effect of a constant inflation on a pension is devastating, as the next table shows

TABLE 5

Inflation Erosion Pension indexation=3% as of age 65 Contribution indexation=3% Inflation=3% Start Age Inflation Erosion 25 69% 30 64% 35 59% 40 52% 45 45% 50 36% 55 26% 60 14%

From table 5 it becomes clear that Inflation erosion is indeed substantial. If you have a fully indexed pension from age 65 (who has?) of and you're N years away from your retirement, an inflation of i% will erode your pension with E%. In formula:           Example Set inflation to 3%. If you're 40 years old and about to retire at 65, you've got 25 years (N=25=65-40) ahead of you. If your pension of let's say $ 10,000 a year is not indexed during this period, you can buy with this $ 10,000 no more than you could buy today with $ 4,800.

Your pension is eroded due to inflation with 52% = 1- 1.03^-25. So only 48% is left.....

Finally

I trust these tables and examples contribute a little to your pension insight. Just dive into your pension, it's financially relevant and certainly will pay out!

Remember that all results and examples in this blog are approximations and simplifications on a net base (no costs or taxes are included). In practice pension funds or insurers have tot charge costs for administration, asset management, solvency, guarantees, mortality risk, etc. . This implies that in practice the results could differ strongly with the results as shown in this blog. The examples in this blog are therefore for learning and demonstration purposes only.

The above calculations were made in a few minutes with help of the Excel Pension Calculator that was developed in 2011 and updated in 2012.

With help of this pension planner you can calculate all kind of variations and set different variables, including different mortality tables (or even define your own mortality table).

You can download the pension calculator for free and make your own pension calculations.

More information about pension calculating with this simple pension calculator at:

MORE ABOUT EXCEL PENSION CALCULATOR

Enjoy your pension, beware of inflation....

Links & Sources:

- Download Excel Pension Calculator (virus free)

- The scourge of multiple hidden pension pots (2012)

- Survey:Individual Differences in Pension Knowledge (2011)

- Kurt Gödel's incompleteness theorems

- EU Inflation Monster

Pension Date Outdated

Have you ever thought about your Pension Date?

Isn't it strange? We live in an era with an increasing (healthy) life expectancy. At the same time, there are strong individual old age health differences, resulting in strong individual 'Job Fit' differences.

Yet our 'Pension Date' is kept collectively fixed at an age of 60, 65 or 67.......

Working keeps you alive
The closer you get to your pension age, the more you realize that a full employment break at 65 (or whatever age) is crazy, unwise and even dangerous.

On top of, the life expectancy of the working population has proven (see: Towers Watson) to be significantly (up to two years!) higher than that of the population as a whole. In other words:

The longer you work, the longer you live....

(Non) Financial Pension Planning
More than just financial, Pension Planning is a common responsibility between the employer and the employee, to fit the employee's work (job) and working hours to his changing abilities as (s)he grows older. This way an employee is able to retire gradually. Now (s)he can adapt step-by-step to the changing new social and working environment, while still adding company value.

As the employer's workforce is - just like society - aging step-by-step, it's in the employer's interest to develop an integral HR-Investment Strategy and Action Plan for every to be defined relevant employee age-group.

Work Ability Index
An excellent way to start is to measure if employees are 'Job Fit' with the so called Workability Index.

Introduction to Workability for Employers from MeteorWorkability

 

Work as a burden?
Our present pension system still carries the characteristics of a social environment of the fifties of the last century. In this bible dominated time-frame, work is seen as a kind of burden.:

Genesis 3:19
In the sweat of thy face shalt thou eat bread, till thou return unto the ground;

for out of it wast thou taken: for dust thou art, and unto dust shalt thou return.

Nowadays more and more people are perceiving work as a challenge to develop themselves and others in a healthy way. You are not working to finally 'enjoy' your pension 'doing nothing', but you work because it gives life meaning and your pension plan helps you to financially manage your decreasing work-income and your increasing health costs as you get older and older in hopefully relatively good health.

Karl Lagerfeld, the Perfect Example
A strong example of such a new 'life policy' has recently been given by Karl Lagerfeld in an interview with Edie Campbell for Vogue. Karl is almost 80 years (!) old and besides one of the world's successful businessmen, fashion designers, artists and photographers, still vital and going strong in life.

View the next summary and enjoy Karl, regarding his view on retirement....




Change our Pension System
To cope with the aging workforce and to profit from 'elderly workers', employers have to:

• fit their employees' work (job) and working hours to their changing abilities as they grow older.
• This implies that employees have to be able to retire gradually.

A NEW PENSION SYSTEM
A new flexible pension system is needed to facilitate gradually retirement of employees:

1. Skip THE Pension Date
Therefore 'THE Pension Date' in our pension regulations has to be fully skipped as soon as possible and  be replaced by an individual, flexible and gradually applied partial pension.

2. Change Pension Payment Structure

• As from the (example) age of 50, every year the employee and employer agree on what income corresponds with the contracted activities of the employee and what the employee supplementary needs as pension income. 
• Each year, this required 'pension' income is deducted from his pension account. 
• The pension account of the employee yearly grows with the realized investment return of the pension fund and an age-dependent proportional part of the accounts of pensioners that died.
• A yearly pension communication benefit statement informs the employee about the expected development of his yearly pension in the future, in line with the agreement between the employee and the individual employer.

FINALLY...: IF NOT

If companies don't change their HR-Strategy and correlating Pension System, they and their employees will be confronted with unsustainable financial pension outcomes in the future, with as a result:
- Pension Cuts,
- Social Turmoil and
- Declining Profits.

It's the responsibility of every actuary to advice employers to take action in renewing their pension system to the demands of our modern and aging society.

If not.... actuaries will not be seen as advisors or helpers, but as the executioners of pension cuts.

Actuaries, it's up to YOU!

Perhaps some actuarial coaching may help us......

Sources/Related Links: 
- Mortality Experience (TW;PDF;2010)
- Does Your Job Fit Your Age?
- ABC-News: Aging: Work Longer, Live Longer
- Example Waikato: Strategies to retain staff in employment as they age
- VOGUE 2012: Karl Lagerfeld: Retirement Is Death
- Make your own free Cartoons at Pixton

ESM, Rate Rating Procedures

As of  October 8, 2012 the European Stability Mechanism (ESM) is a fact.

ESM is a European multilateral lending bank that lends money to euro Area Member Countries in order to facilitate them to restructure their debt and financial position.

Please note that the ESM lending is funded by debt only! 

ESM Rating

On October 12, 2012 Fitch Ratings has assigned the ESM a triple-A (AAA) Long-term Issuer Default Rating  and a Short-Term IDR of 'F1+'. The Outlook is Stable.

All Hosanna one would say. Well almost....

At the end of the FitchRatings document two small remarks state the following:

1. The rating is robust to downgrades of 'AAA' shareholders into the 'AA' rating category.
2. However, as Fitch has previously commented, in the event that Greece were to exit from the eurozone, the ratings of all sovereign and sovereign-rated entities in the eurozone, including the ESM, would be placed on Rating Watch Negative as Fitch re-assessed the broader political commitment to the euro and the potential contagion and financial implications of a Greek exit.

Implicitly the first remark implies that if individual AAA countries are downgraded below AA, the Fitch rating is no longer robust. As the probability that such a downgrade might happen, is substantial, it is strange that this 'downgrade risk' is not explicitly valued in the rating procedure.

The second remark implies that a significant risk (1Y default Risk Greece>30%; see also: Default Risk at Risk) as the exit of Greece, has also not been valued in the rating procedure. Not to mention that a possible default risk or exit of Spain has not even come into the mind of the FitchRating scientists. 

Conclusion
From a risk management and valuation perspective, leaving out both risks in an official rating procedure is ridiculous and looks more like a kind of 'lip service' instead of a serious rating procedure. Above all, it places rating procedures in a bad spotlight.
It's about time to rate the ratings agencies an their rating procedures. Who's willing (or dares) to do so?

Perhaps it's also time to fill in the Risk Manager vacancy in the ESM Organization Chart...... ;-)

Sources/Related Links

- ESMs FitchRatings document 2012 
- Presentation ESM
- ESM Organisation Chart

Aftermath European Crises Explained