Chief Actuary Officer

Let's take a look at the governance of financial institutions from a risk management perspective:

Governance Risk Management

Traditional governance focuses on the organisation-structure, decision-structure, influence and power-weights of all stakeholders. Governance Risk Management focuses on how to optimize and monitor risk and value creation for all stakeholders.

Financial Risk Management Monitoring
After defining a companies Mission, Risk Appetite and Strategic Plan, the year-targets and key indicators are not only translated into a tight budget (b) of 'sales targets' and 'profits', but also into 'balance sheet budget targets' (b).

It takes a real well defined 'Governance Risk Management' to split the balance sheet into such parts (Assets, Liabilities & Capital) that responsible officers in the company are able (and can take responsibility) to monitor the actual values (a) monthly or quarterly to the final or adjusted budget values (b).

  

Officer Role Division
In a well managed and structured financial company the risk-financial roles of the companies officers can be defined as follows:

1. CIO
   The Chief Investment Officer is primarily responsible for managing the asset actuals A(a) versus the (adjusted) budget A(b). So the CIO has to manage [A(a)-A(b)] in terms of value and within defined  the investment risk budget.
    
2. CAO
   Although often unremarked, an important part of the role of the Chief Actuary Officer is to manage the actual liabilities L(a) versus the (adjusted) Liabilities budget L(b).
   This is no easy job, as most longevity and (risk free) discounting of the liabilities are hard to influence.
   Wrapping up: The CAO is responsible for managing [L(a)-L(b)].
   
   Often the role of the CAO seems to be limited to insurers or pension funds. However, also banks need an actuarial officer, as more and more (product) risks on the bank's balance sheet become economic, demographic and bio-related (mortality, disability, lifestyle).  
    
3. CRO
   Often the Chief Risk Officer is seen as someone at arms length reporting about risks to the (supervisory) board. However, one of the main roles of the CRO is to monitor Capital and Capital Requirements. He/She is responsible for realizing the sustainability of the company by managing the (adjusted) Capital budget C(b) while being confronted with continuously changinge Capital actuals C(a). So the CRO is responsible for monitoring [ [C(a)]-C(b)].  

AIRCO Management
Once the targets are set and responsibilities are defined, the hard part of managing a financial institution starts: Cooperation between the Actuarial, Investment, Risk and Capital Organisation (AIRCO) Chiefs.

During a budget year, all individual defined AIRCO budgets and actuals continuously change in practice.
As capital risk development is the complex result of Asset and Liability volatility, capital management and monitoring by (primarily) the CRO manager becomes extra complex. Especially in market crises situations (tail risks), where traditional (linear) correlations between AIRCO components fail by definition. It's the responsibility of the CRO to continuously balance between all stakeholders interests in narrow cooperation with the CAO and CIO, while staying on track with regulatory requirements.

This task is not easy, as AIRCO Management is not a one dimensional mission or game:

• Run-off
  Often AIRCO Management is merely based on regulatory AIRCO requirements, based on run-off portfolios and one-year period confidence levels (e.g. 99.5% [Solvency-II] or 99,9% [ Basel-II/III] ).
   
• Continuous business model 
  However this run-off approach is only based on a kind of default situation with a very low probability (< 1%). It's much more likely (> 99%) that a financial company will exist for more than one year.
  
  Therefore, adding one or more variations of 'continuous business model approaches' to the existing run-off approach on a board's table, will give the board a more (realistic) insight on the heavy an balanced decisions to be taken to continue and control a sustainable risk-return strategy. 

ALC-Team
To manage the complex of AIRCO effects, it's often helpful to set up an Asset Liability Capital Team (ALC-Team) within a financial institution. Main task of this team is to manage risk and returns across all AIC-axes in line with the strategic plan, the defined risk-return appetite and actual regulatory requirements.

The ALC-Team consists of the CAO, CIO an CRO and could in practice be chaired by the board's CFO, or CFRO.

This ALC-Team :

• proposes board adjustments and monitors the risk-return targets and matching policy
• makes clear what the often paradoxical and/or conflicting effects of risk-return management are for all stakeholders on basis of different future business continuity models (e.g. Run-off, Continuous business, etc.)
• Makes clear and advises what measures the board can take due to the impact on ALC of different business models views, changes in economic risks and changes in regulation.
• operates on basis of ALC reporting information,"Own Risk Assessment" reports, external Economic Risk Reports and external Regulatory Change Information.

Pitfalls

One of the most tricky pitfalls in capital management is that a financial institution tries to solve all budget variances and regulation changes only by adjusting its investment policy.

If adjusting is done 'on the fly', without considering the risk-return targets and (even worse) through the mental filter of just one of the stakeholders interests (e.g. 'shareholder value), a financial company implicitly risks to lose track of the overall strategic business targets.

If an economic or regulatory change influences the risk-return objectives, all possible instrumental options to respond, have to be taken into account. One of the most forgotten instruments to respond to market changes, is 'product management' or (new) 'product development'.

Yet, nevertheless the fact that existing (product) contracts are (short term) often hard to adapt, 'product management' is one of the most vital instruments to apply regarding the management of long term risk-return objectives.

Therefore AIRCO Management requires a planned an controlled Stakeholder Management Process in a financial institution.

Stakeholder Value (Risk) Management
Managing a company's stakeholder value implies that the effects of the economic, regulatory and own-company changes on the risk-return objectives are continuously balanced across all stakeholders (Shareholders, Clients, Asset Managers, Board/Employees).

Apart from 'HR value management', regarding possible board and employee reward and benefits adjustments, the instruments to manage and  balance Stakeholder Value:

A-1  Asset Value management
C-1. Capital Management
C-2  Shareholder Value management
L-1  Product Value Management
L-2  Client Value management

are presented in the next chart:

Conclusion
Managing a financial institution in this challenging financial decade (2010-2020) is a complex operation with multidimensional regulation and business risk-return targets. Financial Boards have to manage more truths at the same time in a highly volatile economic risk-return environment.

Surviving in this complex world urges boards to step from a traditional predictable managing approach to a more responsive managing approach, where stakeholders value is continuously monitored and adapted to the real world environment.

This new 'survival approach' urges to improve communication, process information and reporting across Assets, Liabilities and Capital Management within the organisation.

Establishing an ALC-Team approach could be a first step to improve the control on risk-return management within the organisation across all stakeholders and actively using all 'stakeholders value tools' in a balanced way.

Last but not least, the role of the Chief Actuary Officer should be more clearly defined. The CAO is, in line with Client Value objectives, primarily responsible for an adequate liability en product management, that's key in balancing the risk-return objectives of a financial institution.

Success!

Links/Sources
- Cartoon: Government Risk Management by Todd Nielsen
- Risky Business – Making Phenomenal Decisions
   (While Not Forgetting the Risk)

Too Big to Tail

At the end of 2012 the author of the famous book The Black Swan and professor of risk engineering at the NYU, Nassim Nicholas Taleb, published his new book Antifragile.

Antifragile is a term Taleb defines to describe things that benefit more (have more upside) from random events or shocks, than they are harmed by (have downside).

In other words, antifragile things are those that benefit from stress and disorder.

Inevitably, this  ' E=MC² ' book will change the foundations of Risk Management coming decade. Antifragile should be qualified as 'compulsory reading' for all actuaries, CFO's, CEO's and risk or investment managers.

It's impossible to summarize Taleb's Antifragile insights in a single blog, Therefore I'll focus on some examples and the major principles.

Also I would like to point at two more less known and 'mathematical based' text-books(downloadable and in progress) that are related to his popular (non-mathematical) book Antifragile:

1. Taleb Textbook: Fat Tails Math, Probability and Risk in the Real World
2. Taleb Textbook: Fat Tails and (Anti)fragility 

What's Investment Risk?

In a presentation ("Actuaris: From Backroom to Boardroom"; Dutch) to over 200 actuarial professionals at 'Actuarieel Podium' on October 1st 2013 in Utrecht, Jos Berkemeijer discussed, questioned and challenged some major actuarial profession principles. One of these actuarial principles is the:

Concept of Investment Risk

Inspired by Taleb's view on investment risk, I asked my audience to rank the next randomly presented stock charts in order of decreasing risk.

Can you manage?

As expected, most actuaries chose Stock Chart I or II as 'most risky'. Apart from a few Taleb-conscious actuaries, all of them chose Chart III as 'least risky'.

And that last choice is indeed the choice we're trained to qualify as least risky. The way we're brought up, is that risk equals volatility, ultimately resulting in a dangerous and wrong conclusion: non-volatility = 'no risk'.

However, according to Taleb, the opposite is true: Chart III represents the most risky stock.

Why?

Because the company or investment fund that's behind Stock Chart III doesn't have any real experience with 'managing risk' at all !!
  

Taleb's Turkey

In another way, Stock Chart II is risky as well. Chart III shows limited risk and exponential growth.

As Isaac Newton already stated: “What goes up must come down”
Therefore Stock III is a risky investment as well, despite it's limited volatility.

The fact that Chart II Stocks must come down is well illustrated by Taleb's Turkey example   

"A turkey is fed by a butcher.  Every day it is confirmed to the turkey and the turkey’s economics department and the turkey’s risk management department and the turkey’s analytical department that the butcher loves turkeys. And every day brings more confidence to that statement. 

The butcher will keep feeding the turkey until a few days before Thanksgiving. Then comes that day when it is really not a very good idea to be a turkey.

So with the butcher surprising it, the turkey will have a revision of belief—right when its confidence in the statement that the butcher loves turkeys is maximal and “it is very quiet” and soothingly predictable in the life of the turkey. "

This example also makes clear that black swans are not just big negative impact events. The events of a black swan event depend on the position of the observer.

Least Risky
At the end we have to conclude that, despite the largest volatility, Stock III is the least risky investment, because the company or investment fund behind this stock chart, has learned to 'deal' with risk.

Dealing with investment risk is just like raising your child. You try to protect your child against life threatening events (defaults), while at the same time you encourage it to take limited (non life threatening) risks, so it may learn to prevent and absorb damages (losses) in order get better in resisting future other risks. 

Or.., to put it in a philosophical way, as defined by rabbi Anthony Glickman:

 “Life is long gamma.”
=
“Life benefits from volatility and variability”

Antifragile Essentials
Now after this popular intro, let's conclude with some fundamental principles of Taleb:

1. Antifragile
   An investment portfolio (strategy) can be qualified as 'Antifragile' if it benefits more form shocks (high-impact events or extreme volatility, up to a certain level) than it suffers.
   
   
   
   
   
2. Optionality & Investment Strategy
• What makes you antifragile?
  Executing a option strategy
   
• Traditional investment strategies: 'too much focus'
  Traditional investment strategies (e.g. Mean-Variance optimization, profit maximization or risk budgeting) all have explicit goals ('focus') that make their performance outcomes very parameter and model dependent. Because 'medium' risks can be subjected to huge measurement errors, the often 'medium' or 'moderate' risk attitude of these strategies can become catastrophical.
  
  Traditional investment strategies are not designed to explicitly cope with Negative Black Swans events. Neither are they designed to profit from 'disorder clusters': volatility, uncertainty, disturbances, randomness and stressors.
  
  Most important: traditional investment strategies are not set for maximal profiting of Positive Black Swans!
   
• Barbell strategy
  The essence of an 'optionality investment strategy' ('barbell strategy') can be formulated as a 'dual attitude' of extreme risk aversion by playing it ultimate safe in some areas (robust to negative Black Swans) and extreme 'risk loving' by taking a lot of small risks in others (open to positive Black Swans), hence achieving antifragility.
  
  As a consequence this barbell-strategy reduces the downside risk, e.g. the elimination of the risk of ruin. In fact any strategy that removes the risk of ruin is a kind of barbell strategy. It's a strategy of limited loss and large possible outcome.
   
• More Data, Better Outcome?
  Quit contrary to what we as actuaries would expect, Taleb explains in his book Antifragile that the more data you get, the less you know what’s going on, and the more iatrogenics (damage from treatment in excess of the benefits) you will cause.

Finally

Some risks are simply too small or too big to Tail. Try to approach them in an Antifragile way.....

Although the new insights and theories of Taleb are quit appealing, there's still a lot of work to do to make it work in practice.

Fortunately, you may read Taleb's book Antifagile online, or simply download it.

Enjoy!

Download (PDF) Taleb's Book Antifragile

Taleb Links

- Homepage Taleb

- Taleb on Twitter

- FT Interview Taleb (2013)

- Taleb's Rules

- Convexity, Robustness and Model Error inside the FourthQuadrant

- http://www.fooledbyrandomness.com/

- Understanding is a poor substitute for convexity (Antifragility)

- Why Taleb is wrong

- Financial Times: The Inventory: Nassim Nicholas Taleb

- The difference between long gamma and short gamma

Other Link

- Presentation by Jos Berkemeijer: Actuaris from Backroom to Boardroom

Elderly Pension Income Funding

One of the main issues in our aging-society is to achieve an adequate retirement income level for the elderly.

A recently published OECD report called 'Pensions at a Glance 2013' gives a detailed insight in how we are doing.

OECD's report analysis a lot lot of interesting 'pension income' and 'poverty-index' developments. In this blog we'll focus on the relatively income of elderly people as a percentage of the national mean income of the total population .


Relative incomes of people 65-years and older
Let's take a look at the relative incomes of people 65-years and older, per country, in the 'late 2000s' (2007-2010):

Although the OECD-average income level (86.2%) of elderly as a percentage of the national mean income of the total population of a country is (surprisingly?) quite high, there are still some countries, like Australia (65.4%) at the bottom where you wouldn't expect them.....

Elderly: Sources of Income
The next graph makes perfectly clear in which countries the elderly still have to work for the main part of their income.

A lot of countries where people don't have to work for their income depend on a substantial (often not capital funded) public pension system. They are 'at risk' as ageing increases in the next decades.

Relatively robust elderly income countries are countries like The Netherlands, Canada and Israel, where elderly people have a substantial part of their income funded by private pensions or non-pension saving returns.

For more interesting conclusions, download the OECD report.

Links/Sources:
- OECD Pensions at a Glance - Jantoo Cartoons

Are Health Expenditure & Life Expectancy Related?

Does life expectancy depends on how much is invested in in Health?
'Of course' one would say as a first response. But on second thought the relationship between healthcare and life expectancy is rather complex:

• More basic healthcare improves the quality of life and therefore life expectancy
• However, countries with relative bad health conditions urge for relative extra investments in health that at first do not directly pay back in extra  life expectancy
• Developed countries that invest a lot in health might invest more than is needed for an optimal life expectancy

Let's take a look at the last available (2011) Top-20 figures:

As discussed, the relationship between Health Expenditure (HE) as a percentage of a country's GDP from a global point of view, is not directly related to Life Expectancy (LE) at birth in a specific country.

Healthcare Investment Optimum?
If you could speak of a HE-optimum, it would be somewhere around 10,6%.
Higher Health Expenditure costs than 10.6% do not seem to contribute to an increase in life expectancy.

Let's conclude with an interactive chart from Tableau Public:

Learn About Tableau

Sources/Links/Downloads
- Health expenditure, total (% of GDP)
- Life expectancy at birth, total (years)

Not-Working Rate instead of Unemployment Rate

The unemployment Rate in the United States decreased from 7% in November of 2013 to 6.7% in December of 2013.  Good news! Or not?

Unfortunately the unemployment rate is not a beatific 'economy health indicator'.

How come?

Unemployed who no longer search for a job are not 'counted in'.

Do we have a better labor economy health indicator?

An index that would probably be better related to the health of the U.S. economy would be something like the 'Not-Working Rate', implicating the partition of all the people (age 16 or above) that are not working, divided by the number of people that potentially could work.

In fact we can define the 'Not-Working Rate' more or less as 100% minus the 'Employment-population rate'.

'Not Working Rate' = 100% - 'Employment-population rate'

According to chief North American economist for Capital Economics Paul Ashworth,, the employment population ratio is one of the best measures of labor market conditions. This ratio is a statistical ratio that measures the proportion of the country's working-age population (ages 15 to 64) that is employed, inlcuding people that have stopped looking for work.

Enough index-talk discussions... let's look at the Not-Working Rate outcomes.

Not-Working Rates 1948-2013
Let's compare the Not-Working (NW) Rates with the Unemployment  (UE) Rates.

The next chart clearly shows that the NW-Rates are about 4 times the UE rates.
In other words: Unemployment is only a small part of 'Not Working'......

Not-Working Rates 2000-2013
Let's zoom in to the development of the 2000-2013 rates.

Now it becomes clear that the UE Rate keeps up with the NW Rate approximately until the UE Rate in October 2009 hits the 10% ceiling. After that (coincidence?) the UE Rates starts a spectacular downfall from a 10% to a 6,7% level at the end of 2013. However the percentage of people that are not working stabilizes around 41.5% and doesn't  decline!

Let's zoom in to detect this remarkable development..

Conclusion
I'll leave the detailed conclusions up to you.
My main advice is to introduce the 'Not-Working Rate' as an indicator for the labor health of the U.S. economy.

Despite all this labor math, let's hope and pray that people find a job and that the U.S. economy recovers!


Sources/Links:
- BLS Employment-population ratio
- BLS Unemployment rate
- Wikipedia Employment-to-population ratio
-  Actual U.S. Unemployment Rate
- Cartoon

Transparency in a World of Bribery?

To create a world that is less vulnerable to systemic risk, it's important that financial markets become more transparent.

One of the main issues in becoming transparent is the fact that there's still a lot of corruption in the world.

According to 'Transparency International', more than 1 in 4 people around the world report having paid a bribe.

The Netherlands
Even in a  perceived 'low bribery country' as The Netherlands, bribery is a serious issue that still isn't seriously approached. According a OECD report, The Netherlands is failing to vigorously pursue foreign bribery allegations and must do more to enforce its foreign bribery laws.

Fourteen out of 22 foreign bribery allegations have not triggered the opening of an investigation, calling into question the Netherlands’ ability and proactivity in investigating and prosecuting theses crimes.

Transparency Rules
It's useless to set up (financial) transparency rules (like in EMIR) if bribery is still a substantial part of our culture.

The 'Corruption Perceptions Index 2013' shows that even in countries where one would expect a low corruption rate, there's still a lot to improve. Despite of all actions and intentions: worldwide corruption still increases. Therefore it's time for action:

Words must be backed by action

The Corruption Perceptions Index scores 177 countries and territories on a scale from 0 (highly corrupt) to 100 (very clean). Not one country has a perfect score. Two-third of all countries have a score below 50. This indicates a serious, worldwide corruption problem. Hover on the map above to see how your country fares.




What follows are the more detailed scores in a complete list of all countries. Just Scroll down to your own country to find out there's still room for improvement.




Finally 
It will not be easy to achieve an adequate transparency level in a world full of Bribery. Let's discuss what we - actuaries - can do to stimulate integrity and accountability, as these values are crucial to a more risk free world

Relevant links and Sources
- Institutions perceived by respondents to be among the most affected by corruption 
- Complete Oversight of Indexes
- Corruption by TOPIC
- OECD: Netherlands must significantly step up its foreign bribery enforcement
- Bribery Report The Netherlands

Happy 2014 !!!

Happy New Year to all Actuary-Info Readers!!

May 2014 become a fabulous Risk Management Year.

Wonderful Art by Rob Gonsalves ("Deluged").

 Link: Rob Gonsalves

What's your Pension Fund Confidence Level?

In my last blog I discussed the relationship between 'Fund Ratio' (FR) and 'Confidence Level' (CL), mainly for Dutch pension funds.

Some bloggers asked me to visualize this FR-CL relationship also for some other important pension countries.

From a Tilburg University thesis (2010) we can make a comparison. Not for all pensioen funds, but at least for some major public sector pension funds.

Here it is!

Although Dutch pension funds are still discussing whether they should cut existing pension rights or not , US and UK public sector pension funds still believe that as bad dreams have become reality, miracles can also happen!

"No!", my English business friend answered me, "I don't believe in miracles, I rely on them!" .

  

It still sounds as in the good old days, it's just the view that differs.....

Relationship Confidence Level & Funding Ratio

Dutch Pension funds constantly keep their members informed about the development of the funding ratio. But actually..., what is the confidence level that belongs to a certain funding ratio?

The answer to this question varies greatly by pension fund. To create some sort of insight in the relationship between the Funding Ratio (FR) and confidence level, we will discuss a highly simplified, but certainly realistic example.

Confidence and Equity
The required confidence level for Dutch pension funds is anchored in the Dutch Pension Act (Pensioenwet), at a 97.5 %  level.

Article 132 , paragraph 2 of the Pension Act  states:
A pension fund will set the regulatory own funds so that the probability of the pension fund having 
less assets at its disposal than the amount of the Technical Facilities (TF) within a year is reduced to 97 1/2 %

Funding ratio
Under the Dutch Pension Act, the required one-year confidence level of 97.5 % is directly related to the Regulatory Own Funds (ROF) and thus to the Required Funding Ratio (RFR). In a simplified formula stated: RFR = (ROF + TF) / TF.

At higher funding ratios than the RFR, the actual confidence level will be more than 97.5 % and vice versa: if the actual funding ratio is lower than the RFR, the corresponding confidence level will be less than 97.5%.

In practice, calculations show that the required funding ratio of most Dutch pension funds has an outcome somewhere between 120% and 130% .

Funding Ratio and Investment Risk
The fluctuation of the funding ratio depends largely on the investment risk that a pension fund is willing to take. Netherland's largest pension fund, ABP, adopted an investment policy that aims at roughly 40% fixed income and 60% equities. This policy resulted in the next yield and 5-year backward moving annual volatility (risk) :

The average ABP annual return over the past 5 years was about 5 % with a volatility of 15.9%.

Volatility Funding Ratio

The volatility of the funding ratio depends not only on the volatility of investments, but also on the volatility of the discounted liabilities. In the Netherlands, liabilities are discounted at a risk-free rate, with help of the so-called 'ultimate forward rate' (UFR).

On balance, the ABP's annual funding level volatility over the past 10 years turns out to be approximately 17 % .

This percentage has the same order of magnitude as the annual funding level volatility of an average pension fund in the Netherlands .

As the funding volatility has the same order of magnitude as the investment volatility, we may conclude that the confidence level that corresponds to a certain funding ratio is mainly determined by the investment risk .

To get sight at the 'one year confidence level' for various funding levels, please take a look at the the next chart that's based on a highly simplified approach. We do not seek exactness, but want to get an impression of the confidence sensitivity. Therefore, we abstract from the additional volatility effects that may arise from other risks (like liabilities and expenses ). The calculation is performed for two different risk strategies of a pension fund :

1. The 'current risky' investment strategy with an expected investment volatility of 15 %
2. A 'risk-averse' investment strategy with an expected investment volatility of 4%

Here are the results :

On the basis of graph above a first serie of important conclusions can be drawn:

• A 100% funding ratio corresponds with a 50% confidence level
• If the funding ratio exceeds 100%, the 'current risky' investment strategy results - as expected - in a lower confidence level than a risk-averse strategy.
• Although perhaps at first sight surprising, the reverse is also true:
  If the funding ratio falls to a level less than 100% , a risky investment strategy results in a higher confidence level than the 'risk-averse' investment strategy. And this is exactly the situation in which a number of Dutch pension funds, but also many foreign pension funds, are in.

To draw some more specific conclusions, we zoom in on the graph:

Now, a second set of interesting conclusions becomes visible:

• Required Funding Ratio
  The 'current risky' investment strategy of Dutch pension funds in combination with the legally required confidence level of 97.5 %, urges a funding ratio of about 130 %.  In a risk-averse strategy the required funding ratio would be somewhere around 110 % .
   
• Actual Confidence Level
  A legally required confidence level of 97.5% with a funding ratio of 110% for a risk-averse fund would result in an actual confidence level of about 75% in case of a risky investment strategy .
  As most Dutch pension funds have adopted a risky investment strategy, the actual average confidence level is about 75% in case of a 110% funding ratio and about 50% in the case of a 100% funding ratio.
   
• Maximum Confidence Level Decline?
  There's a maximum decline of 24% in confidence level in case of a transition from a risk-averse to a risky investment. The maximum decline corresponds with a funding ratio of approximately 108%.
   
• Indexation Potential?
  The current average funding ratio of Dutch pension funds fluctuates around 100%. This implies that as far as future actual annual returns result in an excess return above the required return on liabilities, this so-called 'excess-return' should first be used to achieve the required funding ratio of about 130%.  In most cases this leaves no room for indexation in the coming 10 years.
   
• Partial Indexation?
  It's quite common to apply 'partial indexation', above a 105% funding ratio. However, if the actual funding ratio is still below the minimum required confidence level (of 130%), "partial indexation" lowers the funding ratio and diminishes the recovery-rate. In this case, the (partial) indexation policy should be tested for feasibility. The expected return minus the (future expected) indexation and minus the required return on liabilities, should be sufficient to grow to the required funding ratio of 130% within the statutory recovery period of 10 years .

Solvency II to pension funds ?
Finally, we zoom in on the possible introduction (IORP legislation) of a required 99.5% confidence level, as is valid for insurers under Solvency-II:

A final set of key conclusions now becomes visible :

• Solvency II
  Increasing the current confidence level of 97.5 % (Pensions) to 99.5% (Solvency II ) implies an increase of the required funding ratio from 110% to about 113% for risk-averse pension funds and an increase from 129% to 139%  for pension funds with a (current) risky investment policy.
   
• Unrealistic Solvency-II Growth Path
  Based on the current average funding ratio of around 100%, pension funds should be able to climb to a funding ratio of around 139% within a (statutory limited) 10 years period to reach a Solvency-II confidence level of 99,5%. I think most of us will agree that this is a complete unrealistic scenario. In this case pension funds will ultimately be forced (by the regulator) to de-risk their investment portfolio. De-risking will result in lower (expected) returns and further loss of indexation potential.  Implementing Solvency-II requirements will turn pension funds into 'nominal pension insurers'.
   
• Basel
  Confidence levels in the financial markets seem to know no end. If, in the long term, the confidence level requirement of 99.9 % ( Basel banking regulations requirement) should become obligatory for pension funds, things would really get out of hand. In this case, the funding ratio requirement would increase further to 116 % ( risk-averse strategy ) or even 147 % ( risky strategy).
   

Reflection
The question is whether it's wise to judge pension funds with long term liability structures and corresponding investment policies, on basis of a one-year 97,5% confidence level. It would probably be more realistic and practical to scale up to a 99.5 % confidence level on basis of a 5 or 10-years period:

Illustration: In case of a portfolio with a 15% risky investment strategy, the 5-year average 99.5 % confidence level would lead to a required funding ratio of 118 % .

Conclusions
Based on the global approach above, the following conclusions can be drawn:

• The actual confidence level of Dutch pension funds is far below the (statutory) required confidence level of 97.5 %. For pension funds with a risky (= 15% volatility) investment strategy and a funding ratio between 100% and 110%, the actual confidence level varies from 50% (at a 100 % funding ratio) to 75%  (at a 110 % funding ratio).
   
• There's only very limited indexation potential for pension funds with a funding ratio between 100% and 130 %, due to the obligation to grow the actual funding ratio (with priority) to the statutory required level (130%).
   
• Introduction of an IORP risk framework based on a Solvency-II confidence level of 99.5% would imply that pension funds are forced to de-risk their portfolio. De-risking will result in lower (expected) returns and further loss of indexation potential. Implementing Solvency-II requirements will turn pension funds into 'nominal pension insurers'.
    
• Due to their long-term obligations and corresponding investment strategies, pension funds can be more adequately controlled and steered on basis of a five-year average 99.5 % confidence level, instead of the actual one-year 97.5% confidence level.

Blog-Disclaimer
The calculations and conclusions in this blog are very rough approximations which by definition do not apply to an individual pension fund and are only intended for discussion purposes. Please consult your own pension fund if you are interested in the confidence level results regarding your own pension fund. In this case don't forget to ask your pension fund to report according the template style of this blog!

Aftermath: International Funding Ratios Comparison
The funding ratio's and mentioned statutory requirements in this blog are based on the actual situation in the Netherlands. Funding ratio's in other countries vary considerably!

In an excellent rare Netspar thesis  (2010) the diverse funding ratios of public sector pension funds are compared regarding three kinds of Methods:

1. Reported Ratio: Funding ratios officially reported by each scheme.
2. Fair Value: This method, inspired by Dutch plans, uses a market discount rate to account for pension liabilities. Dutch pension industry refers discount rates to nominal swap rates since the market of government bonds is not deep enough for the industry. 30-year nominal swap rate, which roughly has the same duration of 15 years as a typical pension fund, is used as the market discount rate for nominal liabilities
3. Expected Return: This (actuarial) method, following the U.S. practice, is based on an assumed discount rate of 8% which reflects the American’s expectation of annualized long term pension asset return.

Here are the results:

For example: if you would like to compare the Netherlands with the US on basis of Fair Value (the Dutch mandatory method), the funding ratio of the US would be 31% compared to around 90% in the Netherlands. Please keep this in mind if you examine the above charts in this blog!

But let's stay optimistic about US pension funds, the funding ratio ofl US corporate plan's is already rising!

US Pension Fund Fitness Tracker

Find out what your actual pension confidence level is!!!


Used Links & Sources
- Dutch Pension Act (in English)
- Advisory Report of the UFR Committee
- A fixed UFR, a costly mistake?
- Long duration bond benchmarks for U.S. corporate pension plans
 - Netspar Thesis (2010): What Explains the Diverse Funding Ratios..
- US Pension Fund Fitness Tracker

Country Corporate Tax Competition Market

The global competition on corporate tax rates is 'on'.

More and more countries use corparate tax as an instrument to attract international companies to stimulate economic growth in their country.

Let's suffice with a sectional view of some remarkable corporate tax outcomes and developments on basis of KPMG's excellent Corporate Tax Oversight.

I'll leave the interpretion up to you.

	Corporate Tax Rates in Year
Location	2006	2007	2008	2009	2010	2011	2012	2013
Top-3 Max. Corp. Tax
United Arab Emirates	55,0%	55,0%	55,0%	55,0%	55,0%	55,0%	55,0%	55,0%
United States	40,0%	40,0%	40,0%	40,0%	40,0%	40,0%	40,0%	40,0%
Japan	40,7%	40,7%	40,7%	40,7%	40,7%	40,7%	38,0%	38,0%
Region Average Corp. Tax
Global average	27,5%	27,0%	26,1%	25,4%	24,7%	24,5%	24,4%	24,1%
OECD average	27,7%	27,0%	26,0%	25,6%	25,7%	25,4%	25,2%	25,3%
Europe average	23,7%	23,0%	22,0%	21,6%	21,5%	20,8%	20,4%	20,6%
North America average	38,1%	38,1%	36,8%	36,5%	35,5%	34,0%	33,0%	33,0%
Asia average	29,0%	28,5%	28,0%	25,7%	24,0%	23,1%	22,9%	22,5%
Europe: Competition
Switzerland	21,2%	20,6%	19,2%	19,0%	18,8%	18,3%	18,1%	18,0%
Netherlands	29,6%	25,5%	25,5%	25,5%	25,5%	25,0%	25,0%	25,0%
Italy	37,3%	37,3%	31,4%	31,4%	31,4%	31,4%	31,4%	31,4%
Sweden	28,0%	28,0%	28,0%	26,3%	26,3%	26,3%	26,3%	22,0%
Ireland	12,5%	12,5%	12,5%	12,5%	12,5%	12,5%	12,5%	12,5%
United Kingdom	30,0%	30,0%	30,0%	28,0%	28,0%	26,0%	24,0%	23,0%
Germany	38,3%	38,4%	29,5%	29,4%	29,4%	29,4%	29,5%	29,6%
Non-Europe: Competition
China	33,0%	33,0%	25,0%	25,0%	25,0%	25,0%	25,0%	25,0%
Kuwait	55,0%	55,0%	55,0%	15,0%	15,0%	15,0%	15,0%	15,0%
Greece	29,0%	25,0%	25,0%	25,0%	24,0%	20,0%	20,0%	26,0%
Indonesia	30,0%	30,0%	30,0%	28,0%	25,0%	25,0%	25,0%	25,0%
Israel	31,0%	29,0%	27,0%	26,0%	25,0%	24,0%	25,0%	25,0%

Global Oversight
Here's the complete global oversight of Corporate Tax Rates in 2013.

Learn About Tableau

More information about 'individual income tax rates' is also available at KPMG.

History

The corporate tax rates competition is not just a last decade issue.

Ever since the eighties of the last century, corporate average OECD tax rates declined.

Only the US, as the world's strongest economy (but for how long?), could affort it to stay at a traditional more or less constant 40% tax level from 1987 to 2013.

Finally

Of course, as we all know, big 'smart' companies like Goole hardly pay any tax...
Famous is the so called "Double Irish Dutch Sandwich"

Source KPMG Tax

Links:

- Monitoring the OECD’s Campaign Against Tax Competition

- US senator deems Ireland the ‘Holy Grail of tax avoidance’ 

- iTax Avoidance 

- OECD Tax Reforms in time

- US Officially Has Highest Corporate Tax Rate In The World