Pension Fund Coverage Ratio Analogy

Let's compare driving your car with managing a Pension Fund. Are you ready?

You, the Car Driver Suppose you plan a trip from New York to Washington, about 200 miles, in a tight time schedule of four hours . You're know your car's average fuel consumption is on average about 25 miles per gallon and your dashboard computer tells you, you've got 10 gallons left in the tank. Simple mental arithmetic shows you'll finish in Washington without any major 'out of gas'  problem if you keep your average fuel consumption above a rough 20 miles per gallon. You tell your partner, who's next to you in the car, you're quite sure (97.5%) there's enough gas left for Washington. Suddenly - your half way climbing a small hill - your Miles Per Gallons (MPG) Meter drops from 25 to 13. A bit worried you take a look at the Average MPG Trip Meter on your dash board computer that shows an average of 35 miles per gallon on the first 100 miles. You conclude there's no problem or real gas shortage issue to be expected and decide to keep checking your dashboard every 5 minutes to find out how the Average MPG develops. Your partner, who's not familiar with driving a car or arithmetic exercises, tells you to stop at a gas station immediately and to end this silly arithmetic game. You - quietly - explain that there's no need to go to a gas station and if you would go to a gas station, the two of you will be late on your appointment in Washington. You tell her that you'll take no direct measures and have decided to look for a gas station if your average GPM meter shows a 25 gallons per mile. Your partner is satisfied and you continue your trip. Problem solved.

You, Pension Fund CEO Suppose you run a 30 year old Pension Fund and your target is to keep a save coverage ratio of 125% on the long run. The outcome of intense and professional Risk Modeling, ALM studies, VaR analyses, FIRM approach and other sound risk techniques, has concluded in an agreed asset mix, implicating that daily coverage ratio's may vary (97.5% CI) between  65% and 185%, corresponding with an average long term coverage ratio of 125%. Suddenly, exactly at the Pension Funds 30th  birthday, interest rates collapse.... Your Dashboard's Daily 'Pension Fund  Coverage Ratio' (PFCR) meter shows a surprising meltdown to 65%! All pension board members look worried. They take a look at the '5 years Average Pension Fund Coverage Rate Meter' at their Dashboard. This meter  shows a trustful 132%. You and your board conclude there is no urgent or substantial problem of  shortage on the long run. Problem solved!, one would think. Unfortunately: No!. At this point the Supervisor starts interfering. The Supervisor is worried and orders the Pension Board to develop a recovery plan outlining measures on how the pension fund will restore minimum funding requirements within a five-year time frame. This Recovery Plan (RP) was not included or part of the original  strategic risk management plan as foreseen. The extra costs of executing this RP and the effects of reallocating the assets to a lower risk position, result in a lower return of the pension fund on the long run with a lower coverage ratio than the original 125% objective average. The pension fund was forced to improve the short term (daily)  coverage ratio a little bit at the cost of substantially lowering the coverage ratio on the long run. Congratulations!

Conclusions...
It's clear that ...

• Pension Funds shouldn't be managed just on daily coverage ratio's, but more on 5 or 10  years average coverage ratios.
  
  
• Demanding recovery plans after a disappointing 'two year coverage ratio' is not wise and damages the long term objectives and financial results of the pension fund.
   
• In case of  long term (more than 5 years) failing coverage ratios, there's enough time to take measures to redefine the Pension Fund's strategy and funding policy. The same applies for interest rates, returns and other Dash Board parameters, excluding liquidity scores.
   
• Much more than banks, Pension Funds are financial institutions with mainly long term obligations and should therefore mainly be managed, controlled and supervised by "long term" score card parameters.

Therefore, Supervisors should change their Risk Management philosophy as well as their control policy on this subject. Supervisors should redefine dash board parameters and only demand recovery plans in case of more than five year consequently failing coverage ratio's.

Related Links
- GN26: Pension Fund Terminology (pdf)
- Coverage ratio Dutch pension funds.png
- ABP assets up, but funding ratio down
- Fuel Convert
- New York Senate passes gallons per mile bill
- GPM psychology

- Volvo Penta (Meter)

Spanish Risk Management

Why does Europe support Greece with a bailout? And why will Europe support other PIGS countries when they get into trouble as well?

Greece

It all started with Greece.
After Greece joined the Euro (2001),  it became clear that the Greek government lied about its deficit, the Greeks simply 'cooked their books'.

Unfortunately there's no way back. The Greeks held us by the hand in their 'systemic dance'.  Ancient Greeks always believed that dancing was invented by the Gods. The Spartans not only danced before battles, they also fought with rhythmic movements to the strains of flutes. And so, still it is in the year 2010.

Spain
Let's dive a little deeper and ask ourselves the question why the EU needs to help Spain out, once it gets into trouble.

ING
Just have a look at ING Bank, as a simple example.
In 2010 ING has a € 41.3 billion (total) exposure to Spain. That's 124% of their equity.

It's clear, despite of all effort in explaining and defending an excellent (?) risk policy in their 2009 annual report,

ING Risk Management Fails

Even an amateur in Risk Management and Diversification can tell you blind-sighted, that a single country exposure exceeding ING's total equity is a major and unacceptable risk.



What about the Dutch regulator?
This ING debacle also implies that Dutch supervisor DNB has failed as well. DNB did not notice the 'exposure mismatch' in ING's 'Spanish Risk Management' adventure.

If DNB continues 'checking boxes and formulas' while warning the whole world about every detailed risk, instead of using common sense, keeping an eye on the headlines and demanding adequate actions, the future of Financial Institutions will remain at risk. The control approach and attitude of DNB has to be fundamentally revised.

Other European Banks
Back to the banks. Although 'Exposure Lader Spain', ING turns out not to be the only bank at risk.

Just have a look at Deutsche Bank (DB). At first Deutsche bank stated that the exposure to Greece was 'very limited' and that they had 'no comment on others'.

On May 25, 2010 the DB CEO stated he has 500 million euros exposure to Greece in sovereign loans and debt and DB has no sovereign exposure to Spain and Portugal.

As we can conclude from a EVO Research report, these statements are simply not true.


Conclusion
It's clear that European Banks are not transparent about their exposures. They're hiding and mis-communicating information.

Thanks to the bailout and financial support of the European government, European banks are (temporarily) saved (by the bell).
Key Question: For how long?????

 Related Links / Sources:

- Complete European banks exposure to Spain

- Youtube: Espeluznante cogida a Julio Aparicio en Las Ventas en el cuello 

- Greek debt crisis a hazard for EU 

- Greece : dance history 

-  ING annual report 2009

Bank on the Run

Let's dive into the development of banking failures......

How many banks are on the run?

FDIC
The Federal Deposit Insurance Corporation (FDIC) is an independent agency created by the Congress to maintain stability and public confidence in the nation's financial system by (1) insuring deposits, (2) examining and supervising financial institutions for safety and soundness and consumer protection, and (3) managing receiverships.

Just have a look at the reported (half May 2010) FDIC Bank Failures (words don't apply):

Things ain't getting better, I'll leave a 2010 Bank Failure forecast to the imagination of your actuarial mind.

Let's hope for the best...

"Thought of giving it all away
To a registered charity
All I need is a pint a day
If I ever get out of here
If we ever get out of here"

Related Links/ resources:
- The Big Picture: FDIC Bank Failures (5.15.10)
- FDIC Failure Stats