Oct 3, 2010
Investment Strategy: The Price of Doubt
Most actuaries have seen it happen: A perfect designed investment strategy......., turning into a real nightmare. How could it come that far? What happened?
Life of an actuary...
Let's dive into a real life simplified actuarial case....:
As the actuary of your company, you've developed a perfect ALM study. Together with the head of the investment department, you've been able to convince your Board of the new developed 'Investment Strategy'. A consequent mix of 50% Bonds and 50% stocks, resulting in an average expected 6% return on the long term, turned out to be the best (optimal) investment mix given the risk appetite of your Board and the regulatory demands. All things are set for execution.
Now let's see how your strategic plan would develop (scenario I) and how it would probably be executed by the Board (scenario II) over the next ten years.
Although your investment strategy plan was designed on a rational basis and the execution of this plan was also intended to be a rational process, in practice they are not.....
Let's follow the discussion in the Board from year to year...
You sleep well that night.
You are defending your Asset Liability Model to the grave, but after extensive discussions all board members agree that a slight 'temporary' adjustment to 70% stocks and 30% bonds would be 'worth the risk' to profit from this high stock return. With great reluctance, you agree....
You - as the responsible actuary - warn again, but the facts are against you. Disappointed and misunderstood you return to your office as the President of the Board tries to cheer you up by thanking you for your 'constructive response' in the board meeting. You abstain from joining the festive Board Party that evening.
The board meeting this year is chaotic. Some members support you as the 'responsible actuary' to readjust the asset mix to the original mix of 50/50%. Others argue that this stock dip is only temporary and that this year's average return is only 0.8% lower than would have been achieved with a 50/50% mix. On top of, most members strain that this year's 0.8% negative return is still lower than the 2.2% positive difference of last year. After two stressful board meetings, the Board decides to stick to their 70/30% investment mix.
The board president's eye fails to meet you, as you leave the board room that night.
Some Board members fear that if stock prices will be down for another few years, the average 'needed' return of 6% will not be met. They doubt the current strategy.
Also the Regulator and some Rating Agencies insist on higher confidence and solvency levels with corresponding measures to be taken. Both are not positive and doubt the outlook on stock returns on the long term...
After a long meeting that night, the Board chooses for reasons of 'savety' (!) to adjust the asset mix to 30/70% in favor of the still 4% stable performing Bonds (Better something than nothing (!) ).
Again... you explain that night, that changing the asset mix following actual market performance, is the worst thing a company can do.... But again, you lose the debate.
The power of emotion is greater than the power of rationality. Now not only the Board seems against you, but the Regulator as well. Who wants to fight that! After all, 'ethical' rule number one is 'complying with the Regulator'. That evening you brainwash yourself and reprogram your attitude to 'actuarial follower' instead of 'actuarial leader'.
After two Johnnie Walkers you see the future bright again and seem ready for the new year.
Year 8
To everybody's surprise stocks performed extremely well at 25% this year. As a result the average return reaches a satisfying performance of 10.3%. With 'mixed feelings' board members take notice of the results. What nobody dears to say and everybody seems to think is: 'Had we stuck to our 70/30% asset mix, the performance would have been: 18.7% (!)......'
The Board President cautiously concludes that the Board took the right decision last year, leading to a proud 10.3% return this year. Compliments to everyone, including the actuary! Supported by your 'converted' mind, the 30/70% asset mix is continued. That evening you accept the invitation to the board party. Lots of Johnnie Walkers help you that night to cope with the decisions taken.
Year 10
Stocks returns have come down to a more 'realistic' level of 7%. As a consequence the average return is down to 4.9%, way down beneath the critical level of 6%. Board members have to strike a balance. Some of them doubt again. Continuing the 30/70% asset mix will not bring them the needed long term 6% objective return. Adjusting to a 50/50% mix probably will, but is more risky. What to do?
All eyes are on you as the 'final advising actuary'. With restrained pride you state: "Dear colleagues, what about our good friend, the original '50/50% asset mix'. Can we confirm on that?" Without anyone answering, the President takes a look around.... His gavel hits the table and the decision seems to have been taken.
When you go to bed for a good night sleep, you smile...., as some little voice in your head tells you that next year this madness decade-cycle will probably start again...
Let's dive into a real life simplified actuarial case....:
As the actuary of your company, you've developed a perfect ALM study. Together with the head of the investment department, you've been able to convince your Board of the new developed 'Investment Strategy'. A consequent mix of 50% Bonds and 50% stocks, resulting in an average expected 6% return on the long term, turned out to be the best (optimal) investment mix given the risk appetite of your Board and the regulatory demands. All things are set for execution.
Now let's see how your strategic plan would develop (scenario I) and how it would probably be executed by the Board (scenario II) over the next ten years.
Let's follow the discussion in the Board from year to year...
Year 1
The company's average portfolio return performs according plan (6%). Stocks: 8%, Bonds 4%, on average 6%. The Board concludes they have the right strategy. You, as an actuary, agree.Year 2
Compliments from the Board. Stocks perform even higher (10%), leading to a 7% average return.You sleep well that night.
Year 3
Another fabulous Stock performance year. A stock return of 20%, leading to an average return of 12%! Some Board members start to doubt and question your ALM-model. They are arguing that if stock prices are that high three years in a row, they would like to profit more from this development. They suggest to adjust the asset mix in favor of stocks. Your ALM model should me more flexible. You are defending your Asset Liability Model to the grave, but after extensive discussions all board members agree that a slight 'temporary' adjustment to 70% stocks and 30% bonds would be 'worth the risk' to profit from this high stock return. With great reluctance, you agree....
Year 4
Although the performance of stocks is not as high as the year before, it's still relatively high (15%) and leads to an average return of 11.7%, which is 2.2% (!) higher than the 9.5% return that would have been achieved with a 50/50% mix. The Board concludes that it took the right decision last year, to adjust the asset mix to 70/30%.You - as the responsible actuary - warn again, but the facts are against you. Disappointed and misunderstood you return to your office as the President of the Board tries to cheer you up by thanking you for your 'constructive response' in the board meeting. You abstain from joining the festive Board Party that evening.
Year 5
Stocks are dramatically down to 0%, leading to an average mixed return of 1.2% this year.The board meeting this year is chaotic. Some members support you as the 'responsible actuary' to readjust the asset mix to the original mix of 50/50%. Others argue that this stock dip is only temporary and that this year's average return is only 0.8% lower than would have been achieved with a 50/50% mix. On top of, most members strain that this year's 0.8% negative return is still lower than the 2.2% positive difference of last year. After two stressful board meetings, the Board decides to stick to their 70/30% investment mix.
The board president's eye fails to meet you, as you leave the board room that night.
Year 6
What was most feared, has become true.. A negative stock return of 10%, leading to an average return of -5.8% .... When you walk into the board room that night, all eyes are on you as the 'responsible actuary'. You hold your breath, just like all other board members. After a short moment of silence the board president states that he proposes to bring back the asset mix to the original 50/50% mix. Without further discussion this proposal is accepted. There's no board party this year.Year 7
Negative stock returns have increased to 15%, leading to an average return of -5.5% this year.Some Board members fear that if stock prices will be down for another few years, the average 'needed' return of 6% will not be met. They doubt the current strategy.
Also the Regulator and some Rating Agencies insist on higher confidence and solvency levels with corresponding measures to be taken. Both are not positive and doubt the outlook on stock returns on the long term...
Again... you explain that night, that changing the asset mix following actual market performance, is the worst thing a company can do.... But again, you lose the debate.
The power of emotion is greater than the power of rationality. Now not only the Board seems against you, but the Regulator as well. Who wants to fight that! After all, 'ethical' rule number one is 'complying with the Regulator'. That evening you brainwash yourself and reprogram your attitude to 'actuarial follower' instead of 'actuarial leader'.
After two Johnnie Walkers you see the future bright again and seem ready for the new year.
Year 8
To everybody's surprise stocks performed extremely well at 25% this year. As a result the average return reaches a satisfying performance of 10.3%. With 'mixed feelings' board members take notice of the results. What nobody dears to say and everybody seems to think is: 'Had we stuck to our 70/30% asset mix, the performance would have been: 18.7% (!)......'
The Board President cautiously concludes that the Board took the right decision last year, leading to a proud 10.3% return this year. Compliments to everyone, including the actuary! Supported by your 'converted' mind, the 30/70% asset mix is continued. That evening you accept the invitation to the board party. Lots of Johnnie Walkers help you that night to cope with the decisions taken.
Year 9
Stocks perform at 20%, leading to an 8.8% average mixed return. No Board member dears to raise questions about the possibility of readjusting the asset mix to a 'more risky' (what's that?) one. After all, the overall performance is still higher than the needed 6%. So who may complain or doubt the new 'On the Fly Strategy'? Who cares or who dears? You go to bed early that night.Year 10
Stocks returns have come down to a more 'realistic' level of 7%. As a consequence the average return is down to 4.9%, way down beneath the critical level of 6%. Board members have to strike a balance. Some of them doubt again. Continuing the 30/70% asset mix will not bring them the needed long term 6% objective return. Adjusting to a 50/50% mix probably will, but is more risky. What to do?
All eyes are on you as the 'final advising actuary'. With restrained pride you state: "Dear colleagues, what about our good friend, the original '50/50% asset mix'. Can we confirm on that?" Without anyone answering, the President takes a look around.... His gavel hits the table and the decision seems to have been taken.
AftermathEmatics.......
That night you decide to change Johnnie Walker for a well deserved glass of 'actuarial wine': a simple 'Mouton Rothschild 1945' (at the expense of the Board of course). You enjoy the moment and the pleasure of being an actuary. Even after the Rothschild you realize that the decade price of doubt was high: 0.9% p.a. ... When you go to bed for a good night sleep, you smile...., as some little voice in your head tells you that next year this madness decade-cycle will probably start again...
Sep 26, 2010
Equity Returns and Mean Reversion
One of the most triggering questions - given the current crisis - is:
Mean Reversion
In 2009 the S&P-500 index - as most stock market indices - reached the lowest level since the turn of the century. In less than two years time world stock indices had dropped around fifty percent of their value. Since then, stock indices increased about forty percent.
It's tempting to think that this recovery could have been predicted in advance. This suspected predictable effect of recovering stock prices returning to their long-term average, is called: 'Mean Reversion'.
More explicitly: 'Mean Reversion of stock prices' is the effect that abnormal stock prices gradually return to their long-term historical average or equilibrium price.
Reversion Speed
In a 2010 working paper, the Dutch regulator DNB provides an answer to this question of recoverability. In this paper, authors Spierdijk, Bikker and Van den Hoek analyze 'mean reversion in international stock markets' in seventeen developed countries during the period 1900-2008.
One of the outcomes of this study is not only an interesting country spread between 'mean returns' and volatility (risk, standard deviation), but also a mind boggling country difference in 'reversion speed' (rs). Reversion speed can be defined as the 'yearly interest speed to return to the long-term average. RS differs strongly per country, as the next slide shows:
Ranked by average return (all %):
Looking with a 'actuarial eye' at the volatile annual development of the S&P-500 returns and their moving averages, it's hard to deny some kind of visual proof of an increasing volatile yearly return and a structural declining 10- or 15-years average return.....
This 'visual proof', combined with the results of the 'DNB Mean Reversion paper', is perhaps the best indicator that the future average long term World Stock return of 8% is probably way too optimistic and still includes too much the optimist mood and hope of the last decades of the 20th century...
S&P-500, averages annual returns and inflation 1950-2010
Key question is : What would be a save 'long-term total return of stocks' as a base for an investment strategy, without the 'Hope Bubbles' of the last two decades of the last century?
Probably a long term stock return of about 6% would turn out to be a save basis for a kind of investment reversion strategy......
However, now we know where we are going, it's absolutely necessary to know where we are now? Unfortunately.... we don't know.... ;-)
Sources, related links:
- DNB 2010: Mean Reversion in International Stock Markets
- (Dutch) DNB-2010: Herstel aandelenmarkten is niet vanzelfsprekend
- Wikipedia: S&P-500 Annual Returns
- Simple Stock Investing: S&P-500 historical data
Will equity returns recover?
Mean Reversion
In 2009 the S&P-500 index - as most stock market indices - reached the lowest level since the turn of the century. In less than two years time world stock indices had dropped around fifty percent of their value. Since then, stock indices increased about forty percent.
It's tempting to think that this recovery could have been predicted in advance. This suspected predictable effect of recovering stock prices returning to their long-term average, is called: 'Mean Reversion'.
More explicitly: 'Mean Reversion of stock prices' is the effect that abnormal stock prices gradually return to their long-term historical average or equilibrium price.
Reversion Speed
In a 2010 working paper, the Dutch regulator DNB provides an answer to this question of recoverability. In this paper, authors Spierdijk, Bikker and Van den Hoek analyze 'mean reversion in international stock markets' in seventeen developed countries during the period 1900-2008.
One of the outcomes of this study is not only an interesting country spread between 'mean returns' and volatility (risk, standard deviation), but also a mind boggling country difference in 'reversion speed' (rs). Reversion speed can be defined as the 'yearly interest speed to return to the long-term average. RS differs strongly per country, as the next slide shows:
Reversion conclusions
The DNB study concludes that in the period 1900-2008:- Average Return
The average World Stock Return is estimated at 8.0% with a volatility of 16.7% (S.D.).
- Half-Life Reversion Period (HLRP)
It takes 'World Stock Prices' on average about 14 years to absorb half (!) of a shock (HLRP), with a confidence interval of [10 years -21 years]
- High Half-Life Uncertainty
The uncertainty of the half-lives estimates is very high. This is due to the fact that the lower bounds for the corresponding median unbiased estimators are close to zero. The upper bounds of the confidence intervals for the half-lives are therefore very high.
- Mean Reversion, a Trading Strategy?
The relative low value of the mean reversion rate, as well as its huge uncertainty, severely limits the possibilities to exploit mean reversion in a trading strategy
Concluding Remarks
We should keep in mind that - no matter how well investigated - historical data - as always - only have a limited predictive power.Looking with a 'actuarial eye' at the volatile annual development of the S&P-500 returns and their moving averages, it's hard to deny some kind of visual proof of an increasing volatile yearly return and a structural declining 10- or 15-years average return.....
S&P-500, averages annual returns and inflation 1950-2010
| Price Change | Dividend Distribution Rate | Total Return | Inflation | Real Price Change | Real Total Return | |
|---|---|---|---|---|---|---|
| 1950's | 13.2% | 5.4% | 19.3% | 2.2% | 10.7% | 16.7% |
| 1960's | 4.4% | 3.3% | 7.8% | 2.5% | 1.8% | 5.2% |
| 1970's | 1.6% | 4.3% | 5.8% | 7.4% | -5.4% | -1.4% |
| 1980's | 12.6% | 4.6% | 17.3% | 5.1% | 7.1% | 11.6% |
| 1990's | 15.3% | 2.7% | 18.1% | 2.9% | 12.0% | 14.7% |
| 2000's | -2.7% | 1.8% | -1.0% | 2.5% | -5.1% | -3.4% |
| 1950-2009 | 7.2% | 3.6% | 11.0% | 3.8% | 3.3% | 7.0% |
Key question is : What would be a save 'long-term total return of stocks' as a base for an investment strategy, without the 'Hope Bubbles' of the last two decades of the last century?
Probably a long term stock return of about 6% would turn out to be a save basis for a kind of investment reversion strategy......
However, now we know where we are going, it's absolutely necessary to know where we are now? Unfortunately.... we don't know.... ;-)
Sources, related links:
- DNB 2010: Mean Reversion in International Stock Markets
- (Dutch) DNB-2010: Herstel aandelenmarkten is niet vanzelfsprekend
- Wikipedia: S&P-500 Annual Returns
- Simple Stock Investing: S&P-500 historical data
Sep 21, 2010
Pension Fund Smoke and Mirrors
Pension Funds are in trouble... How come?
Pension Fund Smoke and Mirrors
Related Link
Funds Stick to 'Unrealistic' Return Assumptions, Threatening Bigger Shortfalls
Pension Fund Smoke and Mirrors
Related Link
Funds Stick to 'Unrealistic' Return Assumptions, Threatening Bigger Shortfalls
Sep 11, 2010
Coverage Ratio Solution Space
Dutch pension funds are in deep trouble. The average coverage ratio of many pension funds has fallen to a level well below 100% (underfunded). Some major Dutch pension funds with coverage levels around 90%, called Government to dissuade the planned pension rights cuts.
A delay in pension rights cuts seems justifiable. Key question is the reason for this requested delay. For reasons of reformulating new pension policies and ambitions, delay seems reasonable. With the intention to just 'buy time' in order to continue 'desperate hope' that the markets and low returns will recover, further delay could prove catastrophic.
Although low interest rates and underperforming stock markets could continue for several years, on the long term interest rates and stock markets will most likely recover, simply because economic growth imply higher returns on the long term.
Underestimating The Longevity Monster
One of the 'big' (?) surprises seems the recent development in longevity. For decades now, actuaries and researchers are structurally underestimating the effect of longevity.
Maggid's Longevity Forecast
Although longevity has been studied a lot, a decrease of the steady growth of the human lifespan in the coming decades will most likely turn out to be idle hope....
Lessons learned, we actuaries will seriously have to take into account that the linear increase of lifespan probably will continue until at least the age of 90 (Maggid forecast). This implies that we'll have to 'spice up' our mainly retrospective life expectancy models and corresponding forecasts with a healthy portion of common sense.
Pension funds face the substantial volatility and the low level of the so called "risk free discount rate" that drives the coverage ratio. Paradoxically we could state:
The - artificial - low level risk free interest rate pulls down the coverage ratio of a pension fund.
At the same time it's necessary to level up the existing 97.5% confidence level of pension funds. A 97.5% confidence level implies that a pension fund will turn into default (underfunding) twice in an average person's lifespan.
Despite the fact that a 'twice in a life meltdown' is probably hard to explain to anyone, new upcoming Solvency demands for pension funds will be inevitable in order to create a level playing field on the financial market. Good governance, common sense and upcoming new regulatory initiatives will therefore certainly urge a higher pension fund confidence level like the 99,5% level in the insurance industry (Solvency II) or the 99,9% level in the banking industry (Basel II) .
Sitting Ducks
As is clear from the above image, successfully financing a pension-fund (portfolio) on the long term at the current ambition level, calls - in general - for high (unrealistic) interest rates. The 'solution space' for achieving the necessary high coverage ratios that match the (new) capital requirements appears to be very narrow.
Therefore (there is no other way), most pension funds have to take time and redefine their (future) ambition instead of playing 'sitting ducks' and hoping for the best.
Used Sources, Links:
- Dutch life expectation 2010-2060
- Japanese life expectation: 86.5 years
- Dutch life expectation 2010-2060
- Japanese life expectation: 86.5 years
- Dutch - De risico's van het leven (risks of life) ...
- Will Life Expectancy Continue To Increase Or Level Off
A delay in pension rights cuts seems justifiable. Key question is the reason for this requested delay. For reasons of reformulating new pension policies and ambitions, delay seems reasonable. With the intention to just 'buy time' in order to continue 'desperate hope' that the markets and low returns will recover, further delay could prove catastrophic.
Facing Reality
Pension funds have to cope with several hurricanes at the same time:- Relatively low interest rates
- Underperforming stock market
- Underestimated longevity risks
- Need for higher confidence levels
Although low interest rates and underperforming stock markets could continue for several years, on the long term interest rates and stock markets will most likely recover, simply because economic growth imply higher returns on the long term.
Underestimating The Longevity Monster
One of the 'big' (?) surprises seems the recent development in longevity. For decades now, actuaries and researchers are structurally underestimating the effect of longevity.
Maggid's Longevity Forecast
Although longevity has been studied a lot, a decrease of the steady growth of the human lifespan in the coming decades will most likely turn out to be idle hope....
Lessons learned, we actuaries will seriously have to take into account that the linear increase of lifespan probably will continue until at least the age of 90 (Maggid forecast). This implies that we'll have to 'spice up' our mainly retrospective life expectancy models and corresponding forecasts with a healthy portion of common sense.
What about the 'risk free' discount rate?
More actu(ari)al trouble is caused by the fact of the low interest rates and sticky stock markets.Pension funds face the substantial volatility and the low level of the so called "risk free discount rate" that drives the coverage ratio. Paradoxically we could state:
There's nothing more risky than a 'risk free' discount rate
The - artificial - low level risk free interest rate pulls down the coverage ratio of a pension fund.
At the same time it's necessary to level up the existing 97.5% confidence level of pension funds. A 97.5% confidence level implies that a pension fund will turn into default (underfunding) twice in an average person's lifespan.
Despite the fact that a 'twice in a life meltdown' is probably hard to explain to anyone, new upcoming Solvency demands for pension funds will be inevitable in order to create a level playing field on the financial market. Good governance, common sense and upcoming new regulatory initiatives will therefore certainly urge a higher pension fund confidence level like the 99,5% level in the insurance industry (Solvency II) or the 99,9% level in the banking industry (Basel II) .
As is clear from the above image, successfully financing a pension-fund (portfolio) on the long term at the current ambition level, calls - in general - for high (unrealistic) interest rates. The 'solution space' for achieving the necessary high coverage ratios that match the (new) capital requirements appears to be very narrow.
Therefore (there is no other way), most pension funds have to take time and redefine their (future) ambition instead of playing 'sitting ducks' and hoping for the best.
Used Sources, Links:
- Dutch life expectation 2010-2060
- Japanese life expectation: 86.5 years
- Dutch life expectation 2010-2060
- Japanese life expectation: 86.5 years
- Dutch - De risico's van het leven (risks of life) ...
- Will Life Expectancy Continue To Increase Or Level Off
Aug 24, 2010
Pension Cut Delay Power
The coverage ratio (= A / DFB = Assets / Discounted Future Benefits) is probably seen as the most important indicator of the health of a pension fund. Due to fair value accounting, low interest rates and the continuing credit crisis, the average coverage ratio dropped from 150% to percent to 85-95% in the Netherlands. On basis of the Dutch pension law, Minister Donner and the Dutch Regulator (DNB) are now forcing some (major) pension funds to (unwillingly) cut pension rights as from January 1, 2011.
Cutting pension rights now is premature
Although it looks certain that some major changes in the Dutch pension system will be necessary in the near future, pension cuts like proposed by DNB and the Dutch minister of Social Affairs seem inappropriate and unwise.
Board members like Dick Sluimers (APG/ABP Pension fund) argue that steering and judging a pension fund solely on basis of a 'day to day' (high volatility) coverage ratio is unprofessional. I would agree with Sluimers that a longer term average coverage ratio would be more appropriate to judge whether a pension fund is on the right track...
Looking from a pension board captain's perspective: having just one Coverage Ratio Indicator (CRI) on your pension dashboard is simply not enough to safely navigate your pension ship into the next harbor . Besides the day-to-day CRI and the Average long term CRI, a more dedicated indicator is needed....
Pension-Cut-Delay-Power
Just like in case of a half full tank it's necessary to know the remaining distance and the the gas mileage of your car, in case of navigating your pension fund in heavy weather (i.c. relatively low coverage rates (70-100%)) it's important to know the the Pension-Cut-Delay-Power (PCDP ) of your pension fund.
The PCDP of a fund can be defined as the approximate maximal number of years that a fund is able to delay a required pension cut rate without ending up with a substantial (P%) higher required pension cut rate afterwards. In (an approximating*) formula:
P = Justifiable extra charge (in %) on top of required pension cut rate after PCDP years in case the coverage ratio is still insufficient at the same level as before.
DFB = Discounted Future Benefits (source : annual report)
ABP = Annual Benefit Payment (source : annual report)
Example: Pension Fund Dutch Metal scheme PME
Coverage Ratio ult. June 2010: CR=95%
From the annual report: DFB= €20bn, ABP= € 1bn
Set (choose) P=10%
Pension cut rate (without delay) as of 2011, suppose : PCR= 5% (=100%-95%)
*) approximating: Mature Pension Fund
Outcome:
Pension-Cut-Delay-Power = PCDP = P * DFB / ABP = 0.1*20/1 = 2 year
Pension cut rate (with 2 year delay) as of 2013: 5.5% (=5%*(1+10%))
Of course, the choice of P an PCR is up to the pension board within the limits set by the regulator.
Conclusion
As is clear from the above example, a two year delay relieves pension fund FME from the burden to put all energy, emotion and costs into an operation with minimal financial effects in the next two years, while at the same time it puts FME in the position to develop a new policy and new models to cope with the new market situation.
It's time for new pension dash board parameters like PCDC.
Actuaries are in the unique position to help pension fund members to regain control. Pick up your responsibility.
Related Links & Sources:
- PF APG (ABP) boss Dick Sluimers on the volatility of coverage ratios (2009)
- Dutch CPB: Who bears the pension loss?
- The great recession. CPB about the credit crisis
- Approximation PCDP Formula
Cutting pension rights now is premature
Board members like Dick Sluimers (APG/ABP Pension fund) argue that steering and judging a pension fund solely on basis of a 'day to day' (high volatility) coverage ratio is unprofessional. I would agree with Sluimers that a longer term average coverage ratio would be more appropriate to judge whether a pension fund is on the right track...
Looking from a pension board captain's perspective: having just one Coverage Ratio Indicator (CRI) on your pension dashboard is simply not enough to safely navigate your pension ship into the next harbor . Besides the day-to-day CRI and the Average long term CRI, a more dedicated indicator is needed....
Pension-Cut-Delay-Power
Just like in case of a half full tank it's necessary to know the remaining distance and the the gas mileage of your car, in case of navigating your pension fund in heavy weather (i.c. relatively low coverage rates (70-100%)) it's important to know the the Pension-Cut-Delay-Power (PCDP ) of your pension fund.
The PCDP of a fund can be defined as the approximate maximal number of years that a fund is able to delay a required pension cut rate without ending up with a substantial (P%) higher required pension cut rate afterwards. In (an approximating*) formula:
PCDP = P * DFB / ABP
With:P = Justifiable extra charge (in %) on top of required pension cut rate after PCDP years in case the coverage ratio is still insufficient at the same level as before.
DFB = Discounted Future Benefits (source : annual report)
ABP = Annual Benefit Payment (source : annual report)
Example: Pension Fund Dutch Metal scheme PME
Coverage Ratio ult. June 2010: CR=95%
From the annual report: DFB= €20bn, ABP= € 1bn
Set (choose) P=10%
Pension cut rate (without delay) as of 2011, suppose : PCR= 5% (=100%-95%)
*) approximating: Mature Pension Fund
Outcome:
Pension-Cut-Delay-Power = PCDP = P * DFB / ABP = 0.1*20/1 = 2 year
Pension cut rate (with 2 year delay) as of 2013: 5.5% (=5%*(1+10%))
Of course, the choice of P an PCR is up to the pension board within the limits set by the regulator.
Conclusion
It's time for new pension dash board parameters like PCDC.
Actuaries are in the unique position to help pension fund members to regain control. Pick up your responsibility.
Related Links & Sources:
- PF APG (ABP) boss Dick Sluimers on the volatility of coverage ratios (2009)
- Dutch CPB: Who bears the pension loss?
- The great recession. CPB about the credit crisis
- Approximation PCDP Formula
Aug 10, 2010
Humor: Actuarial Advice Route
Actuaries have a great job. Giving actuarial advice has become 'boardroom art'.
Although actuarial device differs as much as actuaries differ, the route of actuarial advice is - not surprisingly - mostly the same....
Keep enjoying your job as an actuary!
Although actuarial device differs as much as actuaries differ, the route of actuarial advice is - not surprisingly - mostly the same....
-- click to enlarge picture --
Keep enjoying your job as an actuary!
Aug 9, 2010
Pension Fund Development
Pension Funds....What originally started with well-meant intentions, has developed to one of the most complex risk management topics and will end in a nightmare if we don't change our risk management approach drastically and fast.
Pension Fund times have changed
Back in the second half of the twentieth century, Pension Funds were an excellent (HR)-instrument to stabilize employer-employee relationship and keep retention high. Since then, a lot has changed:
But there's more... Surreptitiously, like the famous 'boiling frog', the (member) composition of a pension fond has fundamentally changed during the last decades.
Some decades ago, at the start of a Pension Fund, almost all participants where existing employees of the corresponding company (sponsor). Today, the number of 'current employees' is often overshadowed by the number of 'pensioners' and the - until now - quiet force of 'deferred pensioners' (former employees, that left the company before retirement).
Managing Pension Fund Powers
All Pension Fund concerned parties, the three member-groups as well as the employer (sponsor), have different and sometimes opposite interests with regard to the financial policy of the Pension Fund. The tension between these parties with regard to what's best for the employer, the employees, pensioners and deferred pensioners, will therefore increase as the Pension Fund becomes more mature.
The first step to manage this tension is to redefine Pension Fund Governance in line with the changed balance of power. Skipping this governance step seems not wise, as this will undoubtedly lead to future financial claims of the concerning power-discriminated parties.
The second step is just as important.
Even with the right balanced governance in place, it will be an almost impossible task to manage a Pension Fund if the often implicit 'embedded options' between the defined member groups (including the sponsor) are not proactively recognized, defined, explicated and - above all - financially and organizational managed (settled).
Pension Fund times have changed
Back in the second half of the twentieth century, Pension Funds were an excellent (HR)-instrument to stabilize employer-employee relationship and keep retention high. Since then, a lot has changed:
- Employees became more flexible and international orientated
- Permanent or Lifetime employment is nowadays no longer key
- Increased social en technical complexity, supervision, governance, etc., urge for an increasing professional approach.
- Original Pension Fund advantages (economies of scale:cost, funding, risk) are at stake, due to the enormous (rising) costs (administration, supervision, management [risk, asset, hedging] , funding, etc).
But there's more... Surreptitiously, like the famous 'boiling frog', the (member) composition of a pension fond has fundamentally changed during the last decades.
Some decades ago, at the start of a Pension Fund, almost all participants where existing employees of the corresponding company (sponsor). Today, the number of 'current employees' is often overshadowed by the number of 'pensioners' and the - until now - quiet force of 'deferred pensioners' (former employees, that left the company before retirement).
All Pension Fund concerned parties, the three member-groups as well as the employer (sponsor), have different and sometimes opposite interests with regard to the financial policy of the Pension Fund. The tension between these parties with regard to what's best for the employer, the employees, pensioners and deferred pensioners, will therefore increase as the Pension Fund becomes more mature.
The first step to manage this tension is to redefine Pension Fund Governance in line with the changed balance of power. Skipping this governance step seems not wise, as this will undoubtedly lead to future financial claims of the concerning power-discriminated parties.
The second step is just as important.
Even with the right balanced governance in place, it will be an almost impossible task to manage a Pension Fund if the often implicit 'embedded options' between the defined member groups (including the sponsor) are not proactively recognized, defined, explicated and - above all - financially and organizational managed (settled).
Regain Pension Fund Risk Control
To regain Pension Fund Risk Control, governance principles have be transparently defined and every possible - likely or unlikely - future situation (scenario), has to be identified, described, valued, controlled and managed.In this approach, a strong segmented, segregated or 'split up' framework, helps to keep oversight at board level and urges to define all possible 'embedded options' as clear as possible and to clear out possible sticky, fuzzy or unspoken arrangements, deals or intentions.
Pension Fund's Objectives
Of course this comprehensive operation makes only sense if the Pension Fund's objectives are (upfront) well defined and if all members agree upon those objectives. Main objectives among others are:General (financial) PF objectives
- Target Pension Benefit Level and volatility
- Target Contribution Level and volatility
- Target PF Growth Rate and volatility
- Target Risk level and volatility
- Target Coverage Ratio and volatility
- Target Indexation level and volatility
- Target Assets Returns and volatility
- Target Cost Rates and volatility
- Target AL-Mismatch and volatility
- Target Mortality Rates and volatility
FMCs
In so called Financial Member-Contracts (FMCs) has to be defined exactly what the explicit financial consequences are for every Pension Fund Member, each time the actual performance of one of the objectives scores (negative or positive) out of the defined expected 'volatility range' for a certain predefined period.On top of, these FMCs have to give a clear upfront financial answer to other general or Pension Fund specific developments. Some examples:
Sponsor Default Risk
Last but not least, let's take a look at an interesting risk element.
One of the most risky and underestimated elements in the Pension Fund's Risk Management Framework is the 'default risk' and correspondent creditworthiness of the sponsor.
The sponsoring employer’s ability to support Pension Fund volatility by providing additional funding if required, is defined in the so called 'Employer Covenant' or 'Corporate Covenant'
Although, with regard to the obligations of the sponsor, legislation from country to country differs strongly, the Corporate Covenant and more explicitly, the capacity of the sponsoring employer to cover (incidental) losses in the event of poor investment outcomes or the guarantee of incidental or temporary underfunding, is crucial and impacts the valuation of the Pension Fund strongly.
That this 'sponsor default risk' is not negligible, is well illustrated by the next table of Global Corporate Cumulative Average Default Rates by Standard & Poor.
Moreover the importance of the sponsor's default risk is in general essential if you take into account that the majority of companies is rated as BB an B, as is clear from the next 2003 and 2009 Corporate Ratings Distributions by S&P:
However, there's one slight problem.......
Vicious Value Circle
Future IASB proposals will gradually move towards 'plain fair value' in case of Pension Funds. The new 2010 IASB draft versions make a first step by proposing - as AON calls it - a "third way" (between buffering and mark-to-market in combination with asset smoothing) .
As Pension Funds become more and more mature and the volatility of pension Funds is more and more reflected in the sponsoring employer's balance sheet and P&L, the question of valuing the Pension Fund becomes a kind of vicious circle.
On the one hand the value of the Pension Fund depends on the default risk and credibility of the sponsor. On the other hand the credibility and default risk of the sponsor depends strongly on the volatility of the Pension Fund.
This dependency implies that if either the sponsor or the Pension Fund gets into serious financial trouble, revaluing forces will pull the value of both institutions into a negative spiral towards a default situation, leaving the Corporate Covenant as a paper farce.
It's clear: Risk Management of Pension Funds is challenging and urges actuaries to keep eyes open.
Related links:
- Corporate Covenant and Other Embedded Options in Pension Funds
- Mercer: Assessing Employer Covenant (2009)
- S&P:Global Corporate Average Cumulative Default Rates (1981-2009)
- S&P:Global Short-Term Ratings and Default Analysis (1981-2009)
- AON: IASB Releases Exposure Draft on DB Accounting
- AAA:Pension Accounting and Financial Reporting by Employers
- Consequences of a sponsor's default or down- or upgrade.
- Consequences of possible exit of substantial employers, corporate split up, outsourcing, etc. (upfront exit conditions, restructure consequences, etc.)
- New upfront entering conditions and principles in case of future take-overs or new employers joining the Pension Fund
- Defining upfront catch-up indexation rules in case the target indexation levels are not met.
- Consequences, principles, methods and guide lines that will be used in case of possible future changes in (pension) legislation, supervisory, governance or value) accounting.
Last but not least, let's take a look at an interesting risk element.
One of the most risky and underestimated elements in the Pension Fund's Risk Management Framework is the 'default risk' and correspondent creditworthiness of the sponsor.
The sponsoring employer’s ability to support Pension Fund volatility by providing additional funding if required, is defined in the so called 'Employer Covenant' or 'Corporate Covenant'
Although, with regard to the obligations of the sponsor, legislation from country to country differs strongly, the Corporate Covenant and more explicitly, the capacity of the sponsoring employer to cover (incidental) losses in the event of poor investment outcomes or the guarantee of incidental or temporary underfunding, is crucial and impacts the valuation of the Pension Fund strongly.
That this 'sponsor default risk' is not negligible, is well illustrated by the next table of Global Corporate Cumulative Average Default Rates by Standard & Poor.
Moreover the importance of the sponsor's default risk is in general essential if you take into account that the majority of companies is rated as BB an B, as is clear from the next 2003 and 2009 Corporate Ratings Distributions by S&P:
Valuing Corporate Covenant
If you're interested....In an excellent article called 'Corporate Covenant and Other Embedded Options in Pension Funds', Theo Kocken explains, how various contingent claims in a pension fund, such as the Corporate Covenant or Conditional Indexation, can be valued with the same techniques that are used to value options on stocks.However, there's one slight problem.......
Vicious Value Circle
Future IASB proposals will gradually move towards 'plain fair value' in case of Pension Funds. The new 2010 IASB draft versions make a first step by proposing - as AON calls it - a "third way" (between buffering and mark-to-market in combination with asset smoothing) .
On the one hand the value of the Pension Fund depends on the default risk and credibility of the sponsor. On the other hand the credibility and default risk of the sponsor depends strongly on the volatility of the Pension Fund.
It's clear: Risk Management of Pension Funds is challenging and urges actuaries to keep eyes open.
Related links:
- Corporate Covenant and Other Embedded Options in Pension Funds
- Mercer: Assessing Employer Covenant (2009)
- S&P:Global Corporate Average Cumulative Default Rates (1981-2009)
- S&P:Global Short-Term Ratings and Default Analysis (1981-2009)
- AON: IASB Releases Exposure Draft on DB Accounting
- AAA:Pension Accounting and Financial Reporting by Employers
Jul 27, 2010
What kind of actuary are you?
We all know plain actuarial skills are not enough to be(come) a successful professional actuary.
Time and time again we have to conclude that it takes more than average communication skills to overcome the persistent communication gap between actuaries and their audience.
In a 2008 workshop Matthias Bonikowski (Senior Manager at Milliman) presented the outcome of a German survey.
Here are the stunning results:
From the Bonikowski survey it's clear that non-actuaries (including: board managers, sales directors, product managers, coaches and headhunters) don't speak highly of actuaries.
It looks like most of the 'actuary species' are perceived as a kind of 'Copy Paste Actuary'. One who's not able to think out of the box.
We are congenital pessimists, trained to do a sort of one trick pony act. An act we can't explain or communicate, like 'normal' people seem to be able to do.
On top of this - just like the famous Baron Münchhausen who was unable to escape from a swamp by pulling himself up by his own hair - we actuarial poor devils seem unable to lift ourselves to the next level.
We're obviously trapped in our 'non-communication' addiction, smoke gets in our eyes and nobody around us seems capable of helping us to move from our alien planet to the world of real people, business and social life.
The non-actuaries' view in Bonikowski's survey emphasizes this image...
The non-actuaries' view
The non actuaries' view on actuaries comes down to::
- They explain complex terms as complex as possible
- Inability to make actuarial things clear to non-actuaries
- They are not able to take a bird‘s eye view
- They are missing empathy for non-actuaries
As possible reasons for this view, non-actuaries notice:
- They are isolated from decision processes…
- High expectations about actuarial knowledge – deep and broad
- Communication skills are not a part of actuarial education
Time and time again we have to conclude that it takes more than average communication skills to overcome the persistent communication gap between actuaries and their audience.
In a 2008 workshop Matthias Bonikowski (Senior Manager at Milliman) presented the outcome of a German survey.
Here are the stunning results:
| Proposition | Actuaries' opinion | Non-Actuaries' opinion | |
| 1. | Actuaries are pessimists | 85% | 85% |
| 2. | Actuaries are not opportunists | 70% | 70% |
| 3. | Actuaries communicate clearly and transparently | 15% | 5% |
| 4. | Actuaries think out of the box | 50% | 15% |
| 5. | Actuaries live in an ivory tower | 10% | 50% |
The Copy Paste Actuary
It looks like most of the 'actuary species' are perceived as a kind of 'Copy Paste Actuary'. One who's not able to think out of the box.
We are congenital pessimists, trained to do a sort of one trick pony act. An act we can't explain or communicate, like 'normal' people seem to be able to do.
On top of this - just like the famous Baron Münchhausen who was unable to escape from a swamp by pulling himself up by his own hair - we actuarial poor devils seem unable to lift ourselves to the next level.
We're obviously trapped in our 'non-communication' addiction, smoke gets in our eyes and nobody around us seems capable of helping us to move from our alien planet to the world of real people, business and social life.
The non-actuaries' view in Bonikowski's survey emphasizes this image...
The non-actuaries' view
The non actuaries' view on actuaries comes down to::
- They explain complex terms as complex as possible
- Inability to make actuarial things clear to non-actuaries
- They are not able to take a bird‘s eye view
- They are missing empathy for non-actuaries
As possible reasons for this view, non-actuaries notice:
- They are isolated from decision processes…
- High expectations about actuarial knowledge – deep and broad
- Communication skills are not a part of actuarial education
As a 'solution', 7 suggestions for successful communication are developed:
- Point out key messages
- Leave out details
- Use more pictures and examples
- Explain more in “black and white”
- Avoid academic language/technical jargon
- Pick up non-actuaries earlier
- Define target-group specific communication rules
As we all know, these issues and solutions are not really new or surprising. Why is this issue of non-communication and 'Ivory Tower Effect' so hard to solve?
Actuaries are invisible
Important decisions that society has to take in coping with challenges as aging, longevity, health, etc. Grover Edie explicates: 'they don’t ask us (actuaries) because we are not visible'.
My view is that the 'invisibility of actuaries' is more or less a global issue.
Undoubtedly this theme of invisibility finds his roots in the actuary's attitude. This is well illustrated by Grover Edie's summarized reactions of actuaries on the issue:
- “If I do good work, others will ask me for more of it.”
- “I don’t need to advertise or to sell my work: My work speaks for itself.”
- “I certainly don’t need to sell others on the value of my work, and if they are too stupid to know the value of what I do, that’s their problem.”
Supply and Demand
Grover Edie thinks that this underlying 'laissez-faire attitude' is the basic problem. A problem that - in his view - can be solved with a simple sales training approach. With all due respect...., the invisibility of actuaries has probably a deeper cause than this superficial laissez faire attitude only, that is mainly the effect of the Law of Supply and Demand.
Most actuaries had to study hard to achieve their goal of becoming a qualified actuary. Once they'd become an actuary, there was, still is and will be, more than enough well paid work. In other words: The Demand side of the market market exceeds (by far) the Supply side of the market. Why should actuaries develop a commercial sales attitude if they don't need it?
A mirror actuary, one who just reflects and gives back what the environment offers him.
He looks a bit like the invisible actuary. Without a real own opinion, the mirror actuary just reflects the financial impact and consequences of decisions taken by others. He acts without sincere social engagement or conviction. Hence he's unable to generate a critical positive feedback viewpoint, necessary to make what its takes, the difference.
What does it takes?
Convincing actuaries to become more visible and socially or publically involved, takes more than a professional sales approach. Actuaries have to be made conscious of why and where they are and what they really want to achieve in life.
In other words:
What kind of actuary would you (really) like to be?
In this case the answer is not a traditional one like 'Pricing Actuary', 'Pension Actuary', 'Health Actuary; or the humorous answer 'very kind'. No, the answer to this question hits our actuarial soul....
The good old actuarial horse
Would you like to be the well paid 'actuarial horse' in front of the wagon, that gets his orders from the coachman and does his calculation work every time he's being asked to do deliver some?
Answering these simple questions is key in solving the persisting actuarial mind setting issue.
This invisibility issue deals with the fundamental structure of an actuary's personality. It's not something that can be easily learned or changed during or after achieving a (long term) study. If we want visible actuaries who are socially and publically involved, we'll have to select them on that attitude at the gate, before they undertake an actuarial study. Just like we test their arithmetic talent and other mental capacities, before actuaries start their study.
The Dancing Actuary
In this situation there's a tricky risk that we enjoy our salary and comfortable position so much that we suppress our critical view and potential power to change things. In which case we become totally dependable on our monthly paycheck and the opinion of our boss or manager.
In doing so, we might gradually become implicitly susceptible to extortion and eventually things will escalate.
Ultimately in this situation, we could even develop to a kind of 'dancing bear', in this case a 'Dancing Actuary'.
Try to keep your eyes open. If you feel completely 'chained' or if our environment constantly forces you to support actions or decisions you can not really account for, seek help or step out before it's too late.
The Wise Actuary
Of course we know better. There are lots of wise and visible actuaries around the world and as you've made your way to the end of this blog, you'll be probably one of them....
Wise actuarial owls that want to make the difference in life and society. Actuaries who are not for sale and who know their personal limits. Actuaries that know when and where to say 'no' or 'yes'.
Actuaries that don't just want to talk about a better world, but want to act(uary) on it.
Are you that 'wise actuary', who's visible, socially active and leading society to the next level?
Test
If you want to find out if you're a wise, invisible, mirror or dancing actuary, take the next 5 minutes 15 questions test called:Good luck with this 'actuary stress test'!
Related links/ Resources:
- Workshop Actuarial Communication (2008) Presentation (pdf)
- Article: They Don’t Ask Us Because We Are Not Visible
- Test:What kind of actuary are you?
Jul 14, 2010
Solvency II Project Management Pitfalls
On top of it all, nobody seems to understand each other, it's a confusion of tongues.....
Now that the European Parliament have finally agreed upon the Solvency II Framework Directive in April 2009, everything should look ready for a successful S-II implementation before the end of 2012. However, nothing is farther from the truth.....
Solve(ncy) Questions in Time
The end of 2012 might seem a long way of...
While time is ticking, all kind of questions pop up like:
- How to build an ORSA system and who owns it?
- What's the relation between ORSA and other systems or models, like the Internal Model
- Where do the actuarial models and systems fit in?
- What are financial, actuarial, investing and 'managing' parameters, what distinguishes them, who owns them and who's authorised and competent to change them?
- How to connect all IT-systems to deliver on a frequent basis what S-II reporting needs......?
- How to build a consistent S-II IT framework, while the outcomes from QIS-5 (6,7,...) are (still) not clear and more 'Qisses' seem to come ahead?
- Etc, etc, etc, etc^10
The Solvency Delusion
Answering the above questions is not the only challenge. A real 'Solvency Hoax' and other pitfalls seem on their way....
It appears that most of the actuarial work has been done by calculating the MCR and SCR in 'Pillar I'.
It's scaring to observe that the 'communis opinio' now seems to be that the main part of the S-II project is completed. Project members feel relieved and the 'Solvency II Balance Sheet' seems (almost) ready!
Don't rejoice..., it's a delusion! The main work in Pillar II (ORSA) and Pillar III (Reporting, transparency) still has to come and - at this moment - only few project managers know how to move from Pillar I to Pillar II.
Compliancy First, a pitfall?
With the Quantitative Impact Study (QIS-5) on its way (due date: October 2010) every insurer is focusing on becoming a well capitalized Solvency-II compliant financial institution.
There is nothing wrong with this compliance goal, but 'just' becoming 'solvency compliant' is a real pitfall and unfortunately not enough to survive in the years after 2010.
Risk Optimization
Sometimes, in the fever of becoming compliant, an essential part called "Risk Optimization" seems to be left out, as most managers only have an eye for 'direct capital effects' on the balance sheet and finishing 'on time', whatever the consequences......Risk Optimization is - as we know - one of the most efficient methods to maximize company and client value. Here's a limited (check)list of possible Risk Optimization measurements:
1. Risk Avoidance - Prevent Risk• Health programs • Health checks • Certification (ISO, etc) • Risk education programs • High-risk transactions (identify,eliminate, price) • Fraud detection (identify,eliminate, price) • Adverse selection (identify, manage, price) - Adjust policy conditions • Exclude or Limit Risk (type,term) • Restrict underwriter conditions (excess, term, etc) - Run-off portfolios/products 2. Damage control - Emergency Plans (tested)- Claims Service, Repair service - Reintegration services 3. Risk Reduction - Diversification - Asset Mix, ALM - Decrease exposure term - Risk Matching - Decrease mismatch AL/Duration - Outsourcing, Leasing 4. Risk Sharing - Reinsurance (XL,SL,SQ)- Securitization, Pooling - Derivatives, Hedging - Geographical spread - Tax, Bonus policy 5. Risk Pricing - Exposure rating, Experience rating- Credibility rating, Community rating - Risk profile rating 6. Equity financing - IPO, Initial Public Offering- Share sale, Share placement - Capital injections |
Solvency-II Project Oversight
Just to remind you of the enormous financial impact potential of 'Risk Optimization' and to keep your eye on a 'helicopter view level' with regard to Solvency-II projects and achievements, here's a (non-complete but hopefully helpful) visual oversight of what has to be done before the end of 2012.....
Be aware that all Key Performance Indicators (KPIs), Key Risk Indicators (KRIs) and Key Control Indicators (KCIs) must be well defined and allocated. Please keep also in mind that one person’s KRI can be another’s performance indicator(KPI) and a third person’s control-effectiveness indicator.
Value Added Actions
As actuaries, we're in the position of letting 'Risk Optimization' work.We're the 'connecting officers' in the Solvency Army, with the potential of convincing management and other professionals to take the right value added actions in time.
Don't be bluffed as an actuary, take stand in your Solvency II project and add real value to your company and its clients.
Related Links:
- A Comparison of Solvency Systems: US and EU
- UK Life solvency falls under qis-5
- Determine capital add-on
- Reducing r-w assets to maximize profitability and capital ratios
- Risk: Who is who?
- Balanced scorecard including KRIs (2010)
- Solvency II, Piller II & III
- Risk Adjusted Return On Risk Adjusted Capital (RARORAC)
- ERM: “Managing the Invisible" (pdf; 2010)
- Unlocking the mystery of the risk framework around ORSA
- Risk based Performance: KPI,KRI,KCI
- Risk of risk indicators (ppt;2004)
- Defining Risk Appetite
- Risk appetite ING KPI/KRI
- Board fit for S II?
- How to compute fund vaR?
- Technical Provisions in Solvency II
- Insurers should use derivatives to manage risk under Solvency II
- Solvency Regulation and Contract Pricing in the Insurance Industry
- Overview and comparison of risk-based capital standards
- Solvency II IBM
- Reinsurance: Munich Re , Reinsurance solvency II
Jul 10, 2010
Actuarial Limit 100m Sprint
In June 2009 Professor of Statistics John Einmahl and (junior) actuary Sander Smeets, calculated the ultimate record for the 100-meter sprint. The actual World record - at that time - was set by Usain Bolt at 9.69 seconds (August 16, 2008, Beijing, China).
With help of the extreme-value theory and based on 'doping free' World Record data (observation period:1991 to June,19 2008) Smeets and Einmahl calculated the fastest time that a man would be ultimately capable of sprinting at: Limit = 9.51 seconds.
However....
As often in actuarial calculation, once your model is finally set, tested and implemented, the world changes...
Or, as a former colleague once friendly answered when I asked him if his ship (project) was still on course:
In this case, the 'model shifting event' took place in Beijing, exactly one year later, on August 16, 2009: Usain Bolt sets a new astonishing 100m World Record in 9.58 seconds !
Of course 9.58 secs is still within the scope of Smeets' and Einmahl's model limit of 9.51 seconds...
Nevertheless, as a common sense actuary, you can see coming a mile away, that this 9.51 secs-limit will not hold as a final future limit.
As is visual clear, one can at least question the validity of the 'extreme-value theory approach' in this 100m sprint case.
Math-Only Models
In this kind of projections (e.g. 100m world records) it's not enough to base estimations only on historical data. No matter how well historical data are projected into future data, things will mesh up!
Why? Because these kind of 'math-only models' fail to incorporate the changes in what's behind and what causes new 100m World Records. To develop more sensible estimates, we'll have to dive into the world of Biomechanics.
To demonstrate this, let's have a quick -amateur - look at some biomechanical data with respect to Usain Bolt's last World Record:
Let's draw a simple conclusion from this chart:
Just like Bolt stated in an interview: "I think I can go 9.50-something", appears to be realistic:
Biomechanical explanations
On top of this, Bolt outperforms his competitors on having a higher step length and a lower step frequency. This implies there must be deeper biomechanical factors like body weight, leg strength, leg length & stiffness (etc), that need to be included in a model to develop more realistic outcomes.
Newest biomechanical research ("The biological limits to running speed are imposed from the ground up" ) shows maximum (theoretical?) speeds of 14 m/s are within reach, leading to potential World Records of around 9 secs on the long run.....
Based on this new biomechanical information output in combination with an appropriate chosen corresponding logistic model, we can now predict a more realistic ultimate World Record Estimation (WRE) in time.
Curvefitting at ZunZun with the 1968-2009 data (including Bolt's 9.58 secs record) on basis of a Weibull CDF With Offset (c), led to the next, best fit equation:
With: y=WRE in seconds, x=Excel date number, and:
a = -3.81253229860548
b = 41926.0524625578
c = 8.97894916004274 (=final limit)
As we may learn more about biometrics in the near future, perhaps the ultimate 9 seconds (8.9789 seconds, more exactly) can possibly be reached faster than we currently estimate (year 2200).
Playtime
Now, just play around with (estimate) world records in this Google time series plotter:
Finally
As actuaries, what can we learn from this 'sprinting example'?
Well... Take a look at estimating future (2030 a.f.) mortality rates.
Just like with estimating World Records, it seems almost impossible to estimate future mortality rates just on basis of extrapolating history.
No matter the quality of the data or your model, without additional information what's behind this mortality development, future estimations seem worthless and risky.
Although more and more factors affecting retirement mortality are being analysed, (bio)genetic and medical information should be studied by actuaries and translated into output that strengthens the devlopment of new mortality estimate models.
Actuaries, leave your comfortable Qx-houses and get started!
Related links and sources:
- Ultimate 100m world records through extreme-value theory
- 90 years of records
- Usain Bolt: The Science of Running Really Fast
- Biomechanics Report WC Berlin 2009 Sprint Men
- BP WC Berlin 2009 - Analysis of Bolt: average speed
- The biological limits to running speed (2010)
- Limits to running speed in dogs, horses and humans (2008)
- Improving running economy and efficiency
- Factors Affecting Retirement Mortality and Their Impact ...
- Cheetah Sets New World Record 100 meter sprint2009 (6.130 sec)
- 100m World record data and WRE (xls spreadsheet)
With help of the extreme-value theory and based on 'doping free' World Record data (observation period:1991 to June,19 2008) Smeets and Einmahl calculated the fastest time that a man would be ultimately capable of sprinting at: Limit = 9.51 seconds.
As often in actuarial calculation, once your model is finally set, tested and implemented, the world changes...
Or, as a former colleague once friendly answered when I asked him if his ship (project) was still on course:
In this case, the 'model shifting event' took place in Beijing, exactly one year later, on August 16, 2009: Usain Bolt sets a new astonishing 100m World Record in 9.58 seconds !
Nevertheless, as a common sense actuary, you can see coming a mile away, that this 9.51 secs-limit will not hold as a final future limit.
As is visual clear, one can at least question the validity of the 'extreme-value theory approach' in this 100m sprint case.
Math-Only Models
In this kind of projections (e.g. 100m world records) it's not enough to base estimations only on historical data. No matter how well historical data are projected into future data, things will mesh up!
Why? Because these kind of 'math-only models' fail to incorporate the changes in what's behind and what causes new 100m World Records. To develop more sensible estimates, we'll have to dive into the world of Biomechanics.
To demonstrate this, let's have a quick -amateur - look at some biomechanical data with respect to Usain Bolt's last World Record:
Let's draw a simple conclusion from this chart:
Hitting 9.50 secs seems possible
Just like Bolt stated in an interview: "I think I can go 9.50-something", appears to be realistic:
- 0.026 secs faster by improving his reaction time to the level of his best competitors: 0.12secs, instead of 0.146secs
- 0.060 secs faster by reaching his maximum speed (12.35 m/s) at V50 and maintaining this speed for the remaining 50 meters.
On top of this, Bolt outperforms his competitors on having a higher step length and a lower step frequency. This implies there must be deeper biomechanical factors like body weight, leg strength, leg length & stiffness (etc), that need to be included in a model to develop more realistic outcomes.
Newest biomechanical research ("The biological limits to running speed are imposed from the ground up" ) shows maximum (theoretical?) speeds of 14 m/s are within reach, leading to potential World Records of around 9 secs on the long run.....
Based on this new biomechanical information output in combination with an appropriate chosen corresponding logistic model, we can now predict a more realistic ultimate World Record Estimation (WRE) in time.
With: y=WRE in seconds, x=Excel date number, and:
a = -3.81253229860548
b = 41926.0524625578
c = 8.97894916004274 (=final limit)
As we may learn more about biometrics in the near future, perhaps the ultimate 9 seconds (8.9789 seconds, more exactly) can possibly be reached faster than we currently estimate (year 2200).
Playtime
Now, just play around with (estimate) world records in this Google time series plotter:
Finally
Just like with estimating World Records, it seems almost impossible to estimate future mortality rates just on basis of extrapolating history.
No matter the quality of the data or your model, without additional information what's behind this mortality development, future estimations seem worthless and risky.
Although more and more factors affecting retirement mortality are being analysed, (bio)genetic and medical information should be studied by actuaries and translated into output that strengthens the devlopment of new mortality estimate models.
Actuaries, leave your comfortable Qx-houses and get started!
Related links and sources:
- Ultimate 100m world records through extreme-value theory
- 90 years of records
- Usain Bolt: The Science of Running Really Fast
- Biomechanics Report WC Berlin 2009 Sprint Men
- BP WC Berlin 2009 - Analysis of Bolt: average speed
- The biological limits to running speed (2010)
- Limits to running speed in dogs, horses and humans (2008)
- Improving running economy and efficiency
- Factors Affecting Retirement Mortality and Their Impact ...
- Cheetah Sets New World Record 100 meter sprint2009 (6.130 sec)
- 100m World record data and WRE (xls spreadsheet)
Jul 5, 2010
Exceptional Longevity Predictable
A genome-wide association study (Paola Sebastiani et al) based upon 1055 centenarians, showed that Exceptional Longevity (EL) - living 90 years or more - can be predicted with 77% accuracy!
EL Genetic Passport
This research development will have major impact on 'life insurance' and pensions. With an EL Genetic Passport in your pocket, you'll have the power to conclude with 77% certainty whether it's profitable (or not) to buy life insurance or to invest more or less in your pension fund.
Genetic Loss by GAS
To prevent major losses caused by 'adverse selection', life insurance companies and pension funds have no other choice left, than to base life insurance premium prices and pension contributions on 'genetic passport information'.
Just like it's (from a company's perspective) devastating to sell mortgages to people who cannot afford it, it's also killing to sell life annuities to people who have knowledge of getting 90 years or older with 77% certainty.
As Genetic Adverse Selection (GAS) also negatively affects current provisions and value of an insurance company or pension fund, GAS development effects should be included and estimated in actual liability calculations.
Without doubt, GAS will generate large Genetic Losses in the next decades. Perhaps GAS can be qualified as a substantial new kind of risk in Pillar I calculations.
Related links - Sources:
- Science: Genetic Signatures of Exceptional Longevity in Humans
- PDF: Genetic Signatures of Exceptional Longevity in Humans
- BU: Signatures of Human Exceptional Longevity (video)
- Centenarians in some European countries, 2007
EL Genetic Passport
This research development will have major impact on 'life insurance' and pensions. With an EL Genetic Passport in your pocket, you'll have the power to conclude with 77% certainty whether it's profitable (or not) to buy life insurance or to invest more or less in your pension fund.
Genetic Loss by GAS
Just like it's (from a company's perspective) devastating to sell mortgages to people who cannot afford it, it's also killing to sell life annuities to people who have knowledge of getting 90 years or older with 77% certainty.
As Genetic Adverse Selection (GAS) also negatively affects current provisions and value of an insurance company or pension fund, GAS development effects should be included and estimated in actual liability calculations.
Without doubt, GAS will generate large Genetic Losses in the next decades. Perhaps GAS can be qualified as a substantial new kind of risk in Pillar I calculations.
Related links - Sources:
- Science: Genetic Signatures of Exceptional Longevity in Humans
- PDF: Genetic Signatures of Exceptional Longevity in Humans
- BU: Signatures of Human Exceptional Longevity (video)
- Centenarians in some European countries, 2007
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