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

QIS: Longevity Risk Sharing

In a recent discussion about the future and fundamentals of the Dutch pension system I discussed the importance of solidarity.

As expected, the participants quickly came up with the various forms of solidarity, including solidarity between:

– higher and less educated people

– women and men

– old versus young people

Longevity Risk Sharing

Remarkably non of the participants had any idea about the financial impact of one of the most fundamental forms of risk sharing in case of a life annuity: Longevity Risk Sharing. Let's call it in general 'mortality solidarity'.

When asked, most participants strongly underestimated the impact of mortality (mortality share) as part of the yearly payment in the form of a life annuity. On the other hand, they overestimated the impact of 'return'.

Some of the participants had the idea that they would be 'better of' with a traditional individual investment plan in combination with a little more investment risk (and return) ...

Life Annuity Composition
So let's do a mini QIS (Quantitative Impact Study) of 'mortality solidarity' by examining the development of the composition of an annual lifetime annuity, regarding three basic elements: Mortality, Return and Desaving.

Here is the result for a Dutch man, age 65, with a lifetime annuity based on an average 5% yearly return:

Translated in table form:

	Yearly Payment Composition				Cumulative Composition
Age	Mortality	Return	Desaving		Mortality	Return	Desaving
65	16%	51%	33%		16%	51%	33%
66	17%	50%	34%		16%	50%	34%
67	18%	48%	34%		17%	50%	34%
68	19%	46%	34%		17%	49%	34%
69	21%	45%	35%		18%	48%	34%
70	22%	43%	35%		19%	47%	34%
71	24%	41%	35%		20%	46%	34%
72	26%	39%	35%		20%	45%	34%
73	28%	38%	35%		21%	45%	34%
74	30%	36%	34%		22%	44%	34%
75	32%	34%	34%		23%	43%	34%
76	34%	33%	33%		24%	42%	34%
77	36%	31%	33%		25%	41%	34%
78	38%	30%	32%		26%	40%	34%
79	41%	28%	31%		27%	40%	34%
80	43%	27%	30%		28%	39%	34%
81	45%	25%	29%		29%	38%	33%
82	48%	24%	29%		30%	37%	33%
83	50%	22%	28%		31%	36%	33%
84	52%	21%	27%		32%	36%	32%
85	55%	20%	26%		33%	35%	32%
86	57%	18%	25%		34%	34%	32%
87	60%	17%	23%		35%	33%	31%
88	62%	16%	22%		36%	33%	31%
89	65%	15%	20%		37%	32%	31%
90	67%	14%	19%		39%	31%	30%
91	69%	13%	17%		40%	31%	30%
92	72%	13%	16%		41%	30%	29%
93	73%	12%	15%		42%	29%	29%
94	75%	11%	14%		43%	29%	28%
95	77%	11%	12%		44%	28%	28%
96	78%	10%	12%		45%	28%	27%
97	79%	9%	11%		46%	27%	27%
98	80%	9%	11%		47%	26%	26%
99	82%	8%	10%		48%	26%	26%
100	83%	8%	10%		49%	25%	25%
101	84%	7%	9%		50%	25%	25%
102	85%	7%	9%		51%	25%	24%
103	85%	7%	8%		52%	24%	24%
104	86%	6%	8%		53%	24%	24%
105	87%	6%	7%		54%	23%	23%

Observations

As is clear from the table above :

• Already at the start the start of the annuity, at age 65, 16% of the yearly payment is due to mortality risk sharing and 'only'  51% is related to the 'return'.
• As a pension member continues to live, the  'mortality share' of the annual payment increases. At the age of 83 already 50% of his annuity is due to mortality effects and the 'return share'  is already down to 22%.
• As from age 77 of, the 'mortality effect' on the annual payment exceeds the 'return effect'.
  
  

Conclusion

From some simple calculations, we can conclude that longevity (mortality) solidarity is a fundamental part of a life annuity.
 

AfterMath

Make your calculations with other interest rates, ages or life tables with the Pension Calculator (Excel).

You may download the pension calculator HERE

Links/Sources

- Solidarity: Sticking together or ..(Google Books, P. de Beer)

- Benefit of collective schemes (IPE)

- HFC: Pension Challenge

- Download the Excel Pension Calculator

Global Country Perspective

Do you find it - just like me - hard to get a clear picture of a country's impact and contribution from global perspective? Here's some help...

GCI
The Global Competitiveness Index (GCI) is a comprehensive tool that measures the microeconomic and macroeconomic foundations of national competitiveness. It is composed of 12 "pillars", or categories.

Competitiveness is the set of institutions, factors and policies that determine the level of productivity of a country taking into account its level of development.

Charts

With the help of the free Tableau (visual) software I've created several charts that give an rough idea of a country's competitiveness an productivity in relation with it's relative global size (% of total world GDP).

The last rectangle chart 'Country GDP world Share' shows in a scaled way the GDP proportions of all 148 measured countries in the world. The color of each rectangle represents the GCI-level of each country (dark red=poor, dark green = splendid).

Remarks

If you look specifically for the Netherlands in the first chart.... Click (or double click) on the word 'Netherlands'. In general, move you mouse across the different circles and rectangles to view more detailed information.

Enjoy!

Source World Economic Forum,

The Global Competitiveness Report 2013-2014

Base period 2013-2014

Learn About Tableau

Test: Rational Thinking in a Crisis

End October 2007 my wife and I were flying from New York to San Diego. Due to an overheated engine our Captain took the one and only right decision: an emergency landing (at Chicago). Thankfully, a successful emergency landing.

Although - for a split second - we were disappointed that we would not arrive at San Diego that night, we immediately realized that our goal was no longer arriving at time, but surviving!

 How do we respond in crises situations? Take the next simple test to find out.

Original Source: Risk & Return

Estimating Bubbles

In a presentation for more than 200 actuaries at 'Actuarieel Podium" (actuarial Platform) on October 2 (2013) (Actuary Day) in the Netherlands, I tested the ability of Dutch actuaries to estimate the number of bubbles in a bottle of champagne.


Take the Test
Test your own bubble estimation ability. Think for a while:

How many bubbles are in a bottle of Champagne?

If you think you've got the right answer, check it by clicking on the picture below...

Conclusion 
If the order of magnitude of your answer was right: Congratulations!
If not, like most actuaries at my presentation, one thing is clear:

As actuaries we fall short in estimating bubbles!!!! (crises)

Key question is: why can't we estimate bubbles?

Short answer: because we have been only professionally trained in estimating relatively small numbers and small risks, not (systemic) crises.

One thing is sure: we need to fix this educational bubble-lack in our professional actuarial training.

Links
- Beekman Wines: Champagne - How Many Bubbles?
- Application of Actuarial Science to Systemic Risk Report (2013)
- Actuarial Viewpoints on and Roles in Systemic Risk Regulation
- Actuarieel Podium (Dutch)

Aftermath
49 Million Bubbles in a bottle of champagne may seem much, it's nothing compared to the U.S. Debt:



Learn more (in Dutch) on how we can do better as actuaries in the next presentation: 'From Backroom to Boardroom' (in Dutch) by Jos Berkemeijer

From Backroom to Boardroom (Dutch) from Jos Berkemeijer

7 Principles of an Effective Capital Adequacy Process

The Federal Reserve Bank not only fights inflation, but also unmanaged risk and  systemic risk.

Recently the FED  announced seven new Capital Adequacy Process (CAP) Principles for complex bank holding companies (BHCs).

Although these principles only intend to effect BHC's with a consolidated assets of $50 billion or more, they are in fact a simple and adequate guideline for any Financial Institution (FI) that takes risk management and its stakeholders seriously.

The new principles emphasize that managers, risk managers and actuaries not only have to focus on technical risk, but also on the implementation of a sound risk framework, including an effective risk control and a transparent risk governance.

Here are the Seven Principles of an Effective Capital Adequacy Process:

1. Sound foundational risk management
   The FI has a sound risk-measurement and risk-management infrastructure that supports the identification, measurement, assessment, and control of all material risks arising from its exposures and business activities.
    
2. Effective loss-estimation methodologies
   The FI has effective processes for translating risk measures into estimates of potential losses over a range of stressful scenarios and environments and for aggregating those estimated losses across the FI.
    
3. Solid resource-estimation methodologies
   The FI has a clear definition of available capital resources and an effective process for estimating available capital resources (including any projected revenues) over the same range of stressful scenarios and environments used for estimating losses.
    
4. Sufficient capital adequacy impact assessment
   The FI has processes for bringing together estimates of losses and capital resources to assess the combined impact on capital adequacy in relation to the FI's stated goals for the level and composition of capital.
    
5. Comprehensive capital policy and capital planning
   The FI has a comprehensive capital policy and robust capital planning practices for establishing capital goals, determining appropriate capital levels and composition of capital, making decisions about capital actions, and maintaining capital contingency plans.
    
6. Robust internal controls
   The FI has robust internal controls governing capital adequacy process components, including policies and procedures; change control; model validation and independent review; comprehensive documentation; and review by internal audit.
    
7. Effective governance
   The FI has effective board and senior management oversight of the CAP, including periodic review of the FI's risk infrastructure and loss- and resource-estimation methodologies; evaluation of capital goals; assessment of the appropriateness of stressful scenarios considered; regular review of any limitations and uncertainties in all aspects of the CAP; and approval of capital decisions.

ORSA for European Insurers
A lot of the above mentioned principles are embedded in the 'Own Risk and Solvency Assessment' (ORSA) for European Insurers  as part of Solvency II regulation:

Implementing ORSA
It's our dedicated mission as actuaries to guide management on the implementation of ORSA or any other risk implementation program. And yes... it won't be easy.....

Links & Sources

- FED's 7 Principles Publication

- Solvency II & ORSA

- Dilbert & Risk

Actuarial Cookery in the Boardroom

Suppose your friend gave you the recipe for a delicious 'Paleo Tomato Soup'.

Does that recipe also guarantees you a delicious meal ?

Undoubtedly you answered this question with a clear "no".

Why?

As we all know, it is the 'touch of the chef' that determines the quality and final taste of the meal. The recipe is the score and the chef the performer of the culinary piece of music, that will end up on your plate.

Although the above example probably sounds logical to us, the actuarial cooking practice appears different. Let's take a look at the next example.

An Excellent ALM Advice

What about a 'plate of five' asset mix advice that's on the board's breakfast table, as the ultimate outcome of your excellent ALM analysis...

Illustration: Colin Daniel

Does this ' computer recipe' actually guarantees a sound decision about an adequate investment policy?

Actually, the answer to this question can hardly be other than 'NO'.

Your advice is a static advice in a dynamic world and - on top of - the final question remains whether the asset manager is able to 'spice up' your recipe.

The actuary as Risk-Director

Key question is whether we as a profession - keeping ourselves inadvertent in the role of  'technical experts' - merely feel responsible for delivering the recipe for a cold asset mix salad on basis of 'expected values' ​​and variances.

Or ... that we actuaries are willing to act as 'risk-director' in the interactive process of creating a dynamic investment policy that's based on a nonlinear constructed healthy and varied based asset mix over time. Albeit..., without taking the driver's seat in the advice process, but with the obligation to report the eventual existence of any GMCs ('Genetically-Modified Cickens') in the asset-mix.

Economic Risk Management or ALM?

In the thorough process of adopting a dynamic investment policy, financial boards more and more take decisions based on the study of different future economic scenarios.

This development challenges actuaries to invest more in the development of "Economic Risk Management" (ECRM) models instead of traditional ALM modeling. In ECRM 'asset class data' (as in ALM) and economic data (GDP, inflation, consumer confidence, etc) are mixed in an integral set of data, that's analysed and - with future expectations, 'stress-test conditions' or of 'believes' -  (nonlinear) translated and optimized in a dynamic asset mix.

This economic risk approach requires new nonlinear economic-asset models that urge for a close cooperation between economists and actuaries, resulting in an serious interactive board discussion (board members and economical & actuarial experts) of the ECRM models.

This approach is not limited to the well-known three or four so-called 'muddle through scenarios', but covers the outcome and impact of a large number of more precise formulated possible economic scenarios on the asset mix and the investment strategy.

Scenarios that help determine the overall risk appetite and result in a major impact on the composition of the strategic asset mix.

New Q&A's

In other words, new scenarios that give answers to questions like:

• What happens if China suddenly withdraws from U.S. bonds?
• What happens when the U.S. Fed stops its QE program?

As with the current ALM approach, the focus should not be only on the quantitative outcome of the ECRM model, but more on the discussion and wider perception of how economic risk affects the optimal asset mix and the dynamic asset policy, allowing boards to take more informed and underpinned investment policy decisions.

In this approach, ALM and ECRM are helpful but not dominating decision support tools in the creation of the final investment policy and not an unintended consultant's dictate that's implicitly adopted ("take note") by the board and then subsequently implemented.

How to Check the Quality of your ALM or ECRM Advice?

Fortunately, it is easy to check whether your ECRM or ALM advice is actually a good quality decision document or just a bite-sized chunk.

If your advice offered only 'one option' or was adopted without a serious debate or any amendments, then -  to put it euphemistically - your advice is 'ready for improvement'.

Actuaries: Backroom to the Boardroom

Finally, it all comes down together whether we as actuaries want to profile ourselves as 'recipe writers' or pick up the 'risk-director role' as an 'actuarial chef'. If you choose the latter, please stand up and help to bring out actuaries from the Backroom to the Boardroom. Success!

Pension Egg Choice

Imagine you're a new pension fund member and your pension fund offers you the next simple proposal regarding your future pension income.

With closed eyes you are allowed to take out two 'pension eggs', either from nest I or nest II. Which nest do you choose?

Think about this proposal and remember: your complete financial old age depends solely on the nest of your choice.

I discussed the above dilemma  last week (august 2013) in a presentation with an across-section of Dutch pension representatives. This dilemma illustrates in a simple way the precarious choice Dutch pension funds and their members have to make in deciding between a traditional Nominal Pension with conditional CPI-indexation (nest I) and a fully CPI-indexed 'Real' Pension (nest II).

Key point is that to achieve a higher Real Pension, you have to put your Nominal Pension 'at risk'.

And who is consciously willing to put 'future income' substantial  at risk?

As 'pension income' is in fact 'deferred income', there's also a kind of implicit understanding that your future retirement income security should be 'in line' with your actual income security and not substantial lower.

Retirement Income Security  ≈ Actual Income Security ?

No wonder that all of the 23 attendees at my presentation chose Nest I (Nominal + Indexation) as favorite.

Remark

After the meeting one of the attendees stated that the '10'-valued egg in Nest II should have been valued at at least a value of 20 or higher to create an equal or higher average expectation, as higher risk would implicate also higher return.

I positively smiled for a moment... told him that his remark (and many others that followed) was formally right and suggested that he would test the 'Pension Egg Choice' in his pension board, including an extra voting with an 20-valued egg instead of a 10-valued egg. A day later he called me back and told me the extra voting didn't substantial change the voting outcome.......

Remember that more risk doesn't automatically imply more return. If volatility (risk) increases without a well-argued expected increase in 'average return', the 'compound average return' will (even) decrease with half of its variance.

Worldwide Pension Funds Alert

Not only Dutch pension funds face the Pension Egg Dilemma, but in fact all pension funds worldwide do. To fund their pension liabilities they have to make average returns of more than 5%, 6% or even 7% for more than 50 years on a row or more. And to achieve those kind of return levels with a (nominal) risk free rate and a treasury bill outlook, both varying between 2 to 3.5 percent, implies that they'll have to invest in risky asset classes.

As a consequence the ultimate pension outcome could be lower than on basis of a risk free approach that guarantees a nominal pension. In other words: your Nominal pension is at risk.

Example

To illustrate what is happening, let's look at a 30 year old Dutch pension fund member (Tom) with an retirement age of 65.

The pension fund (theoretically) offers Tom the next options. Tom values these options on basis of a 20 year period:

1. Option 1
   Tom's contribution is invested in totally risk free assets at 3% (orange line), resulting in a sure (€,$,£,¥)  10000 yearly pension
    
2. Option 2
   Tom's contribution is invested in 30% risk free and 70% risky assets (purple line), resulting in a 25.9% (100%-74.1%) change of an outcome below his yearly 10000 (nominal) pension, but also an almost 50% probability of a pension of around 23904 or more.
   
   Looking closer at the downside, there's also a 10% probability of ending up with a negative return, corresponding with a yearly pension of 4255 a year or less.

However, Tom suddenly realizes the limitations of a linear model approach. If the 'risk free asset part' of his investment  is really completely independent (can't be dragged down) from the risky part and also insensitive to market conditions, there's a downside risk limitation.  A 30% really 'completely market valued risk free' would in Tom's case  imply a total minimal guaranteed portfolio return of nearly 1% (30% of 3% = 0.9% ≈ 1%) , corresponding with a minimal yearly pension benefit level of around 5645.

In case of 70% risk free investment approach (green line), the downside return risk would be limited to a minimal 2.1% return corresponding with a minimal pension of around 7506, approximately 75% of Tom's nominal pension target.

This 70% risk free approach could be quite acceptable for Tom, as he realizes there'll be no extra return without taking extra risk...

Nevertheless..., pension fund life and its member's choices ain't easy. So Tom asks the pension fund's actuary what his pension outcome would be on a 50 year evaluation basis.... here it is

Now Tom's risk of ending up with a yearly pension outcome of 10000 or less has decreased to a 15.3% (100-84.7). Tom could decrease this downside risk further to 8.6% by choosing a less risky asset mix of 70% risk free and 30% risky assets. However, this drops his upside potential. On average (50%) his pension outlook of around 23904 will drop to a little less than 17850.

Now Tom fully starts to grasp the impact of long term return assumptions...  After all, is assuming a 6% or 7% 50-year return not way to optimistic?

Your own Pension Confidence Level Calculator

As shown in the examples above the key questions are i.a. :

1. How much of your guaranteed* nominal pension P are you willing to risk to end up with a higher pension P+U
2. How much uncertainty (100% - confidence) are you willing to accept that your pension is lower than a certain amount?
3. What's the real (nonlinear) downside risk of my pension?

To find the answers to these kind of questions and to calculate your own pension perspective, you may download the

Pension Confidence Level Calculator

in Excel.

With the Pension Confidence Level Calculator you may calculate your pension confidence with all kind of asset mixes, co-variances, (pension) ages and several user definable life tables.

Remember the calculations are only illustrative and indicative approximations, to be used for instructional purposes. Ask your pension fund to make a more detailed and personal calculation.

Next

Now that you've experienced that most pension funds need an ambitious return that may put your nominal pension at risk, the question is what to do?

Main problem is that pension funds do not act in this alarming situation. As a kind of sitting duck they play a kind of 'waiting game' in the hope that bond yields and other markets recover.

Meanwhile you could at least do something to get the fuzzy pension picture clear. Simply follow this Cookbook :

Pension Fund Restructure Cookbook

1. Your Retirement Income is not a one point estimate, so ask your pension fund's actuary:
• to calculate what future average return rate is needed to (100%) fund the liabilities, given the actual market value of the assets of the pension fund
• to calculate (estimate) your future pension at different constant future return rates
• to estimate the probability level of achieving each future return rate or more (confidence level) for the rest of your life, in accordance with the applied actuarial models
2. Next, ask your actuary to formulate his advised investment risk approach in line with the Pension Eggs presentation as presented in this blog, but now with more nests.
3. Now let your board and pension members determine their risk appetite by voting which nest they choose
4. Finally, let the actuary in cooperation with the investment advisory committee, propose an 'investment strategy' that is completely in line with the new defined risk appetite 
5. Take a decision to (phase-wise) implement this new investment strategy.

Result

Perhaps the outcome of the above exercise will be a lower pension than you expected, but:

• probably not as low as you would have got if you kept on gambling on uncertain high returns 
• and certainly not lower than what you need and define as a decent minimum pension income 

Anyhow, enjoy the Pension Confidence Level Calculator....

Links/Downloads

- Download the Pension Confidence Level Calculator

- Long-range confidence interval projections and probability estimates

- Portfolio-optimization by the mean-variance-approach

- 'Employee Retirement Income Security Act - ERISA'

Humor: How Actuaries Can Help

Sources/Downloads
- Original artist Meera Sapra at Toondoo
- Blog 'Life is a Comic Strip' by Meera Sapra
- Download Powerpoint Version of this comic strip
- Download PPT-JPG Version of this comic strip

Actuarial Public Debt

The current definition of Public Debt is very poor. Only accrued past debt and current budget deficits are measured; no future obligations.

Hot from the press, the 'actuaries' behind the 83rd BIS Annual Report 2012/2013 show us the impact of the commitments to future spending on pensions and health care that are missing in current measure of public debt.

Age-related liabilities as a share of GDP, are projected to rise considerably between 2013 and 2040 in a number of countries.

Please notice that reforms enacted after December 2011, are not included in the next graph.

Actual Public Debt
End 2012, the impact of age-related liabilities on the actual public debt was calculated and analyzed by Stiftung Marktwirtschaft, in cooperation with the Research Centre for Generational Contracts.

In a report called "Honorable States? The Sustainability of European Public Finances in Times of Crisis" they calculated the effects for Europe as follows:

Reforming Social Security 
Without going into details, this graph makes perfectly clear that even an attitude of 'just managing debt' is hopeless and doomed to fail.

'Restructuring public debt' will only be possible if we have the courage to fundamentally restructure our social security system of pensions and health care. The sooner, the better.....

For those who still had hope on a positive U.S. outcome, just take a look at the debt-outcome of two non-EU countries:

Concluding Reflections
To get a sound picture of a country's financial sustainability, a first step would be to annually report real(istic) balance sheets on basis of actuarial public debt, e.g. debt including age related future obligations like state pensions and health care.

Ultimate, we need new market value based 'country state accounting principles' that include a complete set of  "future obligations" and "natural resources" (oil, gas, water power, etc.) on the asset side.

One of the main issues will be how to value a virtual and information society including fast changing and new future developments on basis of outdated valuation methods, developed in last decades of the last century.

Of course THE big challenge with such an ultimate country balance sheet will be how to value "human resources" as an asset. Why?

Because flexibility, responsiveness, education and entrepreneurship will eventually make the big difference in adapting a country's economy to a sustainable future. I suggest we start by valuing actuaries ;-).

Links/Sources:
- Spreadsheet with data used in this blog (xls)
-  83rd BIS Annual Report 2012/2013
- Report Honorable States? (2013)

Confidence Level Crisis

When you're - like me - a born professional optimist, but nevertheless sometimes worry about the unavoidable misery in the world, you ask yourself this question:

Why does God not act? 

Think about this question and try to answer it, before reading any further..

The answer to this question is very simple:

God does not act because he's conscious of everything  

The moral of this anecdote is that when you're fully aware of all the risks and their possible impact, chances are high you'll not be able to take any well-argued decision at all, as any decision will eventually fail when your objective is to rule out all possible risks.

You see, a question has come up that we can't agree on,
perhaps because we've read too many books.

Bertolt Brecht, Life of Galileo (Leben des Galilei)

On the other hand, if you're not risk-conscious at all regarding a decision to be taken, most probably you'll take the wrong decision.

'Mathematical Confident'

So this leaves us with the inevitable conclusion that in our eager to take risk-based decisions, a reasoned decision is nothing more than the somehow optimized outcome of a weighted sum of a limited number of subjective perceived risks. 'Perceived' and 'Weighted', thanks to the fact that we're unaware of certain risks, or 'filter', 'manipulate' or 'model' risks in such a way that we can be 'mathematical confident'. In other words, we've become victims of the "My calculator tells me I'm right! - Effect".

Risk Consciousness Fallacy
This way of taking risk based decisions has the 'advantage' that practice will prove it's never quite right. Implying you can gradually 'adjust' and 'improve' or 'optimize' your decision model endlessly.
Endlessly, up to the point where you've included so much new or adjusted risk sources and possible impacts, that the degrees in freedom of being able to take a 'confident' decision have become zero.

Risk & Investment Management Crisis
After a number of crises - in particular the 2008 systemic crisis - we've come to the point that we realize:

• There are much more types of risk than we thought there would be
• Most type of risks are nonlinear instead of linear
• New risks are constantly 'born'
• We'll not ever be able to identify or significantly control every possible kind of risk
• Our current (outdated) investment model can't capture nonlinear risk
• Most (investment) risks depend heavily on political measures and policy
• Investment risks are more artificial and political based and driven, than statistical
• Market Values are 'manipulable' and therefore 'artificial'
• Risk free rates are volatile, unsure and decreasing
• Traditional mathematical calculated 'confidence levels' fall short (model risk)
• As Confidence Levels rise, Confidence Intervals and Value at Risk increase

Fallacy
One of the most basic implicit fallacies in investment modeling, is that mathematical confidence levels based on historical data are seen as 'trusted' confidence levels regarding future projections. Key point is that a confidence level (itself) is a conditional (Bayesian) probability .

Let's illustrate this in short.
A calculated model confidence level (CL) is only valid under the 'condition' that the 'Risk Structure' (e.g. mean, standard deviation, moments, etc.) of our analysed historical data set (H) that is used for modeling, is also valid in the future (F). This implies that our traditional confidence level is in fact a conditional probability : P(confidence level = x% | F=H ).

Example

• The (increasing) Basel III confidence level is set at P( x ∈ VaR-Confidence-Interval | F=H) = 99.9% in accordance with a one year default level of 0.1% (= 1-99,9%).
• Now please estimate roughly the probability P(F=H), that the risk structure of the historical (asset classes and obligations) data set (H) that is used for Basel III calculations, will also be 100% valid in the near future (F).
• Let's assume you rate this probability based on the enormous economic shifts in our economy (optimistic and independent) at P(F=H)=95% for the next year.
• The actual unconditional confidence level now becomes P( x ∈ VaR-Confidence-Interval) = P( x ∈ VaR-Confidence-Interval | F=H) × P(F=H) = 99.9% × 95% = 94.905%

Although a lot of remarks could be made whether the above method is scientifically 100% correct, one thing is sure: traditional risk methods in combination with sky high confidence levels fall short in times of economic shifts (currency wars, economic stagnation, etc). Or in other words:

Unconditional Financial Institutions Confidence Levels will be in line with our own poor economic forecast confidence levels. 

A detailed Societe Generale (SG) report tells us that not only economic forecasts like GDP growth, but also stocks can not be forecasted by analysts.

Over the period 2000-2006 the US average 24-month forecast error is 93% (12-month: 47%). With an average 24-month forecast error of 95% (12-month: 43%), Europe doesn't do any better. Forecasts with this kind of scale of error are totally worthless.

Confidence Level Crisis
Just focusing on sky high risk confidence levels of 99.9% or more is prohibiting financial institutions to take risks that are fundamental to their existence. 'Taking Risk' is part of the core business of a financial institution. Elimination of risk will therefore kill financial institutions on the long run. One way or the other, we have to deal with this Confidence Level Crisis.

The way out

The way for financial institutions to get out of this risk paradox is to recognize, identify and examine nonlinear and systemic risks and to structure not only capital, but also assets and obligations in such a (dynamic) way that they are financial and economic 'crisis proof'. All this without being blinded by a 'one point' theoretical Confidence Level..

Actuaries, econometricians and economists can help by developing nonlinear interactive asset models that demonstrate how (much) returns and risks and strategies are interrelated in a dynamic economic environment of continuing crises.

This way boards, management and investment advisory committees are supported in their continuous decision process to add value to all stakeholders and across all assets, obligations and capital.

Calculating small default probabilities in the order of the Planck Constant (6.626 069 57 x 10^-34 J.s) are useless. Only creating strategies that prevent defaults, make sense.

Let's get more confident! ;-)

Sources/Links
- SG-Report: Mind Matters (Forecasting fails)
- Are Men Overconfident Users?

Europe: Who Pays Who?

Where are we heading with Europe? Let's examine some main topics that illustrate Europe's future direction.

EU Budget Development
The European budget comprises roughly 130,000 Million Euros yearly. The ongoing (2013) budget process in terms of 'net contributions' (= Benefits -Contribution) per country is not transparent. Only the figures until 2011 are available.

Let's take a look a the net contribution development from the start of Europe (2000) until the last available data in 2011. Countries that (net) receive money are 'placed above the x-axis, countries that (net) have to pay money are placed below the x-axis.

Clear is that the amount of money that is transferred from the North&West European countries to the South&East European countries is growing fast from around 15,000 Million Euro in 2000 to around 34,000 Million Euro in 2011.

In a stable Europe the net contributions should decline and vary. However, the opposite is the case!

Who Pays, Who Receives?
It's interesting to look at which countries in Europe are financing other countries.

Take a look at the 2011 transfer of money between all European countries. To create a clear overview, the numbers are rounded in Millions. As a consequence some rows or columns  might not exactly sum up to their total.

To illustrate this table:

• In 2011 Poland received 10,975 Million Euro, of which The Netherlands payed 711 Million Euro of the total of 2,214 Million Euro The Netherlands (net) payed
• Germany payed a net total of 9,003 Million Euros, of which 1,217 Million euro was payed to Greece

It really gets frightening when we analyse the total amount of money transferred between 2000 and 2011:

This table tells us inter alia:

• Over the period 2000-2011 a total amount of 253,119 Million Euro was transferred from North&West to South&East Europe. The end of this imbalanced flow of money is not yest in sight. The future looks dark, due to the current crises in Greece and Cyprus, as well as the worrying situation in Spain and Portugal. 
• Spain has already received 63,563 Million Euro of which 22,115 Million Euro was payed by Germany.
• Germany pay 88,067 Million Euro to support other structural failing European countries, and will continue to do so...... 

Declining Support
On top of the bad financial perspective as presented above, PEW Research recently published, the next survey results:

Only in Germany a small majority still 'believes' in Europe... Other European countries have given up on Europe. Overall, the support for an 'Integral Europe' is declining...

Let's end with the trust European countries have in each other. I leave the trivial conclusions up to the intelligent readers of this blog.. Please don't laugh, while examining the outcomes.

Conclusion
Europe..., how long will it last....???????

 Sources/Links
- Spreadsheets with data used in this blog
- EU Budget 2011
- Folketinget: Net EU Contributions
- PEW Research: The New Sick Man of Europe: the European Union

Willem-Alexander, the New Dutch King

Today - April 30, 2013 - is a special day for The Netherlands.

After 123 years of Dutch queens and a 33-year reign of Queen Beatrix, Willem-Alexander (46) has become the new king in the Netherlands. He's also the youngest monarch in Europe.

A Modern King
Willem-Alexander, a modern King who - together with his wife Maxima and their three lovely daughters - makes his first 'statement' by demonstrating he stands with and for the people that he represents, as his complete family spontaneously appears on stage together with the world's No. 1 DJ Armin van Buuren and the the Dutch Royal Concertgebouw Orchestra.

New Challenges
In his inauguration speech Willem-Alexander stated he's taking the job at a time when many people in the Netherlands feel vulnerable and uncertain. Vulnerable in their work or health. Uncertain about their income or home environment.

Unemployment
And indeed, according to Eurostat unemployment rates in The Netherlands (6.4%) and Europe (10.9%)  are spiking. In Spain even 26.7% of the population is jobless....

Moreover, younger people (under age 25) suffer most from unemployment:

A new generation with good intentions
Willem-Alexander stated that he's concerned about these developments and will contribute to a better world through cooperation, by strengthening the bond of mutual trust between the people and their government, maintain our democracy and serve the public interest.

We need a positive new generation with people like Willem-Alexander.
Let's hope he succeeds! 

Sources 

- Picture: Volkskrant

- Eurostat Unemployment Rates