Bringing you live news and features since 2013
Bringing you news, views and analysis since 2013

12219

Academics publish rules for modelling pension plans

RELATED TOPICS​

The Pensions Institute at Cass Business School has published a set of 15 “good practice” principles for modelling defined contribution (DC) pension plans.

 
Based on more than a decade of research, the principles aim to help pension providers design better pension plans. 
 
The principles cover: model specification and calibration; modelling quantifiable uncertainty; modelling member choices; modelling member characteristics, such as occupation and gender; modelling plan charges; modelling longevity risk; modelling the post-retirement period; integrating the pre- and post-retirement periods; modelling additional sources of income, such as the state pension and equity release; modelling extraneous factors, such as unemployment risk, activity rates, taxes and entitlements; scenario analysis and stress testing; periodic updating of the model and changing assumptions.
 
The principles are consistent with the recently published OECD guidelines for designing DC pension plans. They also meet the European Insurance and Occupational Pensions Authority’s (EIOPA) set of good practices on information provision for DC plans.
 
The principles are:
 
Principle 1: The underlying assumptions in the model should be plausible, transparent and internally consistent.
 
Principle 2: The model’s calibrations should be appropriately audited or challenged, and the model’s projections should be subject to backtesting.
 
Principle 3: The model must be stochastic and be capable of dealing with quantifiable uncertainty.
 
Principle 4: A suitable risk metric should be specified for each output variable of interest, especially one dealing with downside risk. Examples would be the five per cent value-at-risk and the 90 per cent prediction interval. These risk metrics should be illustrated graphically using appropriate charts.
 
Principle 5: The quantitative consequences of different sets of member choices and actions should be clearly spelled out to help the member make an informed set of decisions.
 
Principle 6: The model should take account of key member characteristics, such as occupation, gender, and existing assets and liabilities.
 
Principle 7: The model should illustrate the consequences of the member’s attitude to risk for the plan’s asset allocation decision. It should also show the consequences of changing the asset allocation, contribution rate and planned retirement date, thereby enabling the member to iterate towards the preferred combination of these key decision variables.
 
Principle 8: The model should take into account the full set of plan charges.
 
Principle 9: The model should take account of longevity risk and projected increases in life expectancy over the member’s lifetime.
 
Principle 10: The model should project both at-retirement pension outcomes and post-retirement outcomes. The risks associated with the following strategies should be clearly illustrated:
• the risk of taking a level rather than an index-linked annuity in terms of a reduced standard of living at high ages,
• the risks associated with drawdown strategies in terms of taking out more from the fund initially than is justified by subsequent investment performance.
 
Principle 11: The model should consider the pre- and post-retirement periods in an integrated way. This is necessary to avoid undesirable outcomes at a later date – such as a big fall in the standard of living in retirement. It will also help to determine what adjustment in member choices – in terms of higher contribution rate, an increased equity weighting and later retirement – are needed to avoid this.
 
Principle 12: The model should consider other sources of retirement income outside the member’s own pension plan. These include the state pension and home equity release. A well-designed DC model will also help with lifetime financial planning.
 
Principle 13: The model should reflect reality as much as possible and allow for such extraneous factors as unemployment risk, activity rates, taxes and welfare entitlements.
 
Principle 14: Scenario analysis and stress testing are important. For any given scenario, one should also:
• Make key assumptions explicit;
• Evaluate key assumptions for plausibility; and
• Stress test assumptions to determine which really matter and which do not. This allows the modeller to determine the important assumptions and focus on getting them (as much as possible) ‘right’.
 
Principle 15: The model will need to be updated periodically and the assumptions changed. Such modifications should be carefully documented and explained in order to make sure the model retains its credibility with users.
 
Professor David Blake, director of the Pensions Institute at Cass Business School and one of the co-authors of the principles, says: “Most DC pension plans are currently very badly designed. If a DC plan was well designed, it would be a single, integrated financial product that delivers at reasonable cost to the plan member a pension that provides a high degree of retirement income security. This pension should provide an adequate replacement income for the remaining life of the plan member (and possibly also a partner) and should remove the risk that the member outlives his or her resources. A well-designed plan will therefore be designed from back to front, that is, from desired outputs to required inputs.
 
“The reason that most DC plans are not well designed is that they are not modelled properly. For example, they do not take account of factors such as the member’s occupation, or the possibility of career breaks for child care reasons, or likely increases in life expectancy over the life of the plan member. The principles of good practice can be applied to develop more reliable and robust models. Projections from the models can then be used to more effectively guide both plan design and member choices.”
 
The Pensions Institute is holding a consultation on the principles until 31 May.  

Latest News

The trading and investment platform eToro has extended its proxy voting feature to all stocks..
C8 Technologies, the London-based fintech founded by former BlueCrest Capital Management partners Mattias Eriksson and..
DWS has announced the latest development in its strategic growth push in Alternative Credit with..

Related Articles

The trend of private equity firms acquiring businesses in the professional services sector continues with CVC Capital Partners eyeing a possible buyout of EY’s Italian consulting branch...
The trend of private equity firms acquiring businesses in the professional services sector continues with CVC Capital Partners eyeing a..
Pension funds
UK defined benefit (DB) pension plan sponsors could have access to GBP 1.2 trillion in surplus assets over the next decade, industry research reveals...
UK defined benefit (DB) pension plan sponsors could have access to GBP 1.2 trillion in surplus assets over the next..
Tim Crawmer, Payden & Rygel
Tim Crawmer and Frasat Shah of Payden & Rygel write that higher yields are attracting more demand from investors. Also, given that equities had a strong year last year, big funds have taken some chips off the table in equities and put them into fixed income...
Tim Crawmer and Frasat Shah of Payden & Rygel write that higher yields are attracting more demand from investors. Also,..
Lady justice
Top marks for the Pensions Regulator (TPR) whose efforts to improve resilience in the UK pension funds’ liability-driven investment (LDI) strategies received glowing commendations from the Bank of England in its March report...
Top marks for the Pensions Regulator (TPR) whose efforts to improve resilience in the UK pension funds’ liability-driven investment (LDI)..
Subscribe to the Institutional Asset Manager newsletter

Subscribe for access to our weekly newsletter, newsletter archive, updates on the site and exclusive email content.

Marketing by