Pension funds serve to collect and manage an amount of capital, sufficient to make all payments to which participants of the fund are entitled based on the pension plan. The Akzo Nobel Pension Fund
(APF) is responsible for the provision of pensions for all employees of Akzo Nobel in the
Netherlands. It is the task of the Pensions and Insurance Supervisory Authority (PVK) to provide
rules and regulations which guarantee that pension funds are able to fulfill their pension promises. In response to economic and demographic changes in the environment in which pension funds operate,
the PVK drafted a new Financial Assessment Framework (FTK) that is meant to become effective as
of January 1st 2006.
Essential in the new FTK is the fact that the pension liability resulting from a defined benefit pension plan has to be calculated using market value interest yields as discount rates as opposed to the
current practice which uses a fixed rate for discounting pension liabilities. The new FTK increases
the risk exposure of pension funds, since the value of the liabilities will depend on volatile interest rates. As a result, the volatility of the funding ratio of the pension fund will also increase compared
to the current situation in which the liability value is not influenced by changes in market interest rates. This thesis aims to analyze the impact of the new valuation method of liabilities on the asset allocation of the APF.
[...] Based on a term structure the present value of the liabilities of a pension fund can be calculated Implications of market valuation on the asset mix 5 Implications of market valuation on the asset mix 5.1 Introduction Chapter 4 shows that pension funds have to manage additional variance in the funding ratio as a result of the market valuation of the liabilities. Section 5.2 introduces a model for the analysis of the development of the asset portfolio. Given the development of the assets and liabilities over time, it is possible to analyze the funding ratio of a pension fund. [...]
[...] Figure illustrates that the addition of inflation linked securities does reduce the downside risk for the pension fund Probability density function of simulated funding ratio Funding Ratio Figure 6.5 .4: Comparison of the distribution of the funding ratio of the current asset mix to a mix containing inflation linked securities. Under the actuarial valuation method for liabilities investing in inflation linked securities is less attractive. Considering the fixed discount rate, the asset portfolio must generate a real return of to finance indexation. [...]
[...] The data range of the returns of Emerging Markets equities and Real Estate equities is shorter than for the other equities, hence the figures for these two asset classes contain less data points Appendix D Appendix Duration in more detail This appendix shows that the duration is a measure of elasticity of a fixed income security with respect to changes in interest rates. Hopewell and Kaufmann (1973) argued that a given basis point change in market yield, percentage changes in bond prices vary proportionally with duration.” They base their conclusion on the following calculations. [...]
[...] I 1 INTRODUCTION AND PROBLEM STATEMENT Introduction A new Financial Assessment Framework Stakeholders of pension funds Pension Funds and Financial Risk Problem statement Research Set- Up A PENSION FUND IN RELATION WITH AKZO NOBEL Introduction Akzo Nobel Pension Plans Three pillars of pension plans Two types of pension plans Akzo Nobel Pension Fund Akzo Nobel Pension Fund facts and figures Akzo Nobel Pension Fund structure Current Investment Strategy Summary CHANGING THE VALUATION OF PENSION PLANS Introduction The Pensions and Insurance Supervisory Authority Driving factors for reform in pension supervision The size of pension funds Aging Population Equity market developments Interest rate developments Pension Accounting Standards New Financial Assessment Framework (FTK) Summary I Table of contents 4 ESTIMATING THE LIABILITIES OF THE AKZO NOBEL PENSION FUND Introduction Considerations in estimating the present value of pension fund liabilities The definition of present value of liabilities Actuarial assumptions Estimating liabilities in practice Development of the population of the pension scheme Projection of future cash flows The market value of pension liabilities Term structure models Pricing kernel and no-arbitrage assumption An affine nominal term structure model The model in practice Summary IMPLICATIONS OF MARKET VALUATION ON THE ASSET MIX Introduction Development of the funding ratio A model for the development of the equities of the APF Valuing fixed income securities based on the term structure Duration The funding ratio Simulation results Fair value compared to actuarial valuation Summary APPROACHES TO A STABLE FUNDING RATIO Introduction Increasing the level of fixed income securities in asset allocation Increasing the duration of the fixed income portfolio Cash flow matching Conditional indexation Portfolio composition Summary BIBLIOGRAPHY APPENDIX DERIVATION OF THE TERM STRUCTURE MODEL APPENDIX GRAPHIC VALIDATION OF THE TERM STRUCTURE MODEL APPENDIX GRAPHIC VALIDATION OF SIMULATED ASSET RETURNS APPENDIX DURATION IN MORE DETAIL APPENDIX SIMULATED TERM STRUCTURES II Introduction and problem statement 1 Introduction and Problem Statement 1.1 Introduction A new Financial Assessment Framework The Dutch system of social security is based on the view that every citizen has the right to a decent standard of living. [...]
[...] The models for estimating the value of the assets and liabilities of a pension fund are subject to many parameters such as mortality rates, discount rates, inflation rates etc. Under slightly different assumptions and parameter values, the estimation of the funding ratio can 19 Changing the valuation of pension plans lead to very different results. This makes it very complicated and tricky to analyze and compare the figures in the financial statements of companies that are sponsoring a pension fund. [...]
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