Challenges for pension actuaries

In a speech given by Superintendent Julie Dickson (OSFI) to the Actuaries Club of Toronto, she concluded with 4 points that, while directed towards the work of actuaries for insurance companies, apply equally strongly to pension plan actuaries:

• The bar is rising in all areas of risk management, and that includes actuaries;
• Stress testing and capital planning are two areas where more is being demanded from actuaries;
• Introduction of IFRS – especially phase 2 – presents challenges that the profession should embrace. There can be a very important role, under IFRS, for the CIA and the ASB to maintain solid practices in Canada while still following IFRS standards that are principle-based; and
• The global financial crisis provides actuaries with a tremendous opportunity to demonstrate value and expand their influence, effectiveness and impact.

Dutch pension plan for western Canada?

If the federal government does not move quickly to create a national pension program, the premiers of Canada's three westernmost provinces have pledged to push ahead to develop a regional pension plan in 2010.

The premiers of British Columbia, Alberta and Saskatchewan expressed concern that too few people have adequate retirement savings, noting that only two in 10 employees in the private sector have a company pension plan. They also noted that the number of retirees will increase rapidly as baby boomers stop working.

Many suggestions have been pressed on the federal government as to how to improve the national programs. These include:

• doubling the CPP pension benefits
• increase the OAS from about 15% of the average industrial wage to 75%
• allow non-working spouses to gain entitlement to CPP benefits, either on a purchased or government sponsored basis
  
• introduce a Dutch styled supplemental plan to top up the existing CPP and OAS
  

Of these a Dutch styled plan may be the most amenable to regional adoption. The Dutch styled plan is a collective DC plan that would suit as a company pension plan. Under these plans, the sponsor’s contribution rate is fixed for at least five years but, the pension benefits are denominated as a career average DB plan. Benefits earned each year are expected to be indexed, as are retiree benefits, based on a combination of targeted contributions and fund performance. While the basic benefits are very likely to be paid, they along with the indexing are not fully guaranteed.

Basic plan benefits are funded on a solvency basis. The plan must be more than 105% solvent before partial indexation can be provided, and more than 130% solvent before full indexation can be provided. The sponsor may not recover surplus. Contribution rates may be reset every five years, but current contributions cannot be used to cover past shortfalls. The plan structure means that the sponsor avoids having to realize liabilities on its financial statement. Individual account DC plans are rare in the Netherlands, due to their high administrative costs and bad publicity about their risk.

It will be interesting to see whether the premiers adopt a similar pension plan.

Rethinking Foundations

Paul Krugman, a NY Times columnist and winner of the 2008 Nobel Memorial Prize in Economic Science, writes in this Sunday's NYT about how did economists get the recssion so wrong. He has some important conclusions:

"So here’s what I think economists have to do. First, they have to face up to the inconvenient reality that financial markets fall far short of perfection, that they are subject to extraordinary delusions and the madness of crowds. Second, they have to admit — and this will be very hard for the people who giggled and whispered over Keynes — that Keynesian economics remains the best framework we have for making sense of recessions and depressions. Third, they’ll have to do their best to incorporate the realities of finance into macroeconomics."

"When it comes to the all-too-human problem of recessions and depressions, economists need to abandon the neat but wrong solution of assuming that everyone is rational and markets work perfectly. The vision that emerges as the profession rethinks its foundations may not be all that clear; it certainly won’t be neat; but we can hope that it will have the virtue of being at least partly right."

Similar comments can be made about the need for actuarial profession to rethink its foundations. Fortunately, as per my last post, steps are being taken to do that - at least in the area of pension plans. But until this happens, how can we ensure that we don't repeat past mistakes?

Nassim Taleb, author of The Black Swan: The Impact of the Highly Improbable, offers ten principles for a Black Swan-proof world. Of these, three seem particularly important for pension plans:

• Do not let someone making an “incentive” bonus manage a nuclear plant – or your financial risks. Odds are he would cut every corner on safety to show “profits” while claiming to be “conservative”. Bonuses do not accommodate the hidden risks of blow-ups. It is the asymmetry of the bonus system that got us here. No incentives without disincentives: capitalism is about rewards and punishments, not just rewards.
• Counter-balance complexity with simplicity. Complexity from globalisation and highly networked economic life needs to be countered by simplicity in financial products.
• Citizens should not depend on financial assets or fallible “expert” advice for their retirement. Economic life should be definancialised. We should learn not to use markets as storehouses of value: they do not harbour the certainties that normal citizens require. Citizens should experience anxiety about their own businesses (which they control), not their investments (which they do not control).