Actuaries and Asset Allocations

[rcline46]

We are receiving pressure from a broker who claims that an actuary should be involved, actually must be involved, in the asset allocation of a plan. He is pushing a Dynamic Asset Allocation method and says the actuary should be making the decision on the asset allocation (not the actual products, but the allocation). Especially to 'de risk' a plan as it approaches 100% funding.

My first impression is that this will make the actuary a fiduciary to the plan which is not a good thing. Second, this could increase the actuary's income to do the analysis (ala Fasb 158 or whatever its called today). But more importantly, I think the broker is trying to minimize their liability.

Are there any thoughts the actuaries out there care to make on this new tactic?

[Andy the Actuary]

Years ago, I worked with a number of British Actuaries who would suggest that this fellow "get bent." Translated, he should stick his head in a simply impossible place. Never lose sight that the broker is not your client, unless he is paying you, and then you have an option of reassessing your relationship.

On the other side of these instructions, the actuary may suggest providing cash flow projections, weighted benefits duration, and other supporting information that may be of value to those determining asset allocations.

[frizzyguy]

On larger plans, actuaries will perform an asset liability model where they duration match liabilities to investments. This is a very expensive project though and it needs to be reviewed with the client. Also, this is only a suggestion and then the broker and the client would move the assets where they feel is a good fit. I don't know if that would make you the fiduciary if you perform that project though. That's like giving the client a recommended contribution with their valuation report.

That being said, I'm in agreement with the British actuaries.

Just curious, do you know how many DB plans does this particular broker works with?

[Effen]

I don't think there is anything wrong with the actuary being "involved" with the asset allocation as long as the involvment is informational. I would rather have an investment advisor discuss what he is thinking before he just buys something that really doesn't fit. The actuary should explain the plan and make sure they understand how the plan works so that the investment advisor can do his job. That said, the ultimate responsibility should stay with them.

[david rigby]

Excellent replies above. In particular, if the plan is large enough, and the sponsor willing to pay for it, the actuary can perform asset liability modeling. This is stochastic modeling, usually of alternative asset mixes, and covers multiple years with probabilities that certain outcomes will be met (such as, the plan's funded ratio will be at least X%). As frizzyguy states, this is not cheap, and must also include the sponsor's agreement willingness to fund the plan.

The end result is NOT the single best asset mix, but a model of how different mixes and cash flow patterns are expected to behave. It does not make the actuary a fiduciary; instead it takes advantage of the actuary's consulting and mathematical skills to help the plan sponsor manage the plan's future. That's a good thing, a very good thing.

[Andy the Actuary]

Frizzy introduces the erstwhile befitting but presently confused concept of "fit." Actuarial projections can be made based upon assumed interest rates that relate to reasonable long-term returns that an investment allocation might produce. Unfortunately, it is only of the remote possibilities that under an asset allocation based upon this analysis that theoretical liabilities will fit statutory projections unless the investment allocation is in a bond portfolio that has the same qualities as the IRS funding yield curve. What else fits while minimizing volatility? Of course, managing volatility might not be the primary objective and sometimes the objectives compete. In short, defining "fit" is a oftentimes overlooked or underplayed or under-managed task. The actuary can support the plan sponsor in this determination but should still urge the broker to "get bent" if the broker contends the actuary should determine the asset allocation.

[frizzyguy]

I think the idea is not to completely minimize volatility but is a calculated way for a large pension plan, who has the law of large numbers on its side, to take on risk to allow the assets to do a bit of the heavy lifting. I don't think that this is necessarily as remote as you might think, again, only for a large plan.

I think that duration is a pretty sound concept. There are actuaries who only speak greek everyday because obviously someone thinks this idea must be kinda right? (Greek, get it!)

[Andy the Actuary]

Can't speak for your plans. Can only speak for a couple of frozen insurance company plans where balance sheet is key concern and cash outlay is non-issue. They would be delighted if assets and liabilities moved in concert, though I'm wont to understand how putting in more money (because of low investment returns) to control volatility is desirable.

[frizzyguy]

Can't speak for your plans. Can only speak for a couple of frozen insurance company plans where balance sheet is key concern and cash outlay is non-issue. They would be delighted if assets and liabilities moved in concert, though I'm wont to understand how putting in more money (because of low investment returns) to control volatility is desirable.

I'm right now working on a one man plan who is 70 and has assets are completely in stocks...errrr a stock. My ALM expirience is from a past life and is more academic than practical.

[SoCalActuary]

Can't speak for your plans. Can only speak for a couple of frozen insurance company plans where balance sheet is key concern and cash outlay is non-issue. They would be delighted if assets and liabilities moved in concert, though I'm wont to understand how putting in more money (because of low investment returns) to control volatility is desirable.

I'm right now working on a one man plan who is 70 and has assets are completely in stocks...errrr a stock. My ALM expirience is from a past life and is more academic than practical.

This extreme risk tolerant position is fine if the AB is low, with lots of room below the 415 limit, and assets well above the PVAB. But he does have to consider the potential for catastrophe.

[frizzyguy]

I was exaggerating my situation but he's in a pretty aggressive asset mix. We told him what might happen. Maybe I should offer an ALM study for him!

[david rigby]

... a large pension plan, who has the law of large numbers on its side...

For the non-actuaries out there reading this, the "law of large numbers" is not a "law" at all, but just reflects some ability to predict overall patterns, at least approximately. In any particular case or ALM study, the actuary will take note of any special demographic or plan characteristics that might cause (or increase) volatility in any measurement.

In other words, hiring an actuary is a great idea!

[Andy the Actuary]

... a large pension plan, who has the law of large numbers on its side...

For the non-actuaries out there reading this, the "law of large numbers" is not a "law" at all, but just reflects some ability to predict overall patterns, at least approximately. In any particular case or ALM study, the actuary will take note of any special demographic or plan characteristics that might cause (or increase) volatility in any measurement.

In other words, hiring an actuary is a great idea!

"Law of Large Numbers" ~ If you eat enough celery, you will become large?

[SoCalActuary]

... a large pension plan, who has the law of large numbers on its side...

For the non-actuaries out there reading this, the "law of large numbers" is not a "law" at all, but just reflects some ability to predict overall patterns, at least approximately. In any particular case or ALM study, the actuary will take note of any special demographic or plan characteristics that might cause (or increase) volatility in any measurement.

In other words, hiring an actuary is a great idea!

"Law of Large Numbers" ~ If you eat enough celery, you will become large?

No, in the end, you have nothing....