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Employer Pensions, Risk and Asset Allocation

Employer Pensions, Risk and Asset Allocation. Mike Orszag. Rome, April 2, 2003. Guarantees for Individuals. Pensioners paid first Others paid next Example: pension scheme 75% funded, 50% of liabilities pensioner liabilities Pensioners are paid in full, others get 50% of benefits.

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Employer Pensions, Risk and Asset Allocation

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  1. Employer Pensions, Risk and Asset Allocation Mike Orszag Rome, April 2, 2003

  2. Guarantees for Individuals • Pensioners paid first • Others paid next Example: pension scheme 75% funded, 50% of liabilities pensioner liabilities Pensioners are paid in full, others get 50% of benefits

  3. Level of Exposure to Risk • FTSE100 returns for 2001 • Pension liabilities / market cap: • average = 40% in 2001 • 8 companies over 100%

  4. Deficits 2001 FTSE100: £11bn By end of 2002 much, much worse (£170bn in equities in 2001)

  5. Liabilities Matter • Correlations: • volatility and pension liabilities/market cap - 0.46 Volatility and pension liabilities/free operating cashflow – 0.50 • Pension risk variables can explain roughly 25-35% of cross-sectional volatility in the market

  6. Employer Asset Allocation • Minimum risk is not necessarily in bonds • Equity in pension fund should depend on: • Maturity of pension scheme • Size of exposure to risk by company • Covenant risk

  7. Empirical Evidence • FRS17 disclosures for FTSE 100 for 2001 • How much do risk fundamentals impact on asset allocaiton?

  8. Empirical Evidence • Pension liabilities relative to wage/salary bill is a good measure of maturity • How correlated is it with equity allocation of pension fund? • Elasticity of equity share with respect to pension liabilities/wage salary bill is -0.002

  9. Maturity

  10. Maturity

  11. Empirical Evidence • Covenants – volatility of equity prices is a potentially good measure of how much debt a company has and therefore how strong the pension promise is • Implied and historical volatility • Elasticity of implied at the money volatility on calls on Nov. 19 is -0.039 (t statistic -0.34)

  12. Covenants

  13. Exposure • Pension liabilities relative to market cap is one measure • Elasticity is -0.26 – statistically insignificant from 0 • Pension deficits relative to pension liability is another • Elasticity is -0.13 – again statistically insignificant

  14. Pension Surplus/Pension Liability

  15. Pension Liabilities/Market Cap

  16. Putting it Together

  17. Putting it all together • Our four variables can explain only about one-tenth of cross-sectional differences in equity shares of pension funds. • High exposure to risk by companies • Not necessarily less risk for individuals

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