University of NSW
23 September 2002
Guest Lecture
John Ferraro
James Fitzpatrick
WWW.WATSONWYATT.COM
Agenda

Asset Liability Modelling (ALM)

Working at Watson Wyatt
- James Fitzpatrick
- John Ferraro
Please interrupt if you have a question
The “Problem”

A Trustee’s superannuation fund has lost 10%
over the last few years due to poor investment
markets. With the coverage of assets over
liabilities now at only 100%, further losses will
mean that the Fund will be under-funded.

The “Problem”: the Trustee has asked for
strategic advice to minimise the chance that
the Fund’s coverage of liabilities falls further.
The Solution

The Trustee can benefit from an ALM

What is an ALM?

Why is it needed here?
- stochastic model versus deterministic
- identifies risk

The solution might mean a new strategy
Steps in ALM

Setting asset assumptions

Setting asset allocation strategies

Building the liability model

Running simulations

Interpreting results
Asset Assumptions

Global framework/model

Returns, standard deviations and correlations:
- Australian equities
- International equities
- Australian fixed interest
- Listed property
- Direct property
- International fixed interest
- Cash
- Inflation, and more ……
Asset allocation strategies

The Strategy is the long term weight or
allocation to each asset class

Example:
Australian equities
International equities
Property
Australian fixed interest
International fixed interest
30%
30%
10%
15%
15%
Liability Model

Actuarial input useful for superannuation funds

Imitate actuarial valuations in calculating
contribution rates under each scenario

Conflict: Actuarial (prudent) versus ALM (best
estimate) assumptions
Running Simulations

How many is enough? 5000?

Platform? Watson Wyatt uses Excel/Visual
Basic

Data stored in Access tables

Complex funds can take a number of hours to
run
Interpreting Results

Results need to be interpreted and presented
to the client

Recommendations may (and usually) do mean
a change in strategy

Examples of results:
Example 1: Return Definition?
Vested Benefits Index
XYZ Superannuation Fund
VBI in year 2011 (Active members only)
(Pension liability 80% immunised)
200%
150%
100%
50%
0%
row
th
wth
Gro
wth
Gro
%G
100
90%
80%
wth
50th-75th
Gro
wth
Gro
wth
Gro
wth
Gro
wth
Gro
wth
Gro
25th-50th
70%
60%
50%
40%
30%
20%
wth
Gro
wth
Gro
10%
0%
5th-25th percentile
Example 2: Risk Definition?
Probability of under-funding
XYZ Superannuation Fund
80% Immunised
Probability of VBI < 100% in at least one year over the period - Current
90%
80%
70%
60%
50%
40%
2002
2003
2004
2005
2006
2007
Year
2008
2009
2010
2011
Working at Watson Wyatt –
James Fitzpatrick

Graduated in 2000 with a Bachelor of
Commerce majoring in Actuarial Studies

Joined Watson Wyatt in 2001 in the actuarial
practice

Work in client teams helping Trustees:
- actuarial valuations
- group life reviews
- ad hoc problem solving (eg legislative
changes)
Working at Watson Wyatt –
John Ferraro

Joined Watson Wyatt in 1994

Worked in a number of departments:
- IT
- IT/Administration
- Superannuation Consulting
- Investment Consulting

Currently provide investment advice to
Trustees on strategy, manager selection and
monitoring.