Preface INTEGRATED RISK MANAGEMENT IN PENSION FUNDS Marco Micocci, Greg N Gregoriou, and Giovanni B Masala The world of pension funds is facing a period of extreme changes Countries around t he w orld ve ex perienced u nexpected i ncreases i n l ife ex pectancy and fertility rates, changing accounting rules, contribution reductions, low financial returns, and abnormal volatility of markets All these elements have led to a fall in funded systems and to an increase in the dependency ratios in many countries U.K and U.S pension funds, which have traditionally had relatively high equity allocations, have been hit hard Many public pay-as-you-go (PAYGO) systems in Europe are reducing t heir “ generosity” w ith n ew c alculation r ules po inting t oward t he reduction of the substitution ratios of workers Europe is moving toward a risk-based approach also for the regulation and the control of the technical risk of funded pension schemes Risk management is becoming highly complex both in public pension funds and in private pension plans, requiring the expertise of different specialists who are not frequently disposable in the professional market The world is quite rich with skilled investment managers but their comprehension of the demographic and of the actuarial face of pension risk is often inadequate On the other hand, you have many specialized actuaries who are able to perform very sophisticated calculations and forecasts of pension liabilities but who are not able to fully understand the coexistence (or integration) of financial and actuarial risks Also, the international accounting standards i ntroduce new ac tuarial a nd financial elements i n t he ba lance sheet of the firms that may affect the corporate dividend and its investment ix © 2010 by Taylor and Francis Group, LLC x ◾ Preface policy In other words, little is being said about the integration of actuarial and financial risks in the risk management of pension funds We believe t he chapters in t his book highlight and shed new light on the current state of pension fund risk management and provide the reader new technical tools to face pension risk from an integrated point of view The exclusive new research for t his book can assist pension f und executives, r isk m anagement d epartments, c onsultancy firms, a nd ac ademic researchers to hopefully get a clearer picture of the integration of risks in the pension world The chapters in this book are written by well-known academics a nd p rofessionals w orldwide wh o ve p ublished n umerous journal articles and book chapters The book is divided into four parts— Part I: Financial Risk Management; Part II: Technical Risk Management; Part I II: Reg ulation a nd S olvency T opics; a nd P art I V: I nternational Experience in Pension Fund Risk Management In P art I , C hapter f ocuses o n t he co rrect m easurement o f r isk i n pension funds The author formalizes an intuitive concept of investment risk i n p roviding f or pens ions, t aking i t a s a m easure o f t he financial impact when the actual investment experience differs from the expected Investment risk can be explicitly measured and, through a series of case studies, the author estimates the investment risk associated with different investment strategies in different markets over the twentieth century He shows t hat w ithin a b road r ange, t he relative i nvestment r isk a ssociated w ith d ifferent st rategies i s n ot pa rticularly sens itive t o h ow t he pension objective is framed The investment risk associated with equity investment can be o f t he same order of magnitude as bond i nvestment if the bond duration mismatches those of the targeted pension He suggests that failure to explicitly measure investment risk entails that pension portfolios might not be optimally structured, holding the possibility that i nvestment r isks co uld be r educed w ithout r educing t he ex pected pension proceeds In Chapter , t he authors scrutinize t he f und dy namics u nder a per formance-oriented a rrangement (i.e., bonus fees a nd downside pena lty), whereby a st ochastic co ntrol i s f ormulated t o f urther cha racterize t he defined contribution (DC) pension schemes A five-fund separation theorem i s der ived to cha racterize its optimal st rategy W hen per formanceoriented arrangement is taken into account, the fund managers tend to increase the holdings in risky assets Hence, an incentive program has to be carefully implemented in order to balance the risk and the reward in DC pension fund management © 2010 by Taylor and Francis Group, LLC Preface ◾ xi Chapter p roposes a n a ttribution m odel f or m onitoring t he per formance a nd t he r isk o f a defined benefit ( DB) pens ion f und The model is ba sed on a l iability benchmark t hat reflects t he r isk a nd return cha racteristics of the liabilities As a result, the attribution model focuses the attention of the portfolio managers on creating a portfolio that replicates liabilities The attribution model a llocates d ifferences i n return between the actual portfolio and the benchmark portfolio to decisions relative to the benchmark portfolio In addition, the model decomposes risks according to the same structure by using a measure of downside risk Chapter i nvestigates a n optimal investment problem faced by a DC pension f und ma nager u nder inflationary risk It is assumed t hat a r epresentative member of a DC pension plan contributes a fi xed share of his salary to the pension fund during the time horizon The pension contributions are invested continuously in a risk-free bond, an index bond, and a stock The objective is to maximize the expected utility of terminal value of the pension fund By solving this investment problem, the author presents a way to deal with the optimization problem, in case of an (positive) endowment (or contribution), using the martingale method Chapter deals with the study of a pension plan from the point of view of dy namic o ptimization This sub ject i s c urrently w idely d iscussed i n the literature The optimal management of an aggregated type of DB pension fund, which is common in the employment system, is analyzed by a mean–variance portfolio selection problem The main novelty is that the risk-free ma rket interest rate is a t ime-dependent f unction a nd t he benefits are stochastic In C hapter , t he a uthor h ighlights t he fac t t hat a pens ion f und i s a complex system Asset a nd liability ma nagement (ALM) models of pension f und p roblems i ncorporate, a mong o thers, st ochasticity, l iquidity control, population dynamics, and decision delays to better forecast and foresee solvency i n t he long ter m I n order to model u ncertainties or to enable multicriteria analyses, many methods are considered and analyzed to obtain a dynamic asset and liability management approach In Chapter 7, the authors investigate the optimal asset allocation of U.S pension f unds b y t aking i nto acco unt t he f unds’ l iabilities B esides t he traditional i nputs, such a s ex pected r eturns a nd t he covariance ma trix, the uncertainty of expected returns plays a crucial role in creating robust portfolios t hat a re less sensitive to small cha nges i n i nputs The authors illustrate this with an example of a pension fund that decides on investing in emerging market equities © 2010 by Taylor and Francis Group, LLC xii ◾ Preface Chapter explains that most pension funds already manage the different risks they face, but usually from a “single stakeholder” pension fund perspective, typically expressed in, e.g., the risk of funding shortfall The many d ifferent st akeholders i n pens ion f unds, such a s t he em ployees, retirees, and sponsors, all bear different risks, but there is often hardly any insight i n t he objective ma rket va lue of t hese r isks In add ition, t here is usually no explicit compensation agreement for those who bear the risks Therefore, a tech nique that identifies and values these stakeholders’ risks has many useful applications in pension fund management Chapter focuses on value-at-risk (VaR) VaR has become a popular risk measure of financial risk and is a lso used for regulatory capital requirement purposes in banking and insurance sectors The VaR methodology has be en de veloped ma inly f or ba nks t o co ntrol t heir sh ort-term ma rket risk A lthough, VaR is a lready w idespread in financial industry, t his method has yet to become a standard tool for pension funds However, just as any other financial institution, pension funds recognize the importance of m easuring t heir financial r isks The a im o f t his cha pter i s t o spec ify conditions u nder wh ich V aR co uld be a g ood m easure o f l ong-term market risk Chapter 10 examines the effects of taxation, risk sharing between t he employer and employees, and default insurance on the asset allocation of DB pension schemes These three factors can have a powerful effect on the optimal asset allocation of a fund The authors show that the three factors have the potential to create conflict between the employer and the employees, particularly when the employer is not subject to taxation In Part II, Chapter 11 is devoted to examining how uncertainty regarding f uture m ortality a nd l ife ex pectancy o utcomes, i e., l ongevity r isk, affects employer-provided DB private pension plan liabilities The author argues t hat to a ssess u ncertainty a nd a ssociated r isks adequately, a st ochastic a pproach t o m odel m ortality a nd l ife ex pectancy i s p referable because it allows one to attach probabilities to different forecasts In this regard, t he cha pter p rovides t he r esults o f e stimating t he L ee–Carter model f or se veral OECD co untries F urthermore, i t co nveys t he u ncertainty su rrounding f uture m ortality a nd l ife ex pectancy o utcomes b y means o f M onte-Carlo s imulations o f t he L ee–Carter m odel I n o rder to assess the impact of longevity risk on employer-provided DB pension plans, the author examines the different approaches that private pension plans f ollow i n p ractice wh en i ncorporating l ongevity r isks i n t heir actuarial calculations © 2010 by Taylor and Francis Group, LLC Preface ◾ xiii Chapter 12 analyzes the pension plan of a firm that offers wa ge-based lump sum payments by death, retirement, or dismissal by the employer, but no payment is made by the employer when the employee resigns An actuarial risk model for funding severance payment liabilities is formulated and studied The yearly aggregate lump sum payments are supposed to follow a classical collective model of risk theory with compound distributions The final wealth at an arbitrary time is described explicitly including formulas for the mean and the variance Annual initial level premiums required for “dismissal f unding” a re de termined a nd u seful g amma approximations for confidence intervals of the wealth are proposed A specific numerical example illustrates the non-negligible probability of a bankruptcy in case the employee structure of a “dismissal plan” is not well balanced Chapter 13 starts from the fact that retirement is being remade owing to the confluence of demographic, economic, and policy factors The authors empirically i nvestigate ma jor i nfluences on t he re tirement b ehavior of older U.S workers f rom 1992 t hrough 004 u sing su rvey d ata f rom t he Health and Retirement Study Their analysis builds on the large empirical literature on retirement, in particular, by examining how market booms and busts affect the likelihood and timing of retirement, an issue that will be o f g rowing i mportance g iven t he o ngoing sh ift f rom t raditional D B pensions t o 01(k)s They co mprehensively m odel a ll ma jor so urces o f health i nsurance co verage a nd i dentify t heir va rying i mpacts, a nd a lso reveal t he significant policy-driven retirement differences across cohorts that are attributable to the changes in social security full-retirement age These f undamental r etirement cha nges n eed t o be t aken i nto acco unt when we design corporate and public retirement programs Chapter 14 deals w ith a st udy on occ upational pension i nsurance for Germany—a country where Pillar II pension schemes are (still) widely based on a book reserve system The insurance of occupational pension schemes is prov ided for by t he P ensions-Sicherungs-Verein Versicherungsverein auf Gegenseitigkeit (PSVaG), which is the German counterpart to the U.S PBGC This study investigates potential adverse selection and moral hazard problems originating from the introduction of reduced premiums for funded pens ions a nd a ssesses whether t he r isk-adjusted r isk premiums, as i ntroduced b y t he U.K Pension Pr otection F und, c an be a m eans t o mitigate these problems Chapter de scribes t he l ongevity r isk sec uritization i n pens ion schemes, f ocusing ma inly o n l ongevity bo nds a nd su rvivor s waps The authors analyze the evaluation of these mortality-linked securities in an © 2010 by Taylor and Francis Group, LLC xiv ◾ Preface incomplete market using a risk-neutral pricing approach A Poisson Lee– Carter model is adopted to represent the mortality trend The chapter concludes with an empirical application on Italian annuity market data In Part III, Chapter 16 h ighlights t hat t he i nternational t rend toward adopting a “ fair va lue” a pproach t o pens ion acco unting s t ranspired the r isks i nvolved i n promises of DB pensions The hunt i s on for ways to remove or l imit t he employers’ r isk ex posures to financial statements volatility This chapter examines the U.K firms’ risk management of their pension f und a sset a llocation over a per iod when t he new U.K pension GAAP (FRS 17) became effective The findings suggest that firms manage their pension risk exposure in order to minimize cash contribution risks associated w ith t he ad option o f “ fair va lue”–based pens ion acco unting rules, consistent with a risk offsetting explanation Chapter 17 develops and tests a theory of competition among pressure groups over political influence in the context of conflicting U.K standards concerning the factors affecting the recent development of pension fund accountability rules The chapter models both sources of pressure affecting the accountability relationship as well as how those factors combined to i nfluence U.K pens ion f und ma nagers’ d iscretion o ver t he ad option and retention of disclosure regulations The author finds that auditors and pension management groups exerted most political pressure, which translated to political influence during the extended adoption period The findings are mostly consistent with a capture or private interest perspective on pension accounting regulation Chapter 18 r eviews t hree u seful i nstruments—notional defined-contribution acco unts (N DCs), t he ac tuarial ba lance ( AB), a nd a utomatic balance mechanisms (ABMs)—derived from actuarial analysis methodology that can be applied to the public management of PAYGO systems to improve t heir fa irness, t ransparency, a nd so lvency The a uthors su ggest that these tools are not simply theoretical concepts but, in some countries, an already legislated response to the growing social demand for transparency in the area of public finance management as well as the desire to set the pension system firmly on the road to long-term financial solvency In C hapter 19, t he authors review t he r isk-based solvency regime for pension funds in the Netherlands The supervision of pension funds aims to ensure that institutions are always able to meet their commitments to t he beneficiaries I n add ition, t he pension f und must be l egally separated from the employer offering the pension arrangement Furthermore, the ma rked-to-market va lue o f t he a ssets m ust be a t l east eq ual t o t he © 2010 by Taylor and Francis Group, LLC Preface ◾ xv marked-to-market value of the liabilities at all times (full funding prerequisite) Risk-based solvency requirements are intended as a buffer to absorb the r isks f rom u nexpected cha nges i n t he va lue of a ssets a nd l iabilities Finally, a ke y element of the Dutch regulatory approach is the continuity analysis for assessing the pension fund’s solvency in the long run In Chapter 20, the author addresses the fact that the global financial crisis of 2008 highlighted the importance of shielding pension participants from market volatility This policy concern is of general relevance due to the global shift from DB to DC as main mechanisms for financing retirement income Policy options being debated in the aftermath of the crisis include, but are not necessarily limited to, the following: (1) the introduction o f l ifetime m inimum r eturn g uarantees, ( 2) t he r eview o f defa ult investment options, and (3) the outright reversal to PAYGO earning–related pensions This chapter reviews the performance during the crisis of countries that a lready rely on mandatory DC plans The author suggests that important welfare gains can be ach ieved by requiring the introduction of liability-driven default i nvestment products based on a m odified version of the target date funds commonly available in the retail industry for retirement wealth Such products would reconnect the accumulation with the decumulation phase, improve the hedging of annuitization risk, but avoid the introduction of liabilities for plan managers In P art I V, C hapter h ighlights t he D B pens ion f reezes i n la rge healthy firms such as Verizon and IBM, as well as terminations of plans in the struggling steel and airline industries that cannot be v iewed as riskfree from t he employee’s perspective The a uthors de velop a n em pirical dynamic programming framework to investigate household saving decisions in a simple life cycle model with DB pensions subject to the risk of being f rozen The model i ncorporates i mportant sources of u ncertainty facing households, including asset returns, employment, wages, and mortality, as well as pension freezes Chapter 22 is referred to as the Italian experience In Italy, social security contributions of Italian employees finance a two-pillar system: public and p rivate pens ions t hat a re bo th c alculated i n a DC sch eme (funded for the private pension and unfunded for the public one) In addition to this, a la rge number of workers have also termination indemnities at the end of their active service The authors aim to answer the following questions A re t he d ifferent flows o f contributions co herent w ith t he a im o f minimizing the pension risk of the workers? Given the actual percentages of contributions, is the asset allocation of private pension funds optimal? © 2010 by Taylor and Francis Group, LLC xvi ◾ Preface What per centages w ould o ptimize t he pens ion r isk ma nagement o f t he workers ( considering pu blic p ension, pr ivate p ension, a nd t ermination indemnities)? Chapter 24 examines the Greek experience in limiting the opportunity of investments of pension funds in foreign assets In fact, suffering from inefficient funding, the current imbalance of the Greek social security system, to some extent, was the result of the restrictive investment constraints in the period 1958–2000 that directed reserves to low-yielding deposits with the Bank of Greece with little or no exposure to market yields or the stock market As shown in the 43 year analysis, these investment restrictions i ncurred a s ignificant economic opportunity loss both in terms of inferior returns as well as lower risks Chapter 25 examines the effect of a company’s unfunded pension liabilities on its stock market valuation Using a sample of UK FTSE350 firms with DB pension schemes, the authors find that although unfunded pension liabilities reduce the market value of the firm, the coefficient estimates indicate a less t han one-for-one effect Moreover, there is no evidence of significantly negative subsequent abnormal returns for highly underfunded schemes These results suggest that shareholders take into consideration the unfunded pension liabilities when valuing the firm, but not fully incorporate all available information Chapter 26 f ocuses on t he sel ection o f a n a ppropriate st yle m odel t o explain t he returns of Spanish ba lanced pension plans as well as on t he analysis of the relevance of these strategic allocations on portfolio performance Results suggest similar findings than those obtained in previous studies, providing e vidence t hat a sset a llocations ex plains about 0% of portfolio r eturns o ver t ime, m ore t han 0% o f t he va riation o f r eturns among plans, and about 100% of total returns MATLAB® i s a r egistered t rademark o f The M athworks, In c F or p roduct information, please contact: The Mathworks, Inc Apple Hill Drive Natick, MA 01760-2098 USA Tel: 508-647-7000 Fax: 508-647-7001 E-mail: info@mathworks.com Web: www.mathworks.com © 2010 by Taylor and Francis Group, LLC Editors Marco Micocci is a f ull professor of financial mathematics and actuarial science in the Faculty of Economics, University of Cagliari, Italy He has received deg rees i n eco nomics, ac tuarial st atistics, a nd t he finance of financial i nstitutions H is r esearch i nterests i nclude financial a nd ac tuarial risk management of pension funds and insurance companies, enterprise risk management, and operational and reputational risk va luation He has published nearly 90 books, chapters of books, journal articles, and papers He also works as a consultant actuary Greg N Gregoriou has published 34 books, over 50 refereed publications in peer-reviewed journals, and 22 book chapters since his arrival at SUNY (Plattsburgh, New York) in August 2003 Professor Gregoriou’s books have been published by John Wiley & Sons, McGraw-Hill, Elsevier Butterworth/ Heinemann, T aylor & F rancis/Chapman-Hall/CRC P ress, P algraveMacMillan, a nd R isk/Euromoney boo ks H is a rticles ve a ppeared i n the Journal o f P ortfolio M anagement, t he Journal o f F utures M arkets, the European Journal of O perational Re search, t he Annals of O perations Research, and C omputers and O perations Re search Professor Gregoriou is a coed itor a nd ed itorial boa rd m ember f or t he Journal o f D erivatives and Hedge Funds, a s well a s a n ed itorial boa rd member for t he Journal of W ealth Man agement, t he Journal o f Ri sk M anagement i n F inancial Institutions, and the Brazilian Business Review A na tive of Montreal, he received his joint PhD at the University of Quebec at Montreal, Quebec, Canada, in finance, which merges the resources of Montreal’s major universities (McGill University, Concordia University, and École des Hautes Études C ommerciales, M ontreal) H is i nterests f ocus o n h edge f unds, funds of hedge funds, and managed futures He is also a m ember of the Curriculum Committee of the Chartered Alternative Investment Analyst Association xvii © 2010 by Taylor and Francis Group, LLC xviii ◾ Editors Giovanni B Ma sala is a r esearcher i n mathematical methods for economy and finance at the Faculty of Economics, University of Cagliari, Italy He re ceived h is PhD i n pu re m athematics (differential geometry) at t he University o f M ulhouse, F rance H is c urrent r esearch i nterest i ncludes mathematical risk modeling for financial a nd ac tuarial applications He attended n umerous i nternational c ongresses to le arn more a bout t hese topics His results have been published in refereed national and international journals © 2010 by Taylor and Francis Group, LLC xxii ◾ Contributor Bios Evan Ya-Wen Hwang is an assistant professor in t he Department of Risk Management and Insurance, Feng Chia University She obtained a doctorate in risk management and insurance from the National Chengchi University in Taiwan Her thesis focuses on the topics in continuous time finance and actuarial s cience C urrently she is w orking o n d ynamic ass et allo cation problems for long-term investors Her research papers have been presented in several international conferences, which include the annual conference of Asia Pacific Risk and Insurance Association in Korea, Japan, and Taiwan, as well as the 11th International Congress on Insurance: Mathematics and Economics in Athens Gregorio Impavido is a senior financial sector expert in the monetary and capital markets department of the IMF in Washington, District of Columbia He delivers policy advice on pension reform and the regulation and the supervision of private pensions including market stability and developmental issues Prior to joining the IMF in 2007, he worked for nine years at the World Bank, Washington, District of Columbia He has written for the World Bank, European Investment Bank (EIB), and European Bank for Reconstruction and Development (EBRD) His writings have been published in refereed journals and books on policy issues related to the development of private pension and insurance markets in developing countries He received his PhD and MSc in economics from Warwick U niversity, C oventry, U nited K ingdom, a nd h is B Sc i n eco nomics from Bocconi University, Milan, Italy Ricardo Josa Fombellida was born in Palencia, Spain He received his MS i n mathematics a nd h is PhD i n st atistics a nd operations research, both from the University of Valladolid, Spain He is a profesor contratado d octor (tenured pos ition) i n t he Depa rtment o f S tatistics a nd Operations Research at the University of Valladolid His main research areas i nclude st ochastic dy namic o ptimization a nd a pplications i n pension f unds a nd eco nomics H e s p ublished pa pers i n sc ientific journals suc h a s Insurance: M athematics and E conomics, t he Journal of O ptimization Theory a nd A pplications, Computers and O perations Research, a nd t he E uropean J ournal o f O perational Re search H e s participated i n n umerous c ongresses on m athematical finance, statistics, a nd o perations r esearch H is r esearch i s f unded b y t he M inistry of E ducation a nd S cience o f S pain, a nd t he Reg ional G overnment o f Castilla y Ln © 2010 by Taylor and Francis Group, LLC Contributor Bios ◾ xxiii Paul John Marcel Klumpes, BC om ( hons), MCom ( hons), L LB ( hons), PhD, H on ( FIA), CP A, i s a p rofessor o f acco unting a t t he I mperial College Business School, Imperial College London, United Kingdom His research interests cover the interrelationship of public policy and voluntary reporting, regulation, financial ma nagement, a nd control of financial services, particularly related to pensions and life insurance This growing personal interest has been associated with a g rowing political, economic, and social awareness of the importance of pensions and financial services by government and public policy making institutions He has produced 65 publications, lf of which are in published academic journals Contributions have been to both practice the discipline and to learning and pedagogy Theo Kocken i s t he f ounder a nd t he CEO o f C ardano H e g raduated i n bu siness a dministration (E indhoven), e conometrics ( Tilburg), and r eceived h is P hD a t V U U niversity, A msterdam, t he N etherlands From 1990 onward, he headed t he ma rket risk depa rtments at ING a nd Rabobank International In 2000, he started Cardano As a market leader, Cardano supports end users such a s pension f unds a nd i nsurance companies a round E urope w ith st rategic der ivative so lutions a nd po rtfolio optimization Cardano, now having well over 70 employees, has offices in Rotterdam and London Theo is the (co)author of various books and articles in the area of risk management In 2006, he wrote Curious Contracts: Pension Fund Redesign for the Future, in which he applied embedded option theories as a basis for pension fund risk management and redesign Anne de Kreuk holds a deg ree in applied mathematics from Eindhoven University of Technology, the Netherlands In 2005, she started as a portfolio ma nager i n L DI a nd fiduciary ma nagement a t A BN A MRO A sset Management, wh ere sh e s be en i nvolved i n de veloping a nd ma naging i nstitutional cl ient so lutions t hat i nvolved st rategic a sset a llocation, derivatives overlay, and manager selection input In mid-2008, she joined Cardano as a risk management consultant Susanna Levantesi is a researcher in mathematical methods for economy and finance at La Sapienza-University of Rome She has been an adjunct professor of actuarial models for health insurance and life insurance techniques at the University of Sannio, Beveneto, Italy, since 2004 She received © 2010 by Taylor and Francis Group, LLC xxiv ◾ Contributor Bios her PhD in actuarial science at La Sapienza-University of Rome in 2004 She currently works as an actuary Her main research interests are health and life insurance Yong L i s a P hD i n accounting (Warwick Business School, C oventry, United K ingdom) a nd a n MS c w ith d istinction i n ba nking a nd finance (University of Stirling, Scotland, United Kingdom) She was a research fellow at Warwick Business School (2001–2004) and an academic visitor in the accounting department at the London School of Economics from May to July in 2008 Yong is currently a lecturer in accounting at the University of Stirling, United Kingdom (2004 to date) Weixi Liu is a PhD student in the Xfi Centre for Finance and Investment at the University of Exeter, England His research interest is in pension economics, especially the funding and the asset allocation of occupational pensions H is t hesis ex amines t he va luation effects o f d efined benefit pension schemes in the United Kingdom under the most recent pension accounting standards and regulations Weixi also has teaching experience in fi xed income and derivative pricing David A Love is an assistant professor of economics at Williams College, London, United Kingdom He previously worked as an economist at the F ederal Re serve B oard (2005–2006) a nd v isited C olumbia B usiness School, N ew York (2007–2008) H e r eceived h is B A i n eco nomics f rom the University of Michigan, Ann Arbor, Michigan, in 1996 and his PhD in eco nomics f rom Yale U niversity, N ew Ha ven, C onnecticut, i n 003 His research interests include macroeconomics, public finance, household portfolio choice, and private pensions Ferdinand Ma ger i s a p rofessor a t t he E uropean B usiness S chool i n Oestrich-Winkel, Germany He previously worked at the Queensland University of Technology, School of Economics and Finance, in Brisbane, Australia, a nd a t E rlangen-Nuremberg U niversity, E rlangen, G ermany, where he also received his doctoral degree His research focuses on empirical finance Stuart Manson is a professor of accounting at Essex Business School at the University of Essex, Colchester, United Kingdom, where he is also a de an o f t he F aculty o f L aw a nd Ma nagement H is p resent r esearch © 2010 by Taylor and Francis Group, LLC Contributor Bios ◾ xxv interests a re i n t he a reas o f pens ions r eporting a nd t he r egulation o f auditing H e i s a q ualified cha rtered acco untant a nd i s a m ember o f the Institute of Chartered Accountants of Scotland, Edinburgh, United Kingdom Carmen-Pilar Martí-Ballester, PhD, is a graduate in business administration a nd a P hD i n fi nancial economics at t he Universitat Jaume I, Castellon de la P lana, S pain Sh e i s c urrently a v isiting p rofessor o f accounting in the Department of Business Economics at the Universitat Autònoma de Barcelona, Spain Prior to this, she worked as a research assistant o f fi nance a t t he U niversitat J aume I Sh e wa s a v isiting researcher a t t he U niversidad P ública de N avarra, P amplona, S pain, and Universitat Autònoma de Ba rcelona She has published in various journals, including Applied Economics, the Spanish Journal of Finance and A ccounting, a nd Pensions, a mong o thers H er r esearch i nterests include efficiency, i nvestor behavior, pension f unds per formance, a nd education S he s p articipated i n p rojects o n fi nancial eco nomics and i nvestment a nalysis t hat h ave re ceived gove rnment c ompetitive research grants Massimiliano M enzietti i s a p rofessor o f pens ion ma thematics i n t he Faculty of Economics at the University of Calabria, Cosenza, Italy From 2002 to 2006 he was a researcher in mathematical methods for economy and finance in the Department of Actuarial and Financial Science at the Sapienza University o f R ome, f rom wh ere h e r eceived h is PhD i n ac tuarial science His research has focused on actuarial mathematics of pension schemes, financial mathematics (specifically on actuarial model for credit risk), and automobile car insurance He is now working on actuarial mathematics a nd r isk ma nagement of long-term c are i nsurance a nd on longevity risk securitization Nikolaos T M ilonas i s a p rofessor o f finance i n t he Depa rtment of E conomics, U niversity of At hens, G reece He re ceived h is M BA from Ba ruch C ollege, N ew Y ork Ci ty, h is P hD i n finance from the Ci ty U niversity o f N ew Y ork H e s t aught a t t he U niversity of Massachusetts at Amherst, at Baruch College, and at ALBA His r esearch w ork f ocuses o n i ssues i n c apital, der ivatives, a nd en ergy markets w ith a spec ial em phasis i n t he a rea o f i nstitutional i nvesting Many of his articles have been published in prestigious academic © 2010 by Taylor and Francis Group, LLC xxvi ◾ Contributor Bios journals including the Journal of Finance In his professional career, he has worked as an investment director and as a consultant to several institutional investors and security firms He currently serves as a board member i n t he H ellenic E xchanges S A., A thens, Gr eece, a nd p resides o ver the I nvestment C ommittee o f t he M utual F und C ompany f or P ension Organisations Cristina Ortiz is a junior lecturer in fi nance at the Faculty of Economics and Business Studies, University of Zaragoza, Spain In 2007, she received her PhD in fi nance in the context of the European doctorate She was awarded t he Social Science Award for Graduate Students a nd has some national and international publications to her credit She has also pa rticipated i n na tional a nd i nternational co nferences o n beha vioral finance Gaobo P ang, P hD, i s a sen ior eco nomist a t Watson W yatt Worldwide, Arlington, Virginia His research interests include social security, pension finance a nd i nvestment, l ife c ycle a nnuity–equity–bond o ptimizations, and tax-favored savings Prior to joining Watson Wyatt, Dr Pang worked at World Bank, Washington, District of Columbia, conducting macroeconomic research on sovereign debt sustainability, growth, and efficiency of public spending George A P apachristou i s a n a ssociate p rofessor o f financial economics in the Department of Economics, Aristotle University of Thessa loniki, Greece H e r eceived h is MS c a nd P hD f rom t he U niversity o f P aris I , France Besides pension i nvestment issues he s a lso published i n topics such a s I POs, st ock ma rket efficiency, lot tery m arket e fficiency, and venture capital finance His research has appeared in reviews such as the Journal of Banking and Finance, Pension Economics and Finance, Applied Economics, Applied Economics Letters, and others Auke Plantinga is a n a ssociate professor of finance at t he University of Groningen, the Netherlands He is involved in research and teaching in the field of finance and, in particular, portfolio management His research is focused on the performance measurement issue of investment portfolios, and the impact of liabilities on these methods His research interest includes studying the behavior of participants in financial markets, both private individuals as well as institutions © 2010 by Taylor and Francis Group, LLC Contributor Bios ◾ xxvii Diego Prior-Jiménez, PhD, is a f ull professor in t he business economics department a t t he U niversidad A utónoma de B arcelona, S pain H e is a member of the editorial committees of several academic jo urnals related with acco unting co ntrol a nd financial a nalysis H is r esearch in terests, published in in ternational journals, are t he efficiency analysis of organizations and firms’ financial analysis In the field of efficiency analysis, his research is o riented toward t he design o f mo dels to ass ess t he efficiency of o rganizations a nd t o design p rograms t o im prove t heir p erformance Recent a pplications a re f ocused o n p ublic s ector o rganizations (he alth care, municipalities, ed ucation, a nd st ate-owned firms) a nd als o o n p rivate firms f rom t he ener gy, ma nufacturing, a nd financial s ectors In t he field of financial analysis, his research is oriented toward the comparative benchmark of European firms in a n environment of global competition The analysis includes firms’ financial position, cost efficiency, and the process of value and free cash flow generation Marc Pröpper works as a sen ior policy advisor in the quantitative risk department of De N ederlandsche Ba nk, A msterdam, t he Netherlands, the integrated prudential supervisor and central bank of the Netherlands Areas of his work include the financial assessment framework for pension funds a nd t he f uture solvency a nd supervisory st andard for i nsurance companies, S olvency I I These n ew so lvency st andards r eflect a b road development toward risk-based supervision and quantitative approaches by the adoption of market valuation, risk-sensitive solvency requirements, and internal modeling He is also active in the field o f st ress testing for ba nks a nd a m ember of t he Ba sel I I R isk Ma nagement a nd Modelling Group Marc has graduated as a physicist from the University of U trecht, t he N etherlands, a nd added t wo y ears o f eco nomy a t t he Erasmus University of Rotterdam, t he Netherlands Following t his, he worked for several years at the combined bank and insurance company, Fortis, i n t he t reasury, t he i nsurance a sset a nd l iability ma nagement (ALM) department, and in central risk management He regularly publishes articles on insurance and pensions Theodore A R oupas is a director at the Ministry of Employment and a l ecturer (nontenured) i n t he Depa rtment o f B usiness Administration, University o f P atras, Gr eece H e h olds a ma ster’s deg ree f rom D urham University, United K ingdom, a nd a P hD f rom t he University of Athens, Greece H is c urrent r esearch f ocuses o n i ssues o f h ealth a nd pens ion © 2010 by Taylor and Francis Group, LLC xxviii ◾ Contributor Bios economics H is a rticles ve be en p ublished i n t he Journal o f P ension Finance and Economics and the European Research Journal José Luis Sarto is a senior lecturer in finance at the Faculty of Economics and Business Studies, University of Z aragoza, Spain, where he obtained his PhD in 1995 He has published a la rge number of papers in national and international journals such as Omega, Applied Economic Letters, and Applied F inancial E conomics H is r esearch i nterests i nclude beha vioral finance a nd per formance pers istence i n t he context of collective i nvestment funds Christian Schmieder is a sen ior credit specialist a nd heads t he Ba sel II implementation at the European Investment Bank (EIB), Luxembourg, Belgium Pr ior to joining t he EI B, he worked for Deutsche Bundesbank and DaimlerChrysler AG He has also represented Deutsche Bundesbank in working groups of the Basel Committee on Banking Supervision and has published various articles on banking and finance Ole S ettergren i s t he h ead sec retary o f t he g overnment co mmission charged w ith se tting up a u nified Swedish Pension Agency He wa s t he director o f t he pens ions depa rtment a t t he S wedish S ocial I nsurance Agency 2004–2008 As an insurance expert at the Ministry of Health and Social A ffairs (1995–2000), h e p roposed t he a utomatic ba lance m ethod of securing the financial stability of the new Swedish pension system He developed the accounting principles that have been used since 2001 in the Annual Repo rt o f t he S wedish Pension S ystem a nd wa s i ts ed itor f rom 2001 to 2007 Paul A Sm ith i s a sen ior eco nomist i n t he Re search a nd S tatistics Division o f t he F ederal Re serve B oard o f G overnors H e p reviously worked as a financial economist in the Office of Tax Policy at the Treasury Department H e r eceived h is B A i n eco nomics f rom t he U niversity o f Vermont, Burlington, Vermont, in 1991 and his PhD in economics from the University of Wisconsin, Madison, Wisconsin, in 1997 His research interests include household saving and wealth, pensions, and retirement economics Charles Sutcliffe is a p rofessor of finance at the ICMA Centre, Reading, United Kingdom From 2001 to 2007, he was a director of USS Ltd., © 2010 by Taylor and Francis Group, LLC Contributor Bios ◾ xxix Northamptonshire, E ngland, wh ich i s t he seco nd-largest U K pens ion fund Pr eviously, h e wa s a p rofessor o f finance a nd acco unting a t t he University of Southampton, England, and the Northern Society professor of accounting and finance at the University of Newcastle, United Kingdom In 1995–1996 a nd 003–2004 he wa s a v isiting professor at t he L ondon School of Economics, United Kingdom He has published in a wide range of refereed journals and is also the author of nine books He has acted as a co nsultant t o t he F inancial S ervices A uthority, t he S ecurities a nd Investments B oard, H M Treasury, t he C abinet O ffice, the Corporation of London, the United Nations, the Investment Management Association, the L ondon S tock E xchange, a nd t he L ondon I nternational F inancial Futures a nd O ptions E xchange H e s r eceived r esearch g rants f rom the Social Science Research Council, the British Council, the Institute of Chartered Accountants in England and Wales, and the Chartered Institute of Management Accountants He is a member of the editorial boards of the Journal of Futures Markets, the Journal of Business Finance and Accounting, the European Journal of Finance, and the Journal of Financial Management and Analysis, and is a vice chairman of the Research Board of the Chartered Institute of Management Accountants, London, United Kingdom Laurens Swinkels, PhD, is an assistant professor of finance at the Erasmus School o f E conomics i n R otterdam, t he N etherlands, a nd a n a ssociate member of t he Er asmus Re search I nstitute of Ma nagement, Rotterdam, the Netherlands He is also a senior researcher at Robeco’s Quantitative Strategies Department and a board member of the Robeco Pension Fund He received his PhD in finance at the CentER Graduate School of Tilburg University, the Netherlands Ian Tonks is a professor of finance in the Business School at the University of E xeter, E ngland H e te aches ac ross a ll a reas o f financial economics: asset pricing, corporate finance, market efficiency, and performance measurement His research focuses on ma rket microstructure a nd t he organization of stock exchanges, directors’ trading, pension economics, fund manager performance, and the new issue market Ian is an associate member of t he C entre for Ma rket a nd P ublic Organisation (CMPO), Bristol, United Kingdom, and is also a consultant to the Financial Markets Group at the London School of Economics, United Kingdom He has previously taught at the London School of Economics and the University of Bristol, United Kingdom, and held a visiting position in the Faculty of Commerce © 2010 by Taylor and Francis Group, LLC xxx ◾ Contributor Bios at t he University of B ritish C olumbia, Vancouver, C anada, i n 1991 H is publications include theoretical and empirical articles in leading finance and economics journals Tiziana T orri i s a P hD st udent i n ac tuarial sc ience a t t he S apienzaUniversity o f R ome a nd t he Ma x P lanck I nstitute f or Dem ographic Research in Rostock She graduated in actuarial science and statistics at the Sapienza-University of Rome Currently, she is working as an actuary Her main research areas are mortality projection models and securitization of longevity risk Luis Vicente is a s enior lec turer in finance at t he Faculty of Economics and Business Studies, University of Zaragoza, Spain He obtained his PhD in financial eco nomics in 2003, w here his ctoral w ork r eceived “ the extraordinary prize of social sciences.” He has p ublished papers in s ome important journals such as the Journal of Pension Economics and Finance, Geneva Papers, and Applied Economic Letters, among others His research interests include portfolio management, performance persistence, and style analysis Carlos Vidal-Meliá is an associate professor of social security and actuarial science at Valencia University, Spain, and an independent consultantactuary He h as pu blished a rticles i n i nternational re fereed pu blications on public pension reforms, administration charges for the affil iate in capitalization systems, the demand for annuities, NDCs, and the actuarial balance for pay-as-you-go finance Dr Vidal-Meliá holds a PhD in economics from the University of Valencia and a degree in actuarial sciences from the Complutense University of Madrid, Spain Mark J Warshawsky, PhD, is a director of retirement research at Watson Wyatt Worldwide, Arlington, Virginia He is a recognized thought leader on pensions, social security, insurance, and health-care financing Prior to joining Watson Wyatt, he was an assistant secretary for economic policy at the treasury department; the director of research at Teachers Insurance and A nnuity A ssociation, C ollege Re tirement E quities F und (T IAACREF); and a senior economist at the IRS and Federal Reserve Board He is a m ember o f t he S ocial S ecurity A dvisory B oard f or a ter m t hrough 2012 He is also on the Advisory Board of the Pension Research Council of t he W harton School Dr Warshawsky has w ritten numerous a rticles, © 2010 by Taylor and Francis Group, LLC Contributor Bios ◾ xxxi books, and working papers, and has testified before Congress on pensions, annuities, and other economic issues Ben W eitzer i s a b usiness a nalyst a t A merica On line, I nc ( AOL), Washington, District of Columbia Prior to joining AOL, Weitzer worked at Watson Wyatt Worldwide, a leading human resources consulting group with a global reach Shane Francis Whelan, PhD, FFA, FSA, FSAI, is an actuary with extensive experience of the investment and pensions industries where he has worked as an investment analyst, fund manager, and strategist for over a decade He has acted as a co nsultant to t he Irish Association of Pension Funds and large Irish pension schemes He was a l ecturer in actuarial science and statistics at University College Dublin, Ireland, in September 2001, and later became the head of department Dr Whelan has presented and published many papers on the topics of investment and pension to professional and academic audiences, and his research has been rewarded by prizes from the Institute of Actuaries, London, United Kingdom, and the Worshipful C ompany of Actuaries (a g uild i n t he City of L ondon) He received his degree in mathematical science from UCD and a doctorate from Heriot-Watt University, E dinburgh, S cotland He s a lso played an active role in the actuarial profession both in the United Kingdom and Ireland Aihua Zh ang wa s a postd octoral r esearch f ellow i n t he S chool o f Economics a nd F inance a t t he U niversity o f S t A ndrews, F ife, U nited Kingdom, bef ore j oining t he Div ision o f I nternational B usiness a t t he University of Nottingham, Ningbo Campus She studied at the University of K aiserslautern i n G ermany, where she received her PhD a nd MS c i n financial mathematics She received her first MSc in mathematics education and her BSc in mathematics from the Central China Normal University, and then worked as a lecturer in the China Petroleum University, Beijing, China, before going to Germany She worked as a mentor for MSc students in financial mathematics at the University of Leeds, United Kingdom She studied economics at the University of Edinburgh, United Kingdom, as an MSc student She also studied at the University of Bath, United Kingdom, with a PhD scholarship © 2010 by Taylor and Francis Group, LLC Contributors Laura Andreu Accounting and Finance Department Faculty of Economics and Business Studies University of Zaragoza Zaragoza, Spain Pablo Antolin Financial Affairs Division Directorate for Financial and Enterprise Affairs Organisation for Economic Co-operation and Development Paris, France María del Carmen Boado-Penas Department of Foundations of Economic Analysis II University of the Basque Country Bilbao, Spain and Department of Economics Keele Management School Keele University Keele, United Kingdom Dirk Broeders Supervisory Policy Division De Nederlandsche Bank Amsterdam, the Netherlands Giuseppina Cannas Faculty of Economics University of Cagliari Cagliari, Italy Ricardo Matos Chaim University of Brasilia Brasilia, Brazil Bill Shih-Chieh Chang Financial Supervisory Commission and Department of Risk Management and Insurance National Chengchi University Taipei, Taiwan Marcin Fedor AXA Group Warsaw, Poland xxxiii © 2010 by Taylor and Francis Group, LLC xxxiv ◾ Contributors Ricardo Josa Fombellida Departamento de Estadística e Investigación Operativa Universidad de Valladolid Valladolid, Spain Wilma de Groot Robeco Quantitative Strategies Rotterdam, the Netherlands Werner Hürlimann FRSGlobal Zürich, Switzerland Evan Ya-Wen Hwang Department of Risk Management and Insurance Feng Chia University Taichung, Taiwan Gregorio Impavido Monetary and Capital Markets Department International Monetary Fund Washington, District of Columbia Paul John Marcel Klumpes Imperial College London Business School London, United Kingdom Theo Kocken Cardano Risk Management Rotterdam, the Netherlands Anne de Kreuk Cardano Risk Management Rotterdam, the Netherlands © 2010 by Taylor and Francis Group, LLC Susanna Levantesi University of Rome “La Sapienza” Rome, Italy Yong Li Department of Management King’s College London University of London London, United Kingdom Weixi Liu Department of Management King’s College London University of London London, United Kingdom David A Love Department of Economics Williams College Williamstown, Massachusetts Ferdinand Mager European Business School Oestrich-Winkel, Germany Stuart Manson Essex Business School University of Essex Colchester, United Kingdom Carmen-Pilar Martí-Ballester Business Economics Department Universitat Autònoma de Barcelona Barcelona, Spain Giovanni B Masala Faculty of Economics University of Cagliari Cagliari, Italy Contributors ◾ xxxv Massimiliano Menzietti Faculty of Economics University of Calabria Cosenza, Italy Marco Micocci Faculty of Economics University of Cagliari Cagliari, Italy Nikolaos T Milonas Department of Economics University of Athens Athens, Greece Cristina Ortiz Accounting and Finance Department Faculty of Economics and Business Studies University of Zaragoza Zaragoza, Spain Gaobo Pang Research and Innovation Center Watson Wyatt Worldwide Arlington, Virginia George A Papachristou Department of Economics Aristotle University of Thessa loniki Thessa loniki, Greece Auke Plantinga Faculty of Economics University of Groningen Groningen, the Netherlands Diego Prior-Jiménez Business Economics Department Universitat Autònoma de Barcelona Barcelona, Spain © 2010 by Taylor and Francis Group, LLC Marc Pröpper Quantitative Risk Department De Nederlandsche Bank Amsterdam, the Netherlands Theodore A Roupas Department of Business Administration University of Patras Rio, Greece José Luis Sarto Accounting and Finance Department Faculty of Economics and Business Studies University of Zaragoza Zaragoza, Spain Christian Schmieder European Investment Bank Luxembourg, Luxembourg Ole Settergren Swedish Ministry of Health and Social Affairs Stockholm, Sweden Paul A Smith Federal Reserve Board Washington, District of Columbia Charles Sutcliffe The International Capital Market Association Centre Henley Business School University of Reading Reading, United Kingdom xxxvi ◾ Contributors Laurens Swinkels Robeco Quantitative Strategies Erasmus University Rotterdam Rotterdam, the Netherlands Ian Tonks Xfi Centre for Finance and Investment University of Exeter Exeter, United Kingdom Tiziana Torri University of Rome “La Sapienza” Rome, Italy and Max Planck Institute for Demographic Research Rostock, Germany Luis Vicente Accounting and Finance Department Faculty of Economics and Business Studies University of Zaragoza Zaragoza, Spain © 2010 by Taylor and Francis Group, LLC Carlos Vidal-Meliá Department of Financial Economics and Actuarial Science University of Valencia Valencia, Spain Mark J Warshawsky Research and Innovation Center Watson Wyatt Worldwide Arlington, Virginia Ben Weitzer America Online, Inc Washington, District of Columbia Shane Francis Whelan School of Mathematical Sciences University College Dublin Belfield, Dublin, Ireland Aihua Zhang School of Economics and Finance University of St Andrews Scotland, United Kingdom ... integration of actuarial and financial risks in the risk management of pension funds We believe t he chapters in t his book highlight and shed new light on the current state of pension fund risk management... 50 8-6 4 7-7 000 Fax: 50 8-6 4 7-7 001 E-mail: info@mathworks.com Web: www.mathworks.com © 2010 by Taylor and Francis Group, LLC Editors Marco Micocci is a f ull professor of financial mathematics and actuarial. .. of financial i nstitutions H is r esearch i nterests i nclude financial a nd ac tuarial risk management of pension funds and insurance companies, enterprise risk management, and operational and