Real-time asset-liability testing reduces the stre
With its Pension Risk Management (PRiMa) concept, MetallRente, the Berlin-based pensions fund provider for Germany’s metal industry, believes it has achieved true innovation in pension fund management with the creation of a real-time asset-liability management framework.
The two areas of the German pension reform bill in 2001 that received the most public attention, according to MetallRente, were the new type of benefit obligation and the new type of funding vehicle that is regulated by German insurance authorities. The new vehicle is a hybrid based on defined benefit (DB) and defined contribution (DC) type plans, whereby the employer contributes in the same way as it would in a pure DC scheme but with a capital guarantee to be paid at retirement. If the employer chooses a new style external pension fund, then this vehicle will also provide a capital guarantee on contributions at retirement.
MetallRente says the new pension funds actually have a lot in common with traditional insurance plans, whereby reserve funds are accumulated for future payout and there is collective provision for single losses. But the concept of quantitative investment restrictions has been removed.
The principle of MetallRente’s investment concept is freedom of investment to maximise fund value until retirement whilst simultaneously making adequate provision for the capital guarantee. Its strategy therefore allocates the contributions to three different premium reserve funds that follow a ‘life-cycle’ concept. All employees under 55 contribute to a collective pooled premium reserve fund, which allows for a high level of investment risk and high expected returns. At 55, the individual’s accumulated assets and future contributions are moved to the second premium reserve fund. From 58 onwards, 20% of the accumulated assets are transferred every six months to the third fund with little or no risk ensuring accumulated capital for the individual at retirement.
MetallRente says taking on investment risks calls for a system that calculates actual surplus for each reserve fund and tests the surplus using the most modern stress testing techniques. MetallRente perceives the yearly asset-liability study as the most common form of this activity, which highlights the need for adjustment. MetallRente, however, conducts stress testing on a real-time, day-to-day, 24-hour basis. This inspires confidence in its asset allocation policy when the surplus remains positive. Moreover, and where a negative surplus is shown, real-time monitoring allows for potential deficits and losses to be resolved quickly by hedging with index futures or regular re-evaluation of the asset allocation policy.
One of the main features of real-time surplus calculating is the technical capacity to mark to market the actual value of the fund’s assets alongside regular updates of liabilities data, says MetallRente. All asset positions that are traded on exchanges are marked on a real-time basis and backed by security systems that provide last-booked prices if actual market prices are unavailable. The fund values non-tradable assets as often as possible, which is usually once a day. Since MetallRente uses investment funds in its investments, it analyses each individual asset they contain. MetallRente issues a twice-weekly liabilities report, where the liability is the current collective pooled net value of gross contributions. MetallRente says that although actual surplus is a simple figure to calculate in essence, it has solved the ultimate technical challenge of calculating real-time positions for hundreds of assets and thousands of single liabilities.
The next step is the actual stress testing. MetallRente says one commonly used methodology is to look at historical records, but it prefers the extreme value theory, which is similar to the way banks calculate value at risk (VAR), to derive a realistic view of any potential losses. This covers market conditions ranging from the usual environment considered by VAR to times of financial crises. MetallRente then calculates the maximum loss its portfolios would face in the event of a sudden market downturn. This is done over a two-day range as this is the maximum time needed to hedge the fund’s investments within any of the premium reserve funds.
MetallRente has a two-prong approach to solving negative stress test results. If stress tests over time reveal a surplus of zero, MetallRente would re-assess its asset allocation and make any necessary adjustments in order to reduce risk. However, if the results call for more drastic, but less likely, action, it would hedge all its investments within the shortest possible timeframe. This would probably be in short index futures, since MetallRente holds exchange- traded assets that need to be sold via brokers. Though this is a less accurate solution, the objective is simply to swiftly reduce risk to zero. MetallRente says it might even overhedge to a certain degree.
Highlights and achievements
MetallRente’s innovative Pension Risk Management (PRiMa) concept and real-time asset liability management initiative successfully bridge the gap between Germany’s old insurance fund pensions and new capitalised fund system. The fund claims that it is the ‘most advanced’ asset-liability management tool it knows of in Germany.
Its management and risk control structure ensure pensions and benefits investments can be maximised while the capital guarantee will be paid, as required in the new pensions laws.
Splitting the assets into three main reserve funds that have a different asset allocation policy is the chosen solution to ensure pensions provision will be guaranteed and encourage people to save more voluntarily.
MetallRente’s innovative real-time asset-liability management model is successful in ensuring the right asset mix each fund requires to enable it to meet its objectives as well as effective risk management. Moreover, being able to check and monitor hundreds of individual asset positions and thousands of single liabilities on a 24-hour basis is a major achievement in a country where this kind of investment set-up is relatively new.
The fund’s proactive approach to stress testing and using the most modern techniques in the most extreme conditions means it can retain a favourable long-term and sustainable risk/return ratio, even if short-term hedging action is required.