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Applying Stochastic Programming to the US Defined Benefit Pension System
Abstract
Introduction Integrated Corporate/Pension Planning Model Assisting the Defined Benefit Pension System Conclusions
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A novel parallel decomposition algorithm is developed for large, multistage stochastic optimization problems. The method decomposes the problem into subproblems that correspond to scenarios. The subproblems are modified by separable quadratic terms to coordinate the scenario solutions. Convergence of the coordination procedure is proven for linear programs. Subproblems are solved using a nonlinear interior point algorithm. The approach adjusts the degree of decomposition to fit the available hardware environment. Initial testing on a distributed network of workstations shows that an optimal number of computers depends upon the work per subproblem and its relation to the communication capacities. The algorithm has promise for solving stochastic programs that lie outside current capabilities.
Designed for those individuals interested in the current state of development in the field of investment science, this book emphasizes the fundamental principles and how they can be mastered and transformed into solutions of important and interesting investment problems. The book examines what the essential ideas are behind investment science, how they are represented, and how they can be used in actual investment practice. The book also examines where the field might be headed in the future, and goes much further in terms of mathematical content, featuring varying levels of mathematical sophistication throughout. End-of-chapter exercises are also included to help individuals get a better grasp on investment science.
The defined-benefit pension system may not survive into the future absent changes in the current regulatory environment. A risk-based and anticipatory approach to evaluating pension trusts is proposed as a way to diminish the probability that large and insolvent companies will transfer their pension trusts to the Pension Benefit Guaranty Corporation. Because current difficulties are concentrated in a few industries, there will be severe problems in the future if the healthiest companies reduce their exposure to defined-benefit pensions.
For a given public or private pension plan benefit structure and for a given funding level, a plan sponsor may want to choose an investment strategy to minimize the present value of future contributions to the plan. This goal is consistent with the way most sponsors make decisions on investment projects generally and in the interests of the plan participants. Kerwin comment on accuracy of abstract and editor's response (September/October 2008). Mehrling and Mindlin comment on accuracy of abstract and editor's response (May/June 2009).
Towers Perrin-Tillinghast employs a stochastic asset-and-liability management system for helping its pension plan and insurance clients understand the risks and opportunities related to capital market investments and other major decisions. The system has three major components: (1) a stochastic scenario generator (CAP:Link); (2) a nonlinear optimization simulation model (OPT:Link); and (3) a flexible liability- and financial-reporting module (FIN:Link). Each part improves over existing technology as compared with traditional actuarial approaches. The integrated investment system links asset risks to liabilities so that company goals are best achieved. For example, US WEST saved 1,000 million in opportunity costs in its pension plan by following the advice of the asset-and-liability system.
The defined-benefit pension system poses substantial, long-term risks for the U.S. economy. We describe a flexible asset-liability management (ALM) system for pension planning. The primary goals are to improve the performance and survivability of the pension trust. We first employ a stochastic program for enhancing investment strategies in light of company and other goals and pension risk constraints. The results are linked with a policy simulator for further analysis. We illustrate the concepts via two disparate real-world companies. The first is a slowly growing auto company, and the second a pro. table pharmaceutical enterprise. We show that a stochastic program can help in the process of discovering sound policy rules. The ALM system has been employed extensively throughout the world by a large global actuarial firm.
Pension Fund Investment Management: A Handbook for Sponsors and their Advisors
- R. Arnott
- P. Bernstein
Asset liability management for pension funds. Ph.D. thesis, Erasmus University, Rotterdam, Netherlands
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- K. D. Simsek
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