Augmenting the Funded Ratio: New Metrics for Liability Based Plans
Sanjiv Das, William and Janice Terry Professor of Finance and Business Analytics
Sanjiv Das: Augmenting the Funded Ratio: New Metrics for Liability Based Plans, forthcoming in the Journal of Pension Economics and Finance
Abstract
The primary metric for the health of a liability based plan (LBP) is the ratio of the LBP’s current assets to its present-valued liabilities. This “funded ratio” cannot address some important financial factors, so we suggest three additional metrics of financial health, connected to the probability of fulfilling the plan’s liabilities. The first two metrics compare the current assets and projected future contributions to those needed to attain either (1) a specified probability for meeting all the liabilities (SAM, the solvency assets multiple) or (2) specified probabilities for meeting each liability (FAM, the funded assets multiple). The third metric, the risk-free funded ratio (RFFR), uses the STRIPS curve to determine the fraction of the liabilities that can be covered without risk. We implement these metrics, first using Monte Carlo simulation given a fixed investment portfolio strategy, and then using dynamic programming to optimize investment portfolio strategies that maximize SAM and FAM.