The social security institution ensures that the scheme liabilities are taken into account in the investment process.
A key driver of investment decisions is the timing, level and nature of net cash flows of the social security scheme and how these will evolve in the future. Therefore, the actuary will have a significant role in estimating the future cash flows of the scheme and interpreting these for the investment process. These cash flows consist of future benefit payments, contributions received, expenses and income from assets and other sources. Appropriate modelling can be conducted to determine an investment strategy that is likely to meet the social security institution’s mission and goals. While there is a clear link to the calculations and projections carried out as part of the actuarial valuation process (see Part A of these Guidelines), the actuary is also likely to input into more specific investment analyses relating to future benefit and expense cash flows (for example, Asset Liability Management(ALM)) which will provide an important input into the development of investment strategy and the management of the process.
This guideline should be read in conjunction with Guideline 6 of the ISSA Guidelines on Investment of Social Security Funds.
- The cash flow projections from future benefit obligations and expenses should be determined by using an appropriate methodology and assumption basis. These bases should be documented and reviewed regularly in accordance with relevant good practice and actuarial standards. Considerations regarding methodology and assumptions to use (e.g. open versus closed group valuations) are covered in Guidelines 3 and 4.
- When future cash flow projections are taken from the most recent actuarial valuation, they should be updated to the analysis date using appropriate assumptions.
- When approximate projections are undertaken, or a proxy value of liabilities used, the basis of the calculations and assumptions (e.g. average service) should be stated. An analysis of discrepancies between previous approximate projections and actual experience should be carried out.
- The actuary should perform appropriate analysis to model potential variations from the base case projections in future asset cash flows. This analysis should use appropriate methodology and assumptions reflecting at least three different scenarios (for example, “optimistic”, “pessimistic” and “extreme”). The different factors affecting variations in future cash flow amounts and timings should be considered (e.g. inflation).
- The analysis should take into account the funding policy of the social security scheme. Given that most social security systems are only partially funded, an analysis of the relevance of ALM and how the process should be carried out to reflect the partial funding should be considered and documented.
- It is important that the actuary works closely with other professionals and experts within the social security institution, such as investment managers, auditors, the risk function, the finance function and other relevant members of the institution.
- The actuary and the social security institution should also closely cooperate with other scheme stakeholders and decision-makers to ensure that the results of the ALM are understood and properly reflected in decisions taken.
- In his or her input to the process, the actuary should document the data, assumptions and methodology used, identifying where approximations or estimations have been used. Where events that cannot be measured or quantified but may materially affect outcomes exist, these should be considered separately and explicitly. These risks may include investment manager risk, third-party risks or benefit reform risks. Results should be set out clearly regarding alternative scenarios and sensitivity analyses.
- The analysis should be carried out on a regular basis, the frequency being consistent with the size of the scheme’s liabilities and assets, liquidity requirements, the nature of the assets held, the funding policy, the resources within the institution, and any other relevant constraints or objectives.
- The role of the different stakeholders involved in the determination, analysis and reporting of cash flows should be documented. The actuary should liaise effectively and efficiently with other stakeholders in this regard.
- An assessment of the competencies of each stakeholder relating to the task assigned should be carried out and any gaps should be identified. Where there are gaps, a plan should be set down and carried out to assess actions to address them.
- Clear reporting lines and peer review processes should be set out. The competencies required of each of the stakeholders should be documented and regularly reviewed.
- The actuary should prepare the projections of the scheme’s liabilities and cash flow in accordance with generally accepted actuarial practices and standards.