The social security institution involves actuaries in different areas of the investment process. This guideline refers to the situation where actuaries are directly involved in the design and carrying out of an investment strategy in respect of the reserve funds of the social security scheme.
This guideline considers the different elements of the investment management process where actuarial involvement is likely to be solicited. The investment process is likely to include a number of different steps and be relatively complex in its planning, management and execution. For each of the elements where actuarial input may be required or demanded, it is important that this role is detailed and that it is carried out taking into account appropriate actuarial methods and approaches. A number of the processes detailed below require coordination and collaboration with other professionals and stakeholders both within and outside the institution. Such coordination should be effectively managed and proper peer review processes put in place and executed.
This guideline should be read in conjunction with the ISSA Guidelines on Investment of Social Security Funds (appropriate guidelines are identified below) as well as Guidelines 2, 3 and 4 data, assumptions and methodology respectively.
The areas of the investment process where actuarial input may be required include:
- Defining the risk budget and its utilization (Guidelines 7, 11, 12, 13 of the ISSA Guidelines on Investment of Social Security Funds):
- A risk budget is the amount of investment risk, relative to liabilities, an investing institution wishes to take. The assessment of risk in general and the risk budget in particular is often a key area of actuarial involvement in investment management, and this process assists the institution in understanding the level of risk taken on. Once defined, it will be used to develop a strategic and dynamic asset allocation for the institution. The actuary may also input into strategies to re-balance risk levels which may arise due to changes in the value of assets and/or changes in the scheme’s obligations (for example, when benefit rules change);
- General elements to consider in risk management are set out in Part E. In identifying and quantifying the different elements of risk, the actuary should consider which are the most appropriate methods to assess risk and should work closely with the risk function within the institution as well as the investment management function (internal or external) to ensure this analysis is relevant.
- Choosing appropriate assumptions and methodology for asset valuation and analysis (ISSA Guidelines on Investment of Social Security Funds, Guideline 20):
- Guideline 20 of the ISSA Guidelines on Investment of Social Security Funds considers in more detail the valuation of assets. Although the selection of appropriate methodology and assumptions is a key element of the process, it is important that decisions are taken with the involvement of relevant stakeholders, as the financial implications are likely to be significant. Such stakeholders may include asset managers, custodians, the finance function and the risk function as well as the board or other decision-making body in the institution. The assumptions and methodology used should be in accordance with international or national actuarial standards (and accounting standards, if relevant).
- Selection and calculation of appropriate benchmarks (ISSA Guidelines on Investment of Social Security Funds, Guideline 14):
- The performance and risk characteristics of fund assets as well as specific asset classes will be compared against appropriate benchmarks. The selection of these benchmarks is important, as their characteristics need to be consistent with the objectives of the investment process. The actuary may input into the decision of whether the benchmarks should be absolute or relative, nominal or real, or liability–related, as well as whether they should be a combination of market-weighted indices. The actuary will also provide a view on the quality of the benchmark. The determination of the benchmark return may require the involvement of the actuary, particularly if the benchmark is a combination of different indices or requires currency conversion.
- Other calculations related to asset performance (e.g. other risk analysis including currency hedging considerations, analysis of charges, passive versus active choices) (ISSA Guidelines on Investment of Social Security Funds, Guidelines 17, 21, 22):
- The actuary may be involved in other investment areas. Calculations should be performed using an appropriate methodology and basis. For example, the implications of currency mismatches where assets may be in several currencies and liabilities in the home country currency are significant for institutions and will require an appropriate assessment. Working with other stakeholders (e.g. the risk function, investment managers, valuation actuary, auditors, etc.) is important and should be formalized. Decision-making processes and communication lines should be defined and respected.
- The social security institution should seek to involve the actuary in certain areas of the investment process. The role should be defined and monitored on a regular basis, with the level of experience and competency of the individual defined.
- The institution should facilitate the sharing of information and collaboration between the different stakeholders involved in the investment process.