Investment decisions take into account the nature of the liabilities of the social security institution. In particular, investment strategy reflects the level, timing and nature of liability cash flows and the predictability of such future payment obligations.
As part of this analysis, appropriate modelling can be conducted to determine an investment strategy that is likely to meet the social security institution’s mission and goals. The assets of the social security institution should be modelled in conjunction with its liabilities, or an appropriate proxy of its liabilities. The use of asset liability modelling may, therefore, form an important part of the management and governance process of the institution.
Any modelling should ensure that, e.g. any inflation linking in the cash flow profile is appropriately accounted for, i.e. when a scenario projects a higher level of inflation, this is applied to both real assets and real cash flows so that the expected risk and return from holding nominal assets can be correctly calculated. Similarly, the timing of cash flows will change the risk profile of the scheme and the matching assets which are then appropriate as an investment.
- The management or investment committee should provide the board with a proposed return target and risk budget for the social security institution for review and approval.
- Where appropriate, the management or investment committee should conduct long-term asset liability modelling to demonstrate how the social security institution’s assets and liabilities may evolve in the future. The modelling should be used to determine whether the investment mission and goals are likely to be met from a return/spending/growth perspective, as well as from a risk perspective.
- Accurate information regarding the nature of the social security institution’s liabilities should be incorporated into the modelling process. Where the resources to carry this out do not exist within the institution (e.g. where there is no actuarial resource), there may be a need for the input of an external expert. Where sufficient information is not available, an appropriate proxy of the social security institution’s liabilities should be used in consultation with the social security institution’s actuary.
- Analysis should be conducted to consider the possible impact on assets and liabilities (and, therefore, the ability of the social security institution to meet its commitments) of events not captured by the modelling process. This analysis may be qualitative or quantitative in nature. Examples of such events may include extreme risks identified by the management or investment committee or a third party. It may be appropriate to adjust the investment strategy following such analysis.
- Where asset liability modelling is undertaken, this should be conducted on a frequency considered appropriate to the social security institution reflecting the funding level, investment objectives and other assessments of the liabilities of the scheme that is carried out.
- Where the board, management or investment committee lacks sufficient resource, expertise or governance budget to conduct asset liability modelling, the board, or the management or investment committee with board authorization, should seek expert advice or appoint external professionals to carry out these functions.
- The duration, predictability and maturity of the social security institution’s liabilities should be considered in the determination of investment strategy and the carrying out of investment policy. The management should consider the information required to ensure that there is appropriate consideration of liabilities and that the social security institution’s actuary is involved in the process. Actuarial input into this process is essential to ensure that there is appropriate consideration of the nature of liabilities.
- The resources within the social security institution to assess the nature of liabilities, understand the financing and funding policy, carry out any modelling, and analyse and advise on the risk budget should be assessed.
- Due consideration should be given to the determination of the return target and corresponding risk budget, which should be consistent with the investment mission. Any modelling should, therefore, take into account the rate-of-return target and risk budget, which should be reviewed and approved on a regular basis by the board.
- The investment policy must take into account the funding policy, cash flow requirements and other objectives of the social security institution. When there is partial funding of benefits, an assessment of the relevance of asset liability modelling should be carried out together with how asset liability modelling may be undertaken and how the process needs to be adjusted to appropriately reflect the financing objectives of the social security institution.
- When asset liability modelling is undertaken, events that cannot or are not captured as part of the modelling process should be considered separately and explicitly. Long-term asset liability modelling should, where required, reflect decrees or decisions issued by relevant national authorities or establishing legislation of which they are a part.