Method of determining optimal asset allocation utilizing asset cash flow simulation

• US 20020038271A1
• Filed: 02/05/2001
• Published: 03/28/2002
• Est. Priority Date: 10/30/1995
• Status: Active Grant

• Current Assignee: Cheiron, Inc.
• Original Assignee: EFI Actuaries
• Inventors: Friend, Edward H., McCrory, Robert T.
• Granted Patent: US 7,243,081 B2
• Time in Patent Office: Days
• US Class Current: 705/36
• CPC Class Codes: G06Q 40/00 Finance; Insurance; Tax strategies; Processing of corporate or income taxes
• CPC Class Codes: G06Q 40/06 Asset management; Financial planning or analysis
• CPC Class Codes: G06Q 40/08 Insurance

Abstract

A method of simulating future cash flow for a given asset allocation under a variety of economic conditions, measuring the frequency of failure of the cash flow to avoid one or more predefined risks. Assigning user-selected weights to avoidance of specified risks and alternative user-selected weights to maximization of rate of return, the invention utilizes the cash flow simulation to produce a performance index. By methodological testing through asset allocation adjustments, the optimum performance index is determined, thereby identifying the optimum asset allocation.

Claims

1. A computer program product storing computer instructions therein for instructing a computer to perform a process for determining a plan specific optimal asset allocation utilizing cash flow simulation, the program product comprising:

a recording medium readable by the computer; and

the computer instructions stored on said recording medium instructing the computer to perform the process, the instructions including;

(a) entering at least one of user selected risk avoidance weights or a user selected rate of return including plan specific definitions of risk for a given retirement plan;

(b) selecting a range of tolerable asset allocations for specific asset classes contained in an asset allocation list, the asset allocation list comprising a fixed class of investment and an equity class of investment, said selecting step (b) selecting maximum and minimum tolerable asset allocations for each of the fixed and equity classes of investments;

(c) generating one or more risk tolerance baselines based on one or more user defined risk tolerance factors;

(d) simulating benefit and asset cash flows as future financial projections based on the selected asset allocation and on the plan benefit and payroll cashflows;

(e) determining if risk tolerance failure events occur by comparing the future financial projections with the one or more risk tolerance baselines;

(f) determining a performance index for the selected asset allocation based on a weighted average of the occurrence of the risk tolerance failure events and the cost of the plan; and

(g) repetitively performing said steps (d), (e) and (f) for different asset allocations within the range of tolerable asset allocations generating a plurality of performance indices, and determining an optimum [until the plan specific optimal] asset allocation having a best performance index [is determined] from among the plurality of performance indices.

2. A computer program product storing computer instructions therein for instructing a computer to perform a process for determining a plan specific optimal asset allocation utilizing cash flow simulation, the program product comprising:

a recording medium readable by the computer; and

the computer instructions stored on said recording medium instructing the computer to perform the process, the instructions including;

entering at least one of user selected risk avoidance weights or a user selected rate of return including plan specific definitions of risk for a given for a given financial plan into a computer;

selecting an asset allocation for specific asset classes contained in an asset allocation list previously stored in the computer;

generating a plurality of asset cash flow projections based on the selected asset allocation;

generating a single baseline, simulation average baseline or collection of risk tolerance baselines based on (i) a single predefined risk tolerance factor, (ii) an average of the risk tolerance factors evolving from all the asset cash flow projections in each simulation or (iii) a separate risk tolerance factor evolving from each cash flow projection within each simulation trial;

determining if a risk tolerance failure event occurs by comparing the asset cash flow projection with the risk tolerance baseline projection(s) underlying the said simulation and repeating this process for other asset allocations until that asset allocation generating the lowest rate of risk tolerance failure is found to determine the optimum asset allocation.

3. A computer program product storing computer instructions therein for instructing a computer to perform a process for optimizing a defined benefit retirement plan asset allocation, the program product comprising:

a recording medium readable by the computer; and

the computer instructions stored on said recording medium instructing the computer to perform the process, the instructions including the step of optimizing the defined benefit retirement plan asset allocation as a mix of assets which may be expected to deliver a lowest probability of the plan experiencing a user defined adverse circumstance as of a selected future date or within a specified period,

wherein the plan is a specific year-by-year projected benefit outflow from a specific level of underlying assets, a specific employee contribution stream from an open group of current and future employees and a specific percentage of open group payroll employer contribution stream, buffeted by anticipated asset class gains and losses that may be above or below expected levels,

wherein the user defined adverse circumstance includes at least one of user selected risk avoidance weights or a user selected rate of return including a weighted average of one or more of the following;

(i) assets falling below a specific multiple of benefits, (ii) employer contributions required to maintain a level percentage of payroll cost for plan financial soundness rising above or falling below a first certain percentage of initial level, (iii) assets falling below a second certain percentage of liabilities or (iv) assets falling below a point from which a return to the initial level of expected investment return has a lower than acceptable probability, and

wherein the mix of assets is subject to user constraints as to the portion of assets allowable in each asset class in the final portfolio.

4. A computer program product storing computer instructions therein for instructing a computer to perform a process for determining a plan specific optimal asset allocation utilizing cash flow simulation, the program product comprising:

a recording medium readable by the computer; and

the computer instructions stored on said recording medium instructing the computer to perform the process, the instructions including;

(a) entering user defined criteria including at least one of user selected risk avoidance weights, a user selected rate of return, or user selected plan profile information, asset information (including current market value, current asset allocation by class), economic assumptions (including assumed rate of return on plan assets, employee contribution requirements, third-party financing input and employer funding method in place;

(b) selecting a range of tolerable asset allocations for specific asset classes contained in an asset allocation list, the asset allocation list comprising a fixed income class of investments, and an equity class of investments, said selecting step (b) also selecting maximum and minimum tolerable asset allocations for each of the fixed and equity classes of investments;

(c) for a tentatively selected asset allocation within the tolerable range, generating (projecting over a designated future time frame in stochastic manner by Monte Carlo simulation) multiple cash flow forecasts of (i) plan assets and (ii) one or more user-selected risk tolerance baselines; and

determining a weighted average measure of risk tolerance failure (unfavorable outcomes) by computer examination of the number of crossing violations of the risk tolerance baselines; and

generating, on a computer monitor for printout display and analysis, a reflection of the depth (degree of badness) of crossing violations as well as the height (degree of goodness) of favorable outcomes, where;

Plan assets are projected into the future by starting with assets on hand, subtracting benefits as they are projected to be disbursed, adding projected employee and third-party contributions, introducing projected investment returns and such projected percentage of payroll employer contributions as are necessary to maintain financial soundness of the plan.

Risk tolerance baselines include

a user-selected multiple of benefits,

a projected percentage of payroll employer contribution level at more (less) than the initial level by a user-designated margin,

a user-designated percentage of user-defined liabilities,

that diminished level of assets from which return to the initially assumed rate of investment return within a user-selected number of years has a lower user-designated probability of occurrence than acceptable to the user, and

other comparable user-designated alternatives,

Projected investment returns of individual asset classes are either the interaction of projected inflation deflators and real (net of inflation) asset class returns generated independently of each other or in tandem, with projections historically (or modified historically) or parametrically developed. Alternatively, projected nominal rates of return of individual asset classes are extracted from history by stringing together consecutive periods of user-selected length.

Projected percentage of payroll employer contributions are dependent on feedback from the results of other simulated inflows and outflows, the overlay of computer-developed amortization over a user-selected amortization period of investment return gains and losses relative to an underlying user-selected baseline rate of return, such percentage of payroll employer contributions to reflect the requirement that employer contributions be the balancing item to maintain financial soundness of the plan.

(d) repetitively performing step (c) for different asset allocations within the tolerable range until the asset allocation having the lowest weighted average measure of risk tolerance failure, or performance index, is determined.

5. A computer program product according to claim 4, wherein said generating step (c) further comprises the step of including, in a determination of the best performance index, risk tolerance failures (unfavorable outcomes) at or within different intervals (whether or not weighted as to importance).

6. A computer program product according to claim 4, wherein said generating step (c) further comprises the step of including, in a determination of the best performance index, a weighted measure of the cost of the plan.

7. A computer program product according to claim 4, wherein said generating step (c) further comprises the step of selecting another range of tolerable asset allocations for the specific asset classes contained in the asset allocation list.

8. A computer program product storing computer instructions therein for instructing a computer to perform a process for determining a plan specific optimal asset allocation utilizing cash flow simulation, the program product comprising:

a recording medium readable by the computer; and

the computer instructions stored on said recording medium instructing the computer to perform the process, the instructions including;

(a) entering at least one of user selected risk avoidance weights or a user selected rate of return including plan specific definitions of risk for a given for a given financial plan into a computer;

(b) selecting a range of tolerable asset allocations for specific asset classes contained in an asset allocation list, the asset allocation list comprising a fixed income class of investments and an equity class of investments, said selecting step (b) also selecting maximum and minimum tolerable asset allocations for each of the fixed and equity classes of investments;

(c) generating, over a designated future time frame, one or more risk tolerance baselines including minimum level of plan assets, maximum or minimum level of plan costs, percentage of liabilities, required plan earnings, and other user-designated alternatives;

(d) simulating benefit and asset cash flows as future financial projections based on the selected asset allocation and on the plan benefit cashflow projections;

(e) determining the frequency (crossovers) of risk tolerance failure events by comparing the simulated future financial projections including liabilities, costs, benefits, recovery interest rate and assets with one or more risk tolerance baselines as of selected points in time or within selected time frames;

(f) generating, on a computer monitor for print-out display and analysis, a reflection of the depth (degree of badness) of crossing violations of said risk tolerance failure events as well as the height (degree of goodness) of favorable outcomes;

(g) determining a performance index for the selected asset allocation, based on (i) user-selected weighted average of the frequency of the various risk tolerance failures at (ii) user-selected points in time or during time intervals, and on (iii) user-selected weights on a measure of cost of the plan;

(h) repetitively performing said steps (d), (e), (f) and (g) for different asset allocations within the range of tolerable asset allocations until the plan specific optimal asset allocation having a best performance index is determined;

(i) selecting another range of tolerable asset allocations for the specific asset classes contained in the asset allocation list; and

(j) simulating benefits and asset cash flows as additional future financial projections based on the newly selected range of tolerable asset allocations by repeating steps (d) through (h);

(k) determining another performance index for each newly selected range of tolerable asset allocations;

(l) repetitively performing said steps (i), (j) and (k) within other ranges of tolerable asset allocations until other plan specific optimal asset allocation having other best performance indices are determined;

(m) selecting the plan specific optimal asset allocation with the best performance index.

9. A computer program product storing computer instructions therein for instructing a computer to perform a process for determining a plan specific optimal asset allocation utilizing cash flow simulation responsive to plan information, a range of tolerable asset allocations and one or more risk tolerance baselines based on one or more user defined risk tolerance factors, the program product comprising:

a recording medium readable by the computer; and

the computer instructions stored on said recording medium instructing the computer to perform the process, the instructions including;

(a) determining when a risk tolerance failure event occurs by comparing a user defined future financial projection responsive to a selected asset allocation in the range of tolerable asset allocations with the one or more risk tolerance baselines;

(b) generating a performance index for the selected asset allocation responsive to at least the occurrence of the risk tolerance failure event; and

(c) repeating steps (a) and (b) for a plurality of selected asset allocations in the range of tolerable asset allocations generating a plurality of performance indices, and determining an optimum asset allocation having a best performance index from among the plurality of performance indices.

10. A computer program product according to claim 9, wherein the user defined risk tolerance factors comprises user selected risk avoidance weights which are applied to at least one of predefined risk failure weights and average return for each asset allocation.

11. A computer program product according to claim 9, wherein the user defined risk tolerance factors establish a threshold multiple of a risk factor as of at least one of a given time and within a given time frame.

12. A computer program product according to claim 9, wherein the user defined future financial projection comprises at least one of user selected risk avoidance weights or a user selected rate of return including plan specific definitions of risk for a given retirement plan.

13. A computer program product according to claim 9, wherein said generating step (b), further comprises the step of generating a performance index for the selected asset allocation based on a weighted average of the occurrence of the risk tolerance failure event and a cost of the plan.

15. A computer program product according to claim 14, wherein said determining step (a) includes consideration of other tolerable asset ranges.

16. A computer program product according to claim 15, wherein said generating step (b) comprises the step of generating a measure of the cost of the plan to be included, with its user selected weight, as a component of the performance index.

17. A computer program product according to claim 15, wherein said determining step (a) further comprises a display of the depth (degree of badness) of crossing violations of said risk tolerance failure events as as the height (degree of goodness) of favorable outcome

14. A computer program product storing computer instructions therein for instructing a computer to perform a process for determining a plan specific optimal asset allocation utilizing cash flow simulation responsive to plan information, a range of tolerable asset allocations and one or more risk tolerance baselines based on one or more user defined risk tolerance factors, the program product comprising:

a recording medium readable by the computer; and

the computer instructions stored on said recording medium instructing the computer to perform the process, the instructions including;

(a) determining the frequency of risk tolerance failure events within any selected future time interval by counting the number of crossings of (i) a specified number of simulations of user defined projected plan assets, user defined projected plan costs or a user defined projection of any other evolving financial characteristic of the plan over (ii) one or more risk tolerance baselines, where plan assets are allocated to any one of a number of asset class configurations within a particular range of tolerable asset allocations

(b) generating for each asset allocation within the tolerable range a weighted average failure rate frequency performance index, wherein the frequency of failure to avoid each user selected risk tolerance factor at each user specified interval is given a user assigned weight; and

(c) repeating steps (a) and (b) for a sufficient number of asset allocations within the tolerable range so as to determine the particular asset allocation with the best performance index.