Bonds

Pension Pulse: Hidden Burden of Ultra-Low Interest Rates?

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Guest Post By: Leo Kolivakis via Pension Pulse: Hidden Burden of Ultra-Low Interest Rates?.   Matthew Philips and Dakin Campbell of Bloomberg report, Banks Join Pensions in Squeeze as Federal Reserve’s Low Rates Erode Profit:   The Federal Reserve, which cut its target for the federal funds rate to a zero-to-0.25 percent range on Dec. 16, 2008, said last month that rates would remain “exceptionally low” at least through late 2014. While the unprecedented period of near-zero rates is meant to aid an ailing economy, it poses challenges for banks, insurers, pension funds, and savers. The hope is that by making mortgages and … Read more

Money Managers Seek to Profit from Europe’s Woes

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Money Managers Seek to Profit from Europe’s Woes They’re buying downgraded bonds and betting on a slowdown Illustration by Oliver Munday When Moody’s Investors Service (MCO) downgraded Ireland’s sovereign debt to junk status on July 12, a week after giving Portugal’s debt similar treatment, it came as no surprise to Sandor Steverink. Europe’s best-performing government bond fund manager over the last decade, Steverink predicted both downgrades. Soon it will be time to buy, he says. “What we’ve learned from emerging markets is that you get only a full recovery after a proper restructuring,” says Steverink, who is co-head of a … Read more

Segmenting to Make Better Decisions

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This post was stimulated by this academic research piece: When Smaller Menus Are Better: Variability in Menu-Setting Ability.  The truth is, we do best in choosing between a limited menu of options.  Let me give you an example.

For a while, my wife asked me if we could replace our living room furniture.  Trying to be frugal while starting up my business, I showed her some items from Ikea, and she said yes, but I could not replace the recliner at Ikea.

So, after a month, she asked about the recliner.  I did a little searching and went to La-Z-Boy.  (Note: she uses the recliner most.)  I looked around the place and had three thoughts:

  • Low price
  • Reclines the way she likes.
  • Fabrics/colors that I know she likes.

Those criteria enabled me to narrow down the field to two recliners, and a field of six or so “maybes.”  I know my wife pretty well; she trusts me in purchases that many wives would not let their husbands touch.  But for something she uses so much, I took her to the store, along with our youngest (who got a kick out of playing with the electronic recliners).  I took her to the two recliners.  She oohed over them and sat in both.  She liked the fabric better in one, and the comfort of the other.  She tentatively chose the latter, and went on to look at other recliners. As she went on, she said that she wasn’t finding anything that she really liked.  We ended up buying the second chair.  It’s at home now, and she likes it.  Score one more for the husband.

The key to my success was winnowing down the choices.  There were over 100 recliners at the store. But by eliminating options that I knew would not work, I came to solutions that would save my wife time, while

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On Longevity Derivatives

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I am a firm believer in “you can’t get something for nothing.”  So it is when a new derivative is proposed.  Either there are natural counterparties to take up the exposure (reducing their risk), or speculators must be encouraged to take the risk (more likely).

So, with longevity derivatives, the risk is people living too long leading to more pension payments in future years.  The proposition is: find a party that is willing to make more payments if mortality is better than expected, and offer him a payment, or series of payments, as an inducement to enter the transaction.

Let’s think for a moment, what entities benefit from a rise in longevity?  I can think of one: life insurers.  But there is a problem: anti-selection.  People who buy life insurance tend to be sicker than those of the general population, who tend to be sicker than annuitants.  Annuitants live the longest, and their lifespans improve the most on average.  Life insurers would find taking on longevity risk to be a dirty hedge at best for their life insurance books.  In general there have been few reinsurance agreements for longevity risk for immediate annuity portfolios, but then, that would be a really small component of the life insurance industry at present.

Even when terminal funding was permitted (back in the 1980s to early 90s) — where plan sponsors could buy annuities from insurers to

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