Handbook of Finance: Investment Management and Financial Management

Appendix A. DETAILS FOR THE ILLUSTRATIONS

Cash Requirements for Liability-Immunizing Portfolio

Table 47.A1 provides very roughly the approximate funding requirements for an overlay program. The table shows the percent of notional liability required to fund the liability overlay so that the program would be well enough funded as to not need to draw on funds in the nonover-lay portfolio. This is a broad and rough gauge of funding requirements for the overlay. A more in-depth analysis would have to be done, including information regarding benefit payment cash flow needs, for any certainty regarding the numbers in Table 47.A1. These numbers are approximations and would change depending on the particular structure of each pension fund's benefits and the nature of the benefits (that is, the degree of sensitivity to inflation and interest rates).

These are approximations and are intended to represent the amount of capital needed to create a self-sustaining overlay that can fund margin calls over indicated time periods, at various levels of confidence. Note that we use assumptions in constructing these estimates (including the normal distribution of returns). We generate these estimates based on historical 1, 2, and 3 standard deviation moves for typical liabilities (that is, liabilities with that have 12 years of duration and of which 20% are inflation sensitive). The longer the duration, the more capital required. Note that this capital is required to fund a largely autonomous exposure, ...