Deterministic and Stochastic Modeling

Most pension plans rely on two sources of funds to meet future obligations:

• Assets that the plan has right now
• Contributions that will be made over future years

Deterministic ALM (stands for asset-liability modeling), answers the question from a plan sponsor:

If I follow this funding policy and investment policy for making contributions, how will my assets and liabilities develop over future years?

In other words, the ALM package extends the concept of comparing assets to liabilities. Instead of looking only at the comparison as of today, ALM looks at the comparison over an extended period such as 30 years.

ALM dynamically models the functioning of the pension plan into the future. For example, the following things happen every year:

• Members accrue benefits according to plan specifications
• Contributions come in according to the funding policy
• Benefit payments go out
• Assets earn returns
• Actuarial valuations are performed

ALM allows the plan sponsor to test different funding policies and investment policies for making contributions. Such testing would be done in order to select the policies that are most likely to meet the goals of the sponsor.

ALM allows sensitivity testing to be performed, whereby the plan sponsor can see how the asset and liability picture changes if, for example, assets earn a higher return than over recent history.