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Asset liability management for individual households

Published online by Cambridge University Press:  25 November 2011

M. A. H. Dempster  and
E. A. Medova
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Abstract

Personal finance is a challenging topic which can benefit from a scientific approach to individual financial planning. This paper presents an individual asset liability management (iALM) model for life cycle planning which uses the methodology of dynamic stochastic optimisation and incorporates ideas from both classical and behavioural finance. Its implementation is in the form of a decision support tool for use by financial advisers or wealth managers. The investment universe is given by a set of indices for major asset classes and their returns are simulated forward over the lifetime of a household. On the liability side the foreseen cash flows of incomes and outgoings are simulated and punctuated by life events such as illness and death. The household's utility function is constructed for each time period over a range of monetary values in terms of household financial goals and preferences. Taxes and pension savings are treated using the tax shielded saving accounts specific to a national jurisdiction in terms of constraints in the optimisation sub-models. The paper goes on to present an analysis of iALM model recommendations for a representative UK household, together with an evaluation of the sensitivity of the financial plan generated to changes in market environments such as the 2007–9 crisis. The promise of this new technology is to bring modern decision support tools to individual investors in order to facilitate custom designed consumption, savings and investment policies.

Keywords

Asset return simulationDecision support systemDynamic stochastic programmingEvent simulationFinancial planningFinancial adviceGoalsLiability simulationLife cycle modelOptimisation meta-modelsOptimal decisionsRetirementSustainable wealthRisk attitudeRisk managementSIPP and ISA retirement accountsTax efficiency
Type
Sessional meetings: papers and abstracts of discussions
Information
British Actuarial Journal , Volume 16 , Issue 2 , 25 November 2011 , pp. 405 - 439
Copyright
Copyright © Institute and Faculty of Actuaries 2011

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