ENDOWMENT

Decreases the endowment’s ability to take risk.

• The endowment’s support to the university is essential in keeping the university competitive. Therefore,
disruption in the subscription service due to poor returns would have serious consequences.
• The endowment is not expected to receive any donations in the foreseeable future.
 Lack of additional contributions limits the size of the investable base and reduces the portfolio’s ability
to absorb losses.

Increases the endowment’s ability to take risk.

• The investment horizon is perpetual, allowing time to make up for poor short-term investment returns.
• The fund reinvests any surplus, resulting in an increased ability to maintain purchasing power.

1. SU’s endowment has a lower relative commitment to SU’s operating budget than WU’s endowment to
WU’s operating budget (10% versus 25%). Hence, SU is less likely to face a spending obligation short-fall
and, holding all else constant, suggests that SU’s risk tolerance is higher than WU.
2. SU’s endowment is committed to covering the SU operating deficit, but only up to its spending rule. If
the operating deficit (in dollar terms) is smaller than its spending rule (in dollar terms), it will spend less.
Therefore, in any period where it is required to spend less than 5%, it can accumulate real value. Given
WU’s secondary goal of funding 25% of the operating budget, it is less likely that WU’s spending will be
less than 5%.
3. SU’s operating expenses are expected to grow at a slower rate than WU’s, thus SU is less likely to face a
spending obligation short-fall in the future and, holding all else constant, suggests that SU may have a
higher risk tolerance than WU.
4. Donations have been increasing for SU and decreasing for WU. SU requires fewer liquid assets and
relies less on portfolio returns to satisfy spending needs. Thus, SU’s risk tolerance is higher than WU.
5. SU’s investment manager is evaluated with a longer-term return metric. Hence, SU’s manager has less
short-term performance pressure, and is able to tolerate greater short-term volatility.
6. SU receives government funding whereas WU relies on a private funding. Therefore, SU has a more
stable or reliable external funding source, resulting in a higher risk tolerance.
7. SU has a spending rule that is smoothed over a three year period versus WU’s annual spending rule. A
smoothed spending rule will decrease volatility in spending requirements, allowing SU to assume higher
risk tolerance.

PENSION FUNDS
Above-average for the following reasons:
1. Saylor is usually highly profitable. High expected profitability supports above average (AA) risk
tolerance because the impact of unfavorable investment returns can be mitigated by the ability to increase
Plan contributions. Saylor’s past high profitability is expected to resume in the future.
2. Saylor has a young workforce, which implies a long duration of Plan liabilities. This allows for an AA
risk tolerance due to low liquidity requirements and a longer time to make up funding shortfalls.
3. Saylor has no current pension recipients, which increases the duration of Plan liabilities. This allows for
AA risk tolerance due to low liquidity requirements and a longer time to make up funding shortfalls.
4. Saylor’s return on Plan assets has a low correlation with both the broad equity market and the company’s
operating results because the company is cyclical. The low correlation between Saylor’s operating results
and Plan asset returns allows for AA risk tolerance. The Plan can seek higher asset returns; there is low
probability that unfavorable returns will coincide with poor operating performance.
5. The absence of an early retirement provision increases the duration of Plan liabilities and allows for AA
risk tolerance due to lower liquidity requirements and a longer time to make up funding shortfalls.
6. FF has greater ability to take risk than Wirth-Moore’s pension plan. FF has a spending goal that is
supported by an objective of minimizing taxes. In contrast, the pension plan must pay defined benefits,
which constitutes legal liability. This difference increases FF’s ability to take risk compared to Wirth-
Moore’s pension plan.
1. FF’s board has chosen to seek additional return to maintain the real purchasing power of the portfolio, or
2. Increase the size of the endowment in real terms.
3. Wirth-Moore pension plan’s asset allocation is conservative (currently completely invested in bonds)
indicating a low willingness to take risk.

Low risk tolerance are:

Aquiline has declining profitability. This limits the ability of the company to make contributions to the
Plan.
Aquiline’s operating earnings are positively correlated with pension asset returns. Low or negative asset
returns could occur when the firm is least capable of making contributions.
The new provision for early retirement reduces the duration of Plan liabilities and increases the liquidity
requirement.
The relatively older workforce (average age of 54) results in a short duration of Plan liabilities.
The diminished funding status for the Plan increases the probability of shortfall risk, which could require
Aquiline to make additional contributions.
There is a risk that actual inflation could exceed expected inflation. This would lead to a greater need to
pay the inflation-indexed retirement benefits for current retirees and certain former employees.
• BC Plc’s pension plan is more under-funded. The ratio of plan assets to plan liabilities at 0.83 is less than
1.0 and below the FTSE 350 average of 0.97.
• BC Plc’s workforce has a higher average age.
• BC Plc’s workforce has a higher ratio of retired lives to active lives.
• BC Plc’s workforce has higher years of service.
• BC Plc has lower profitability.
• BC Plc has a higher debt ratio.

Advantages to Employer:
In the Defined Contribution setting, Aquiline does not have the responsibility to set objectives and
constraints; rather, the plan participants set their own risk and return objectives and constraints.
Aquiline does not bear the risk of investment results; employees and beneficiaries bear the risk.
Aquiline’s future pension obligations are more stable and predictable.
Aquiline does not need to recognize any additional pension liabilities on its balance sheet under the new
plan.
As long as Aquiline provides a wide range of investment choices and periodically evaluates them, it
fulfills its fiduciary responsibilities as the plan sponsor.

Advantages to Employees:
The participant is able to choose a risk and return objective reflecting his or her own personal financial
circumstances, goals, and attitudes toward risk.
Defined contribution plan assets are more readily portable.
Under Aquiline’s defined contribution plan, employees are immediately vested.
Defined contribution plans do not present early termination risk, i.e., the risk that the plan is terminated
by the plan sponsor.
Participants can rebalance and re-allocate investments.
Defined contribution plans reduce participants’ exposure to Aquiline’s financial condition.
 Account balances legally belong to participants.
FOUNDATIONS
Above average:
• The Pearce Foundation has a perpetual time horizon, which allows it opportunities to make up for losses
sustained by the portfolio.
• The Pearce Foundation expects to receive ongoing annual contributions.
• The Pearce Foundation does not have a contractually-defined liability stream. Its 6% annual spending
requirement is not a contractual obligation.

INSURANCE
Decrease in ability to take risk:
1. Time Horizon: Since the duration of the liabilities is decreasing, the time horizon of the investment
portfolio should be reduced accordingly, thus lowering Pawtucket’s ability to take risk.
2. Reinvestment risk: As the fixed rate annuity product grows as a percentage of Pawtucket Mutual’s
business, reinvestment risk increases since contract rates are guaranteed using estimates of the rate at which
interest payments will be reinvested. The fixed rate nature of the annuities reduces Pawtucket’s ability to
take risk.
3. Pawtucket’s surplus has dropped from $500 million to $475 million, thus reducing its ability to take risk.
4. Liquidity needs – As fixed rate annuities make up a larger share of the business mix, a higher level of
liquidity is required in order to meet the current periodic payouts to annuity holders. The need for greater
liquidity reduces Pawtucket’s ability to take risk.
5. Liquidity needs – In a rising rate environment, fixed rate annuities are more likely to be subject to
disintermediation. Without sufficient liquidity, Pawtucket would be forced to sell securities at a loss to
meet surrenders of policies and annuity contract disbursements. The need for greater liquidity reduces
Pawtucket’s ability to take risk.

INDIVIDUALS
Decreases the ability to take risk.
• The Mattisons plan to make a large cash outlay, relative to their current savings, in five years to purchase
a second home.
• The Mattisons have a small asset base relative to their spending needs. They are making up for that by
saving a significant portion of the income in order to prepare for retirement.
• They are five years older which means their life expectancy is shorter than it was five years ago. As a
result, the couple has less time to convert human capital into financial capital and to recover from any
shortfall in the market.
• With the mortgage payments on the new house, they are now able to save only EUR 72,000 per year
rather than EUR 100,000.
• The Mattisons have increased their indebtedness with the new mortgage, which decreases their financial
flexibility.
Their investment portfolio is heavily weighted towards fixed income, indicating a low willingness to
take risk.
They would like to retire in only four years, so they would not have a long time to recover from
investment losses before retirement, indicating a low ability to take risk.
Neither Louis nor Marie are eligible for a defined benefit pension and are thus totally reliant on their
investments to fund their needs in retirement, indicating a low ability to take risk.
To the extent that their wealth has been passively accumulated through savings, they might be less
confident they can rebuild their wealth should it be lost, indicating a low willingness to take risk.
• The Beckers, being retired, are in the maintenance stage of life. They do not intend to work; no additional
income flows are expected.
• Michael Becker has a small pension relative to living expenses. The Beckers must depend primarily on
their investment portfolio.
• The Beckers have a high level of spending relative to investable assets, making them less able to tolerate
volatility and negative short-term returns.
• The Beckers want their portfolio to be invested conservatively (low willingness to take risk).
• The Beckers inherited their wealth (passive source of wealth), which may result in a reduced willingness
to take risk.

They have a moderate asset base relative to required cash flows from the portfolio
- There is no assurance the children’s education will be covered by a scholarship and the cost could be
substantial
􀂃 His only source of income is his investment portfolio.
􀂃 He desires to maintain the real value of the portfolio.
􀂃 He could decide to increase his spending needs during retirement.
􀂃 He is at the peak of his career and earnings power. He is unlikely to be able to achieve comparable
earnings power in the future.

Increases ability to take risk.

• They are net savers (annual savings of EUR 100,000): their after-tax salaries more than cover their living
expenses and generate savings without the need to use investment income.
• They have a long time horizon because they are relatively young and plan to work for another 15 years.
They could delay retirement or return to work if needed, and still have a large amount of human capital.
• The liquidity requirement for the second home is a “want”, not a “need.” They could stay in their current
home if necessary.
• Paul Mattison will be entitled to an inflation-adjusted pension upon retirement. Although it might not
cover all of their expenses, it serves as a cushion against a decline in portfolio value.
• They currently have no debt, which increases their financial flexibility.
• The Mattisons have a much larger asset base, relative to their spending level compared to five years ago.
• The Mattisons no longer have a large cash outlay on the horizon for their house purchase.
• They are relatively young and have a long time horizon, so they are likely to have time to recover from
any unanticipated adverse financial event.
• They have a substantial asset base relative to their spending needs.
• The couple has relatively stable spending habits and does not expect any significant cash outflows in the
future.
• They own a home and have no debt, so the home could be sold or borrowed against if cash is needed.
• They are relatively young and have the ability to seek employment if necessary.
He has the ability to consistently save part of his annual earnings.
He has a relatively large asset base in comparison to his goal, and thus a low required return, allowing
him to withstand short-term market volatility.
Alonso makes a substantial gift every year to a children’s sports program. If necessary, he could decrease
or eliminate the gift, reducing his expenses.
Alonso has a medium- to long-term investment horizon for saving the funds needed at retirement.
Alonso does not plan to leave an estate.
Lima has a long time horizon until retirement (25 years) -- a long investment time horizon.
Lima receives a USD 1,000,000 payment at age 60 (retirement).
Lima has the flexibility to stop the annual payments to charity of USD 6,000.
Lima has no debt.

Rual’s current income significantly exceeds her current level of spending.

She only needs to provide for herself.
Rual’s current portfolio value (USD 1,500,000) is large relative to her living expenses.
Rual does not have to make the charitable contribution upon the sale of her business.
Rual has a flexible retirement date -- a long (15 years) investment horizon.

Rual has a greater willingness to take risk because:

Rual owns her business.
Rual plans to retire relatively early at age 52.
Rual is confident that equities will deliver positive returns.
• Small amount of investable assets to support them in retirement relative to their spending levels,
particularly if they choose to retire at age 60
• Because there will be no post-retirement employment income, there will be no further funds added to their
portfolio (no human capital during retirement).
• With one year to retirement, there will be no further funds added to investable assets since current annual
income equals expense.
• Alexander does not participate in any company or individual retirement plan.
• Their desire for preservation of the real value of their portfolio
• Patricia’s preference to avoid losses due to previous experience
• Conservative nature of current investments

They have a long time horizon

- They are young and have more human capital
- They will receive another trust payout in 10 years
- They will potentially inherit a large sum of money from Mariana’s parents
- They have stable income

1. Given their life expectancies, the Ingrams are using a long term (35 year) planning horizon.
2. The Ingrams have a substantial asset base relative to their spending needs.
3. In the event that their performance is not satisfactory, the Ingrams may reduce or eliminate the planned
testamentary gifts. This larger margin for error allows them to accommodate volatility in the portfolio.
4. The Ingrams could change their plans to donate the house/land.
5. Opportunities for additional income exist (reemployment, etc.).

􀂃 He has a long time horizon and thus more ability to recover from any intermediate investment shortfalls.
􀂃 He has investable assets that are more than sufficient to cover his retirement objectives.
􀂃 He could pursue a second career or pursue endorsement deals.
􀂃 He could reduce his living expenses.