3.4 Stochastic projections of net worth
The risk-budget results are useful indicators of the Crown's exposure to risk. But their value is limited because they do not take into account expected returns or give an indication of the future path of net worth.
We measure the Crown's projected exposure to risk as the frequency distribution of the value of these assets and liabilities and hence of the Crown's comprehensive (or GAAP) net worth. Our measures are based on projections of taxes and spending, so they are estimates of projected risk, not actual risk.[15] From the estimated frequency distributions, we derive estimates of the probability distribution of the Crown's future net worth and thus of the probability that the Crown's net worth will fall below a given value for various time horizons (all assuming planned policy).[16] We present results for the estimated frequency distributions over the next ten years, though the nearer-term estimates (say one to five years ahead) are the most relevant: the greater the elapse of the time, the greater the chance that the government will respond to unexpected outcomes by changing its policies.
Projections are plotted in Figures 3 to 6 below. Estimates of value-at-risk at the 95% probability level for one-, three-, and five-year horizons are shown in Table 7. These estimates indicate the maximum loss in net worth that could be expected to occur with 95% probability over the given time horizon. Or put another way, an event as bad as this or worse could be expected to occur once every 20 years.
These results indicate, as would be expected, that the range of probable outcomes widens with time (holding policy constant). The comprehensive portfolio has the largest variance. There is significant volatility associated with social assets and hence the portfolio excluding social assets is much less risky than other portfolios.
The results suggest that the Crown's value-at-risk at the 95% probability level over a 5-year horizon is very large. With an estimated probability of 5%, for example, net worth excluding social assets could fall by more than $70 billion and comprehensive net worth by more than $120 billion. Such a reduction in comprehensive net worth is equivalent to a required increase in tax revenue of 12%.
- Figure 3 - GAAP net worth ($ billion)
- Figure 4 - Net worth excluding social assets ($ billion)
- Figure 5 - Comprehensive net worth excluding social assets ($ billion)
- Figure 6 - Comprehensive net worth ($ billion)
| 1 year | 3 year | 5 year | ||||
|---|---|---|---|---|---|---|
| $ billion | Tax change (%) | $ billion | Tax change (%) | $ billion | Tax change (%) | |
| GAAP net worth | 27 | 2.8 | 54 | 5.7 | 77 | 8.0 |
| Net worth excluding social assets | 18 | 1.9 | 48.5 | 5.1 | 76 | 7.9 |
| Comprehensive net worth excluding social assets | 52 | 5.4 | 101 | 10.5 | 138 | 14.4 |
| Comprehensive net worth | 52 | 5.4 | 90 | 9.4 | 122 | 12.7 |
Notes
- [15]That is, we estimate the frequency distributions of future net worth conditional on planned policy, not the unconditional frequency distributions of future net worth.
- [16]Comprehensive net worth is defined here as the expected value of future cash flows, and so is represented as a point estimate in the current time period, rather than a probability distribution. The distributions of future values for comprehensive net worth can be interpreted as the distribution of possible expected values of cash flows (valued at the future time period), conditional on different states of the world.
