Managing Pension and Other Long-Term Liabilities
Winter 2006, Volume 18.1
"De-risking" Corporate Pension Plans: Options for CFOs
To reduce and control the cost of providing for their employees’ retirement, companies with DB plans should consider: issuing debt and funding any unfunded liabilities; reducing pension equity and interest-rate exposures by shifting some (or all) assets into bonds; and freezing or terminating their plans and switching to a “hybrid” or defined contribution plan.
Allocating Shareholder Capital to Pension Plans
Although pension shortfalls have garnered the most attention, the more serious problem is the risk mismatch between pension assets and liabilities that is effectively transferred to the corporate balance sheet. Companies should take an integrated perspective that treats the pension asset allocation decision as a critical aspect of an enterprise-wide risk management program.
An Investment Management Methodology for Publicly Held Property/Casualty Insurers
To best add shareholder value, insurance companies' investment policies should focus on immunizing insurance reserves with a fixed-income portfolio and earning “abnormal returns” on the surplus in “a responsible and disciplined” way. Both accounting and economic considerations suggest that after-tax net investment income, as defined by U.S. GAAP, is the best performance benchmark.
Defeasing Legacy Costs
A solution to defeasing the legacy costs of America’s defined benefit pension system is proposed that would allow companies to exchange their legacy pension debt for another liability with more attractive terms. The gain is greater transparency into sponsors’ balance sheets and the potential to take the PBGC out of the impossible position of insuring against events over which the insured have considerable control.
Downside Risk in Practice
Investors associate risk with negative outcomes and downside fluctuations, but modern portfolio theory does not. This article highlights the shortcomings of traditional risk measures (standard deviation and beta), introduces the concept of downside risk, and discusses “semideviation” and “downside beta.” These measures are used in asset-pricing models to estimate required returns on equity.
From Stock Selection to Portfolio Alpha Generation: The Role of Fundamental Analysis - An Investor Roundtable
Most of the investors in this roundtable take large, multi-year positions in companies they believe to be well-managed, but temporarily undervalued. Their analysis begins with a “deep dive” into a company’s financials, reinforced by primary research. The aim is to identify, well before the broad market, companies that promise to earn consistently high and sustainable returns on invested capital.
How Behavioral Finance Can inform Retirement Plan Design
Recent behavioral finance research offers several key lessons for pension design based on how much workers save (too little), how they manage their retirement investments (poorly), and when they draw down their assets in retirement (too quickly). Suggested design features include automatic enrollment, scheduled annual savings increases, and default investment options that represent optimal portfolio choices.
New Leadership at the Federal Reserve
Alan Greenspan guided monetary policy in a way that has led to low and stable inflation, but the Fed he leaves behind has no explicit institutional commitment to long-run price stability. Operating with a set of rules and guidelines, or clearly stated institutional objectives, the Fed would eliminate much of the second-guessing about what it is doing and why, and the associated market volatility.
Risk Allocation in Retirement Plans: A Better Solution
All pension plan designs allocate three primary risks—investment risk, interest-rate risk, and longevity risk—between the plan sponsor and the employees. This article describes a pension design, the Retirement Shares Plan (RSP), which combines many of the best features of DB and DC plans by allocating investment and interest-rate risk to the employees, but keeps the longevity risk with the sponsor.
The Employer's Role in Reforming the U.S. Health Care System
Private-sector employers must be the source for effective reform of the U.S. health care system. Reforms should include the use of value-based purchasing criteria that consider more than just the price and access, the provision of information about the cost and efficacy of health care services before the choices are made, and the encouragement of “consumerism” through health savings accounts.
The Tax Consequences of Long-Run Pension Policy
Equities in pension funds add to the sponsoring firm’s “leverage” because contributions will be high when times are bad and the firm can least afford them. Conversely, holding bonds in a fund increases a firm’s borrowing capacity. Selling equities and buying bonds that earn a pretax interest rate, while issuing tax-deductible debt and buying back stock, creates a tax arbitrage.
The views and opinions expressed in the Journal do not necessarily represent those of Morgan Stanley or its affiliates.
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For close to 20 years, the Journal of Applied Corporate Finance has distinguished itself as a unique forum for addressing the topics that drive corporate value. Featuring articles by top academic thinkers and financial practitioners, this quarterly publication presents the practical application of the best current research in finance.
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