A lower discount rate usually translates into a substantially higher pension liability figure. But some doubters point out that in periods of rising interest rates, pension liabilities are dramatically reduced, as during 1994, which result in higher discount rates and drastic reductions in pension liabilities in the following year.
The discount rate for the Salomon Brothers Pension Liability index, which was constructed to represent a typical pension liability, declined steadily during 1995 to 6.76% on Dec. 29, 1995, from 8.65% at year-end 1994.
Overall pension liabilities generally will be substantially higher this year, said Y.Y. Ma, director in the structured portfolio group at Salomon Brothers Inc., New York, even with the hefty market returns in 1995.
"Unless a pension plan sponsor did something unusual such as using long duration bonds, the fund will probably have underperformed (its) liabilities last year," said Mr. Ma.
Because of FAS 87 reporting requirements, plan sponsors face yearly changes in discount rates as long as interest rates remain volatile.
Mr. Church agreed that for 1995, "there will be a substantial shortfall" in pension plan asset performance compared with the growth in liabilities.
"Many companies lost funding on pension plans and will be worse off even though we had a massive bull market .*.*. There will be a continuing increase in the number of underfunded pension plans. Some lost substantial amounts last year" because of the growth in liabilities, much of which could have been avoided by matching liabilities with long duration bonds.
Another proponent of managing the asset and liability relationship is Michael Peskin, president of Michael Peskin Associates Inc., Weston, Conn.
Mr. Peskin said plans should consider significant changes in funding policies to include lengthening the duration of the fixed-income portfolio and more closely matching liability duration with assets.
Doing so, he said, could result in elimination of pension contributions while remaining fully funded.
He admits such a change in pension policies would be drastic. He acknowledges such a move will come only when corporate chief executives recognize the value to shareholders.
But mainstream pension industry executives claim duration matching of assets and liabilities is difficult, if not impossible, to do accurately.
Said Alan Glickstein, actuary and principal at Kwasha Lipton, Fort Lee, N.J.: "There are different kinds of pension liabilities, and some don't behave in the way this model promises. Some traditional defined benefit plans may, but liabilities don't always move in an easy and simple way," he said.
He said if the plan objective is to stabilize funded status the idea may work in some cases, "but in most plans the government as well as financial executives believe in having the assets do the heavy lifting. And equities have shown they almost always outperform fixed-income investments over the long term. It's hard to get away from that starting argument.
"If the objective is to manage returns and to minimize contributions and pension costs to the company, it may have merit. But it is hard to say that a zero coupon bond portfolio will do that," said Mr. Glickstein.