Old idea is a new innovation to CFOs
My strongest apologies to Bill Priest, Pat Regan and Jack Treynor for not mentioning in my interview with Pensions & Investments (Dec. 11, page 3) their pioneering 1976 work on integration of pension assets and liabilities with the entire corporate balance sheet for making pension asset allocation decisions.
I extend that apology also to William Sharpe, Irwin Tepper, the late Fischer Black and a host of other financial economists who in the 1970s-’80s applied this integrated approach to analyze the issues surrounding optimal pension asset allocation.
My remarks on pension policy were drawn from a more general enterprise-risk-management proposition to CFOs that publicly traded corporations should minimize the amount of “passive” (zero net-present-value) risks they take so as to deploy their firms’ expensive equity capital most efficiently (“You Have More Capital Than You Think,” Harvard Business Review, November 2005). One managerial implication is that firms should avoid positive systematic equity market risk exposures in their pension funds. Despite some firms adopting immunization strategies, the nearly universal current practice of holding large equity allocations makes readily apparent that the 30-year-old Priest- Regan-Treynor concept of using an integrated analysis of the entire corporate balance sheet to determine optimal pension allocations remains a new innovation for practicing CFOs to consider. Old idea is a new innovation to CFOs
My strongest apologies to Bill Priest, Pat Regan and Jack Treynor for not mentioning in my interview with Pensions & Investments (Dec. 11, page 3) their pioneering 1976 work on integration of pension assets and liabilities with the entire corporate balance sheet for making pension asset allocation decisions.
I extend that apology also to William Sharpe, Irwin Tepper, the late Fischer Black and a host of other financial economists who in the 1970s-’80s applied this integrated approach to analyze the issues surrounding optimal pension asset allocation.
My remarks on pension policy were drawn from a more general enterprise-risk-management proposition to CFOs that publicly traded corporations should minimize the amount of “passive” (zero net-present-value) risks they take so as to deploy their firms’ expensive equity capital most efficiently (“You Have More Capital Than You Think,” Harvard Business Review, November 2005). One managerial implication is that firms should avoid positive systematic equity market risk exposures in their pension funds. Despite some firms adopting immunization strategies, the nearly universal current practice of holding large equity allocations makes readily apparent that the 30-year-old Priest- Regan-Treynor concept of using an integrated analysis of the entire corporate balance sheet to determine optimal pension allocations remains a new innovation for practicing CFOs to consider.
Robert C. Merton
John and Natty McArthur University Professor
Harvard Business School
Boston
P&I/Oxford DB study
Your timely survey and interesting article on the future of defined benefit plans was a valuable contribution to the debate on this topic (“Experts: DB plans will survive,” P&I/Oxford survey, page 1, Feb. 19).
I think most true experts understand that a DB plan is the most economical way to provide retirement benefits to large groups of employees. It is characterized by professional investment management, low fees and expenses, and sharing of mortality risk. DB plans can accommodate employee contributions and portability, characteristics often mentioned when companies shift plan design. Usually when a company switches to a defined contribution or hybrid plan design with the objective of reducing cost, the company’s retirement plan cost is reduced, not because the new plan design is inherently less expensive, but because it provides a lower level of benefits, and requires the employee to pay part of the cost.
I believe the major factor in corporations’ decisions to terminate their DB plans is that they cannot tolerate surprises in their quarterly earnings reports. In your survey question about why plans are frozen this is covered by three responses: unquantifiable risks (33% positive responses), inflexible regulation (32%), and unreasonable accounting rules (29%).The accounting expense for DB plans is inherently unpredictable and new accounting rules will make it even more so. Liability-matching investment strategies can improve the predictability of short-term accounting expense, but at a cost so high that the DB plan is no longer viable economically.
Since employees now seem to prefer 401(k) plans, corporations have no reason to live with the expense volatility of a DB plan. The new laws regarding enrollment, advice and investment options for 401(k) plans will help to make them reasonable retirement vehicles for the current generation of workers. Those of us who make a living from retirement assets need to accept the inevitable demise of corporate DB plans, focus on where we fit into the new DC world and stop looking for a miracle cure for the numerous ills of corporate DB plans. Superior economics is not enough in today’s corporate world.
David T. Jack
Baden, Pa.
