Pension finance : putting the risks and costs of defined benefit plans back under your control

"Defined benefit pension plans are in a severe crisis. With nearly a $4 trillion deficit in the U.S. alone, Canada, the UK, Japan, and Holland also suffer from unfunded liabilities. In short, the pension crisis is nearly global in proportion, and there is little likelihood that plan sponsors will be able to come up with the funds to repair the damage. One of the major problems behind the crisis is the approach: pension plans use actuarial science as the basis of assumptions but are subject to the laws of economic finance in terms of their returns. In short, there is a gap between the world presumed by actuaries who determine funding levels and the world as it come to be as determined by market performance and investment outcomes. Waring tackles this thorny issue head on. Well versed in both economic and actuarial science, he walks professionals through the differences and shows why plan sponsors need to focus on the economic account perspective to meaningfully measure present values. Complete coverage of credit risk and the discount rate to determine liability values is examined, contribution levels are then presented based on this revised approach to actuarial accounting. Pension plan sponsors and their employee representatives must face the economics - and adjust their accounting and actuarial view - to gain a true perspective on achieving sustainable benefit levels. Waring is one of the first investment professionals to tackle this controversial topic head on to present realistic solutions to potentially catastrophic problems looming in the very near term"-- � Read more... Abstract: The flood of information, unprecedented transparency, increasing interconnectedness-and our global interde--pendence-are dramatically reshaping today's world, the world of business, and our lives. We are in the Era of Behavior and the rules of the game have fundamentally changed. � Read more... Machine generated contents note: Foreword.Preface.List of Propositions.Acknowledgments.Chapter 1 Achieving Long-Term Health for Pension Plans Using Improved Managerial Accounting Tools.Perspectives on DB Plans.What is Economic or Market-Value Accounting?What the Following Chapters Provide.Chapter 2 Today's Conventional Pension Finance Practices.Why Managers Need to Adopt the Economic Accounting Perspective.Where are we today?The Accounting Always Follows the Economics.Historical Context: The Actuaries' Contribution to the Existence of Pensions.Conclusion.Chapter 3 Measuring Meaningful Present Values.What is the Right Discount Rate to Use?The Liability-Matching Portfolio: General Perspective.Risk-Free Rate vs. Expected Return on Assets."If We Can Earn 7.5% Per Year Over The Long Term": Happy and Unhappy Distributions.The Employer's Experience.The Discount Rate Is In Fact The Same On Both Sides Of The Full Economic Balance Sheet, But That Doesn't Mean That The Liability Changes Its Value With Changes In Investment strategy!GASB's White Paper and Public Employee Fund Discount Rates.Conclusion: Discount Rates.Appendix: Are There "Market Values" for Pension Plans?Chapter 4 The Full Economic Liability: The Off-Book Starting Point for Management of Pension Costs.The Liability: Inherently an Economic Entity.A Newly Formed Pension Plan.Multiple Correct Measures of the Accrued Portion of the Liability but Only One "Parent" Measure.Building a Pension Budget Identity.Chapter 5 Core Principles of Pension Accounting.The Full Economic Liability Meets Accrual Accounting and "Normal Costs".Full Economic Normal Cost.Enter the Matching Principle: Normal Costs Accruing Over Time.Normal Costs and Retirees, Active Employees, and Future Employees.Normal Costs: Allocating Pension Costs to Current Employees.Payment Patterns Other Than Level Payments.Illustrating Normal Costs and Accrued and Total Liabilities over Time.Comparing Normal cost Methods.Normal Costs and Contributions: Multiple Measures?Normal Cost and Agreed Levels of Benefit Security: An Accrual Method Not Reliant on the Matching Principle.Balance Sheet with Accruals of an Economic Measure of Periodic Normal Cost.Updating the Beginning-Period Pension Budget Identity.Summary of Discussion of Normal Costs.Appendix: Computing Level-Payment Normal Costs with a Hand-Held Calculator In Order to Gain Understanding of the Nature of the Problem.Chapter 6 Credit Risk and the Discount Rate.Two Useful Views of the Liability's Value.Termination and Default Risk.Conclusion.Chapter 7 Paying for the Plan.Pension Expense and Contributions.Other Components of Pension Expense In Addition to Normal Cost.Distinguishing Economic from Conventional Supplemental Costs.Economic Pension Expense.Economic Pension Expense in an Accrual System.Contributions to the Asset Pool, and the Sponsor's Credit Risk.Investment Returns on Contributed Assets.Benefit Payments.The Components of Economically Determined Contributions.An Example: Analyzing Contributions for the Aggregate Plan with an HP 12c.Conclusion.Chapter 8 Investment Strategy I: Surplus Optimization.The Augmented Balance Sheet: Optimizing on the Combined Risks of the Sponsor and the Plan.Brief Review of the Theory of Surplus Return and Surplus Asset Allocation.The Elephant in the Strategic Asset Allocation Room.Chapter 9 Investment Strategy II: Managing Risks to the Plan's Surplus, to Pension Expense, and to Contributions Using the Liability-Matching Asset Portfolio.Show Me the Money: Risk Control through the Liability-Matching Asset Portfolio.What Liability Should Be Hedged In The Surplus Asset Allocation Process?: Defining Capital Gains and Losses in the Accrued Liability.Hurdles to Adoption of Surplus Asset Allocation and to Holding an LMAP Portfolio: Why Isn't This Easier to Implement?The Shape of Investment Strategy for Pension Plans Using Surplus Optimization and the Two-Fund Theorem.Conclusion.Appendix: Why Use Dual Durations in the Liability Measures?Chapter 10 Investment Strategy III: Risk Tolerance and the Decision to Hold Risky Assets Over and Above the Liability-Matching Asset Portfolio.Why Hold Any Equities or Risky Assets?Can the Sponsor Afford the Risk if it Happens? One Part of Identifying the Organization's Tolerance for Risk.Visualizing and Comparing Return/Risk Tradeoffs Among Alternative Investment Strategy Choices.Controlling Economic Risk to the Surplus = Controlling Accounting Risks to the Plan.Implementing a RAP in Addition to a Liability-Matching Portfolio.Benefits of Surplus Optimization and the LMAP When a RAP Is Held.Conclusion.Appendix: When Is a Plan Truly in Surplus?Chapter 11 Investment Strategy IV: Asset/Liability Studies--the Conventional Approach.Traditional Actuarial Asset/Liability Studies.Modeling in the Traditional Actuarial Pension Approach.Possible False Correlations and Bad Investment Strategy Results.Do the Results Prove the Asset/Liability Method?Managing the Present Value of Future Contributions Through Investment Strategy.Conclusion.Chapter 12 A Retirement Party for the "Required Rate of Return".Visualizing the Required Rate of Return.The Effect of Investment Risk on Surplus Risk and Contribution Risk Over Time.Effect of the Required Rate of Return on Investment Strategy.Actuarial Confidence in High Expected ReturnsPresenting the Gold Watch.Postscript.Chapter 13 The Fully Generalized Pension Budget Identity.The Inviolability of the FEL.Chapter 14 Tough Love.Saving the Underfunded Pension Plan.An Action Plan: Something Has To Be Done, But It Isn't Going To Be Easy.Accounting and Reporting Policy.Contribution Policy and Benefit Policy.Investment policy and strategy.Making These Changes is Important!Chapter 15 Public Policy Suggestions--Revising Accounting and Actuarial Standards for Pensions.Only One Accrued Liability, Please!Articulation Between Financial Statements.Pension Expense.Smoothing and Amortizations?Pension Contributions.Financial Amortization Rather Than Actuarial Amortization.Reconfiguring the Elements of Pension Expense on the Income Statement.Should the Pension Trust Be Off the Sponsor's Balance Sheet, or On?Financing the PBGC's Guarantee, or Financing Pension Plans Directly?The IRS and Pension Deductibility.Summary of Public Policy Suggestions.Beyond Managerial Accounting: Should Accounting and Actuarial Regulatory Frameworks Be Changed?Chapter 16 Beyond the Crisis.Making Better Management Decisions and Managing Plans at Lower Risk.Mark-to-Market Accounting Is Not a Reason to Terminate the Plan.The Intuition Is Already Out There.Our Legacy As Pension Advisors.Appendix A Variables and Terms Used in the Book.Appendix B Implicit Options in the Pension Plan.Termination option.PBGC put.Participant call on economic surplus.Appendix C Use of Protective Put Options in the Investment Strategy.References.About the Author.Index. For PENSION FINANCE/ "Pension Finance is a comprehensive, integrated, and self-contained offering on the structure, management, and oversight of defined benefit pension plans, carefully composed by a prime observer and practitioner in the defined benefit pension world. . . an important and most needed contribution to defined benefit pension knowledge. Whether a prime academic researcher, experienced public policymaker, seasoned private-sector practitioner, or novice student of retirement finance, the reader is in for a treat: bon appetit!"'Robert C. Merton, MIT "This book is a major advance in the literature of pension finance, breaking much new ground in the market value approach to pension finance. Thorough and hard-hitting, Waring warns that many will consider his blunt views to be 'controversial' or even 'heretical.' But his approach sheds a much-needed bright light on the fundamental nature of pension liability. There are also many valuable suggestions about how to structure an asset portfolio that addresses these now more clearly defined liabilities, given a specific fund's risk tolerance, contingent reserves, back-up resources, and payment schedule."'Martin Leibowitz, Managing Director, Morgan Stanley "The value of Pension Finance is not in propounding any new or novel finance ideas, but in systematically explaining the guts of the actuarial process, and then restating the process in sound terms. After reading this book, those involved in the pension arena will understand the causes of the pension crisis and appreciate how easy the 'right answers' are once those causes are understood."'Frank Fabozzi, Professor of Finance, EDHEC Business School and Editor, The Journal of Portfolio Management "Pension Finance is now the seminal work on the subject and should be required reading for policymakers, practitioners, and plan fiduciaries. Waring makes a compelling and persuasive case that the only way to ensure the long-term viability of defined benefit plans is to accurately measure the true costs and risks of providing the benefits and provisioning accordingly."'Bradley D. Belt, former Director, Pension Benefit Guaranty Corporation, and Senior Managing Director, Milken Institute "Pension Finance draws cross-disciplinary lessons learned the hard way to set in motion a much-needed overhaul of the U.S. defined benefit pension system. Waring's risk management approach will help guide corporate and public plan sponsors to better measure, pay for, and manage their pension assets and liabilities using modern financial principles. Chock-full of examples and sometimes sad lessons from the pension trenches, this book will set the terms of debate for corporate boards and public plan trustees, consultants and actuaries, unions and financial advisors, and most of all, policymakers seeking to return the U.S. retirement system to health." 'Olivia S. Mitchell, Professor of Insurance & Risk Management/Business & Public Policy The Wharton School, University of Pennsylvani The flood of information, unprecedented transparency, increasing interconnectedness-and our global interdependence-are dramatically reshaping today's world, the world of business, and our lives. We are in the Era of Behavior and the rules of the game have fundamentally changed. It is no longer what you do that matters most and sets you apart from others, but how you do what you do. Whats are commodities, easily duplicated or reverse-engineered. Sustainable advantage and enduring success for organizations and the people who work for them now lie in the realm of how, the new frontier of conduct. For almost two decades, Dov Seidman's pioneering organization, LRN, has helped some of the world's most respected companies build "do it right," winning cultures and inspire principled performance throughout their organizations. Seidman's distinct vision of the world, business, and human endeavor has helped enable more than 15 million people doing business in more than 120 countries to outbehave the competition. In HOW: Why HOW We Do Anything Means Everything, Dov Seidman shares his unique approach with you. Now updated and expanded, HOW includes a new Foreword from President Bill Clinton and a new Preface from Dov Seidman on why how we behave, lead, govern, operate, consume, engender trust in our relationships, and relate to others matters more than ever and in ways it never has before. Through entertaining anecdotes, surprising case studies, cutting-edge research in a wide range of fields, and revealing interviews with a diverse group of leaders, business executives, experts, and everyday people on the front lines, this book explores how we think, how we behave, how we lead, and how we govern our institutions and ourselves to uncover the values-inspired "hows" of twenty-first-century success and significance. Divided into four comprehensive parts, this insightful book: * Exposes the forces and factors that have fundamentally restructured the world in which organizations operate and their people conduct themselves, placing a new focus on their hows * Provides frameworks to help you understand those hows and implement them in powerful and productive ways * Helps you channel your actions and decisions in order to thrive uniquely within today's new realities * Sheds light on the systems of how-the dynamics between people that shape organizational culture-and introduces a bold new vision for leading and winning through self-governance. The qualities that many once thought of as "soft"--Values, trust, and reputation-are now the hard currency of success and the ultimate drivers of efficiency, performance, innovation, and growth. With in-depth insights and practical advice, HOW will help you bring excellence and significance to your business endeavors- and your life-and refocus your efforts in powerful new ways. If you want to stand out, to thrive in our fast changing, hyperconnected, and hypertransparent world, read this book and discover HOW

Pension plans around the world are in a state of crisis. U.S. plans alone are facing a total accrued liability funding deficit of almost $4 trillion (of the same order of magnitude as the federal debt), a potential financial catastrophe that ranks among the largest ever seen. It has become clear that many government, corporate, and multi-employer pension sponsors will not be able to cope with this crippling debt and may default on promised benefits. And many of those sponsors that might be able to cope are exasperated by continuous, ongoing negative surprises-large unexpected deficits and higher-than-expected required contributions and pension expense-and are choosing to terminate their plans.

But it need not be so. Pension Finance: Putting the Risks and Costs of Defined Benefit Plans Back under Your Control walks the reader through the conventional actuarial and accounting approaches to financing pension benefits and investing plan assets, showing that the problems described happen as a natural consequence of the dated methods still in use. It shows in detail how modern methods based on market value will easily minimize these risks: Pension plans can in fact be comfortable for employers to sponsor and safe for employees to contribute todepend on for their retirement needs.

This book is must-read for defined benefit pension plan sponsors and employee representatives, plan executives, board members, accountants, fund managers, consultants, and regulators., Research sponsored by the CFA Institute, this book demystifies pension finance, previously accessible only to actuaries. It teaches the topic in lay terms by drawing complete analogies to ordinary transactions such as paying off a mortgage or saving for college. Armed with this book, anyone comfortable with finance and investments in any other context can be comfortable with pension finance and pension investment policy. And further armed with a handheld financial calculator, any layperson can quickly estimate the contributions needed to keep a given plan comfortably solvent, giving them a powerful tool for oversight.

Pension plans around the world are in a state of crisis. U.S. plans alone are facing a total accrued liability funding deficit of almost $4 trillion (of the same order of magnitude as the federal debt), a potential financial catastrophe that ranks among the largest ever seen. It has become clear that many government, corporate, and multi-employer pension sponsors will not be able to cope with this crippling debt and may default on promised benefits. And many of those sponsors that might be able to cope are exasperated by continuous, ongoing negative surprises-large unexpected deficits and higher-than-expected required contributions and pension expense-and are choosing to terminate their plans. But it need not be so. Pension Finance: Putting the Risks and Costs of Defined Benefit Plans Back under Your Control walks the reader through the conventional actuarial and accounting approaches to financing pension benefits and investing plan assets, showing that the problems described happen as a natural consequence of the dated methods still in use. It shows in detail how modern methods based on market value will easily minimize these risks: Pension plans can in fact be comfortable for employers to sponsor and safe for employees to contribute todepend on for their retirement needs. This book is must-read for defined benefit pension plan sponsors and employee representatives, plan executives, board members, accountants, fund managers, consultants, and regulators., Research sponsored by the CFA Institute, this book demystifies pension finance, previously accessible only to actuaries. It teaches the topic in lay terms by drawing complete analogies to ordinary transactions such as paying off a mortgage or saving for college. Armed with this book, anyone comfortable with finance and investments in any other context can be comfortable with pension finance and pension investment policy. And further armed with a handheld financial calculator, any layperson can quickly estimate the contributions needed to keep a given plan comfortably solvent, giving them a powerful tool for oversight.

"My friend Dov Seidman has dedicated his life's work to studying how people conduct their business and their lives. As we settle into the twenty-first century with all of its unique challenges . . . it's clear that people worldwide will rise or fall together. Our mission must be to create a global community of shared responsibilities, shared benefits, and shared values. This new focus will require all of us to think about the how, and to find new ways to take action to solve the global issues that none of us can tackle alone."
—From the Foreword by President Bill Clinton

"Dov Seidman's How is a brilliant social-ethical study. It simplifies for the reader the complexity of vital challenges facing humanity today. Students and teachers alike will profit from reading this book."
—Elie Wiesel, Nobel Peace Laureate

"Dov Seidman basically argues that in our hyperconnected and transparent world, how you do things matters more than ever, because so many more people can now see how you do things, be affected by how you do things, and tell others how you do things on the Internet anytime, for no cost and without restraint . . . and so it must be with us. We need to get back to collaborating the old-fashioned way. That is, people making decisions based on business judgment, experience, prudence, clarity of communications, and thinking about how—not just how much."
—Thomas L. Friedman, New York Times columnist

"A trained moral philosopher, Dov Seidman has built a highly successful business on the theory that in today's wired and transparent global economy, companies that 'outbehave' their competitors ethically will also tend to outperform them financially."
—Fortune magazine

"Defined benefit pension plans are in a severe crisis. With nearly a $4 trillion deficit in the U.S. alone, Canada, the UK, Japan, and Holland also suffer from unfunded liabilities. In short, the pension crisis is nearly global in proportion, and there is little likelihood that plan sponsors will be able to come up with the funds to repair the damage. One of the major problems behind the crisis is the approach: pension plans use actuarial science as the basis of assumptions but are subject to the laws of economic finance in terms of their returns. In short, there is a gap between the world presumed by actuaries who determine funding levels and the world as it come to be as determined by market performance and investment outcomes. Waring tackles this thorny issue head on. Well versed in both economic and actuarial science, he walks professionals through the differences and shows why plan sponsors need to focus on the economic account perspective to meaningfully measure present values. Complete coverage of credit risk and the discount rate to determine liability values is examined, contribution levels are then presented based on this revised approach to actuarial accounting. Pension plan sponsors and their employee representatives must face the economics - and adjust their accounting and actuarial view - to gain a true perspective on achieving sustainable benefit levels. Waring is one of the first investment professionals to tackle this controversial topic head on to present realistic solutions to potentially catastrophic problems looming in the very near term"-- Provided by publisher Content: Achieving Long Term Health for Pension Plans Using Improved Managerial Accounting Tools -- Today's Conventional Pension Finance Practices -- Measuring Meaningful Present Values -- The Full Economic Liability: The Off-Book Starting Point for Management of Pension Costs -- Core Principles of Pension Accounting: The Full Economic Liability Meets Accrual Accounting and Normal Costs -- Credit Risk and the Discount Rate -- Paying for the Plan -- Investment Strategy I: Liability-Relative Optimization -- Investment Strategy II: Managing Risks to the Plan's Surplus, to Pension Expense, and to Contributions Using the Liability-Matching Asset Portfolio -- Investment Strategy III: Risk Tolerance and the Decision to Hold Risky Assets Over and Above the Liability-Matching Asset Portfolio -- Investment Strategy IV: Asset/Liability Studies: The Conventional Approach -- A Retirement Party for the Required Rate of Return -- The Fully Generalized Pension Budget Identity -- Tough Love: Saving the Underfunded Pension Plan -- Public Policy Suggestions: Revising Accounting and Actuarial Standards for Pensions -- Beyond the Crisis: Making Better Management Decisions and Managing Plans at Lower Risk -- Variables and Terms Used in the Book -- Implicit Options in the Pension Plan -- Use of Protective Put Options in the Investment Strategy -- References -- About the Author. Praise for PENSION FINANCE ""Pension Finance is a comprehensive, integrated, and self-contained offering on the structure, management, and oversight of defined benefit pension plans, carefully composed by a prime observer and practitioner in the defined benefit pension world. . . an important and most needed contribution to defined benefit pension knowledge. Whether a prime academic researcher, experienced public policymaker, seasoned private-sector practitioner, or novice student of retirement finance, the reader is in for a treat: bon appetit!""-Robert C. Merton, MIT ""This book i