The paper suggests that defined benefit plans posed an even greater risk to corporations in 2006, as laws and regulations such as the Pension Protection Act of 2006 and new accounting rules threaten to increase liabilities by as much as 15%, raise plan sponsors’ funding requirements and force companies to reconfigure their balance sheets.
In order to curb the risks associated with the plans, the paper argues for a corporate finance approach that measures and controls the risk the plans add to the balance sheet, earnings and cash flow. The paper also proposes an integration of the plan’s liability management and asset selection decisions into the corporate risk profile.
Some of this would mean handing more power over the plan to executives at the company, giving them the power to:
- Have greater control over the balance sheet risk exposures resulting from the plan,
- Reduce the level and volatility of contributions, and
- Minimize corporate earnings at risk.
In this new framework, JPMAM suggests new ways to measure the risk in the assets and liabilities of a company’s pension plan on overall corporate risk.
One of the recommendations from JPMAM is to
reduce “uncompensated” interest rate risk by narrowing
the duration mismatch between plan assets and liabilities
and the management of the risk of equity concentration in
a pension plan through the implementation of a Broadly
Diversified Investment Portfolio.
JPMAM also calls for a customized asset allocation based on risk levels set by company management, instead of the the standard 60% equity, 30% fixed income and 10% alternative assets allocation, and suggests that plans discontinue their traditional reliance on public equities, in exchange for a more investible universe.