How should we value the pension obligation of a corporate defined pension
plan in financial distress? This is the question posed by research from
Cass Business School, City University London,
which offers a new way of valuing pension plans whilst taking into account
The plight of US vehicle manufacturer General Motors during 2002 is
examined. In a climate of falling stock markets and falling interest rates,
here was a company whose pension assets had decreased to $60.9 bn, while its
projected benefit pension obligation had increased to $80.1 bn, resulting in a
funding ratio of 76%. Employees of the company would have been quite justfied
in fearing for the security of their promised future pension.
The researchers derive an asset-liability model that simultaneously
determines a funding-risk-adjusted discount rate and an asset allocation that
is fully consistent with this discount rate. This means that it is possible to
determine a value for the pension obligation that is consistent with the asset
allocation and hence the risk exposure assumed by the pension fund. This stands
in marked contrast with current practice, in which the valuation of liabilities
and the investment of pension assets are treated as separate tasks.
Applying this model to the General Motors scenario would have demonstrated
that beneficiaries of the General Motors plan should have expected a reduction
in their pension wealth in the order of 15-20%.
Professor Blake said "This approach has important advantages for all
stakeholders of the corporate pension plan. Staff taking out pensions will have
a clearer picture of the true value of their pension promise.
"Our approach also increases transparency for the sponsoring company and -
especially - its shareholders who are now better able to plan for future
contributions into the pension plan and to value the sponsoring company more
accurately. A revision to the accounting standards that report the valuation of
corporate defined benefit obligations is a clear policy implication from our
The research therefore should help staff obtain a clearer picture of the
true value of their pension promise. It should also be of interest to
The full research paper will be published in The Journal of Risk and
Insurance. A draft version of the paper is available for download