Academics at Cass Business School say they have devised an approach to valuing funding levels in defined benefit (DB) pension funds by adding investment risk to the discount rate.
Cass said corporate sponsors were misleading investors and pension fund members by failing to value their pension funds and portray financial risks accurately.
Supported by the University of Melbourne’s Joanchim Inkmann and Zhen Shi, professor David Blake, director at the Cass Pensions Institute, proposed an asset/liability model using a “funding risk-adjusted discount rate” and asset allocation to match.
Blake said this should help corporate-scheme stakeholders, giving members and investors greater insight on “true valuations”.
“Our approach also increases transparency for the sponsoring company,” he said.
“Its shareholders are now better able to plan for future contributions into the pension schemes and 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 analysis.”
The new asset/liability model aims to paint a more accurate picture of risk within a pension fund by accounting for liabilities that are consistent with asset allocation.
Cass said its new model differed from the current system, where liabilities and investments of assets are treated separately.
In a paper entitled ‘Managing Financially Distressed Pension Plans in the Interest of Beneficiaries’, the authors argue that liabilities must be valued using a discount rate that actually reflects a scheme and its sponsor’s funding ability.
And this, they say, depends on asset allocation.
“We cannot value the pension obligation without knowing the strategic asset allocation policy of the pension plan,” the academics write.
“What we are proposing is nothing less than a fully integrated asset-liability management solution for pension plans.
“The ability of schemes and sponsors to fund pension promises depends on the future values of assets, which themselves depend on the current strategic asset allocation.
“Thus, funding spreads that appropriately reflect funding risk depend on the chosen asset allocation.”