The global transformation

We are in the midst of a revolution in the organisation of global markets and the competitiveness of corporate form and functions. This has enormous implications for financial markets and their interest in defined benefit (DB) pension liabilities.
Employer-sponsored funded supplementary pensions were a success story in Anglo-American economies and some continental European countries over the second half of the 20th century. For large employers with significant domestic market positions and a claim on other markets around the world, DB pension schemes were important in managing their labour forces consistent with the scale and scope of their activities. In the years following the establishment of these pension schemes for salaried and hourly workers, it seemed that modest commitments to employees’ future welfare measured in terms of deferred wages and salaries were entirely consistent with the interests of employers and employees alike. In any event, average life expectancy around 1960 was not much more than the official retirement age of 65 years.
To my mind, the current predicament facing many DB plan sponsors can be traced back to three types of commitments made during the second half of the 20th century without much regard to their long-term consequences:
q Firstly, through to the mid 1980s incremental steps taken to improve the value of promised benefits could be justified by reference to strong economic growth and the unrivalled market power of plan sponsors;
q Secondly, the extension of eligibility for benefits and the generalisation of benefit values without regard to labour productivity (workers’ tasks and functions) didn’t seem to matter: in any event, many corporations were ramshackle organisations with very poor internal accounting and control systems such that wages and benefits were set by custom and convention;
q Thirdly, as market forces started to impinge upon corporate performance, early retirement paid for out of the accumulated surpluses of DB pension plans seemed an easy way of rationalising unwanted corporate capacity. Who would have doubted the market prospects of these household names?
The costs of these commitments were apparent in some DB plan sponsors by the late 1980s. By then, a few academic studies had been published raising questions about the relationship between forecast DB liabilities and the traded market price of corporate securities.
Corporate raiders had latched onto the idea that DB pension fund assets and liabilities could be important in mergers and acquisitions as well as the financing of hostile takeovers and the like. In play around that time were also the relationships between corporate entrepreneurs and the trustees of their inherited DB pension systems.
But the run-up in domestic and global financial markets during the 1990s was such that rates of return on pension fund assets washed away concern for inherited liabilities, bringing to the fore the subtleties of asset allocation, investment management, and governing the relationships with financial service providers. As a consequence, the available expertise is heavily weighted towards the management of assets rather than the management of liabilities.

We now face a very different world. The calibration of corporate assets and liabilities is part of the burgeoning demand for financial information by all kinds of market participants who have a stake in pricing expected performance.
In the wake of the growing market for information has come the introduction of new accounting standards aimed at standardising within and between markets this kind of information so as to enhance the efficiency of market pricing. In a similar vein, any discretion available to corporate treasurers and auditors with respect to the measurement and reporting of DB pension liabilities was lost in a growing realisation that over the 1990s, at least, investment returns on invested assets in these pension plans papered-over profound long-term competitive problems of many plan sponsors. Information on accumulated DB pension liabilities is at our fingertips even if there remains debate over the proper measurement of expected liabilities.
Some plan sponsors recognised their exposure to DB pension plan liabilities in the 1980s, introducing the option for employees to take-up defined contribution pension plans. While we might laud their remarkable powers of forward thinking we should also recognise that the demand for defined contribution plan benefits amongst younger employees played a role in shifting the balance between benefit systems. Those firms that introduced defined contribution schemes alongside inherited DB schemes 10 or 15 years ago, benefited from high rates of economic growth over that period effectively discounting their DB liabilities by decreasing the proportion of their workers covered and by relying upon the productivity of younger workers within the firm to contribute to the growing market value of the firm.
For these firms, market concern about accumulated and expected DB liabilities is just one item amongst many when estimating corporate value. Indeed, in these cases DB schemes may survive and prosper (albeit in a limited way).
As we know, however, many other plan sponsors have closed their DB plans to new participants. One wonders if they have come too late to this strategy. With greater financial market volatility, more exacting standards of the measurement of liabilities, and growing public awareness of the low value of proffered replacement pension and retirement income plans, one wonders whether the best option would be to keep open DB plans as long as possible and/or increase the rate of employer and, most importantly, employee contributions.
In the Anglo-American world at least, DB pension plans are highly-funded pay-as-you-go pension systems, where shortfalls in rates of return relative to liabilities can be made-up by shifting the burden of contributions from one generation of workers to the next. This was the rationale for smoothing the funding of pension plans over long periods of time. Of course, it relied upon long-term commitment and inter-generational solidarity between workers within the firm (something increasingly problematic).
Those in favour of such an inter-generational (worker) funding model lost the war of words in the formulation of new accounting standards. In part, this was because of the growing maturity of many corporate DB pension systems and because of growing uncertainty over the economic prospects of plan sponsors. Ironically, closing DB schemes can only accelerate analysts’ interest in pricing these liabilities. As for the economic prospects of plan sponsors, global competition for home, EU and international markets is accelerating; it is increasingly clear that some businesses, some firms, and even some regions and nations may be left stranded by rapidly changing market conditions.
We are in the midst of a revolution in the organisation of global markets and the competitiveness of corporate form and functions. It is not surprising that market analysts have wanted to better understand the temporal profile of plan sponsors’ expected liabilities. In play is the future of private plan sponsors.

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  • QN-2519

    Asset class: Fund wrapper.
    Asset region: Global.
    Size: EUR 80m.
    Closing date: 2019-03-29.

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