The problem is that pension sponsors do not understand the economics of the liabilities. they only understand what is on the balance sheet and what the actuary tells them… They dont think liabilities have any market exposure…
Liabilities are effectively exposed to interest rates, since they can be modeled as being short a zero coupon bond of par value = Liability Payment and Duration=Maturity=Time to Liability Due date (because Duration=Maturity for zero coupon stuff). Liabilities may also be sensitive to inflation rates, such as when pension benefits are inflation adjusted. Some of that inflation sensitivity can be baked into current interest rates (anticipated inflation), but unanticipated inflation is a separate market effect. Unless there are specific promises to liabilities, though, they don’t seem to be related to equity markets. The only exception might be foundations, where they have to pay out 5% of their assets each year (if US based and they want to maintain tax-exempt status). In that case, if a lot of their assets are in equities, and equities go up, the liabilities go up. Of course, I’ve worked with foundations when I was in non-profit stuff, and their problem is often finding sufficient “worthwhile projects” to spend their money on. This problem, of course, isn’t so bad when the market is down. I am glad, though that the problems for Pensions and Insurance don’t force us to make actuarial calculations to figure out what the heck the liabilities are… that sounds like the hard part to me.
If they would require us to do that, I would demand a fellowship from an actuarial society… —"“Liabilities may also be sensitive to inflation rates, such as when pension benefits are inflation adjusted. Some of that inflation sensitivity can be baked into current interest rates (anticipated inflation), but unanticipated inflation is a separate market effect. “” Yeah, they do that for the actives and also for the plans that have COLAs built in to them… —”“Unless there are specific promises to liabilities, though, they don’t seem to be related to equity markets. The only exception might be foundations, where they have to pay out 5% of their assets each year (if US based and they want to maintain tax-exempt status). In that case, if a lot of their assets are in equities, and equities go up, the liabilities go up. Of course, I’ve worked with foundations when I was in non-profit stuff, and their problem is often finding sufficient “worthwhile projects” to spend their money on. This problem, of course, isn’t so bad when the market is down. “” All you are doing (not you per se) with having a high discount rate for the liabilities is taking all your gains up front… Why would a dollar invest in Equities be worth more than a dollar invested in Bonds? Thats what people assume in these plans, since they hike up the rate, have a pension holiday (dont pay any normal costs or contribs) and then wonder why all the DB plans are going into the toilet… —”“I am glad, though that the problems for Pensions and Insurance don’t force us to make actuarial calculations to figure out what the heck the liabilities are… that sounds like the hard part to me.”" Amen…