As capital markets have declined and interest rates have fallen, pension surpluses have eroded into pension deficits. Pension plan risk has always been present; however, during the ’90s, top percentile returns on pension plan assets allowed many plan sponsors to capitalize on the market run-up by boosting corporate earnings with pension income while enjoying an extended period of not having to make any cash contributions to their pension plans. In many cases, the asset allocation to equities began to creep higher and higher, increasing the pension risk associated with poor capital market performance. It is not clear whether this was due to active decision making on the part of plan sponsors or just a case of riding the financial wave. Now, courtesy of the capital markets and interest rate declines during the past three years, employers have been reacquainted with the reality that pension plans:
don’t always produce pension income;
require cash contributions (sometimes large cash injections); and
can dramatically affect the corporate balance sheet when plans become underfunded.
In evaluating the financial management of the pension plan programs, we believe you should:
Review benefit policies Take a fresh look at benefits, including plan design options, to see whether they meet corporate finance and “employer of choice” objectives. Determine whether a plan’s features contribute to cost volatility or whether benefit adjustments should be made if investments aren’t measuring up.
Review accounting policies Ascertain whether a plan’s assumptions harmonize with the company’s accounting policies and risk tolerance or whether assumptions need to be scaled back.
Review plan investment policies Evaluate policies in light of the company’s total financial picture and risk tolerance. Determine how assets correlate with liabilities and whether the relationships and correlations have hanged among various asset types. Estimate what percentage of net income would be at risk if the plan underperforms.
Review funding policies Periodically reevaluate funding policies to align assumptions more closely with plan performance. Pay attention to available options for managing the timing of plan contributions to take best advantage of them. Cash flows could be substantial and could have a significant effect on expense results, future flexibility, and overall business capital spending. Explore opportunities to make long-range strategic contributions that might reduce the total cash requirement to the plan.