The Funding Debate: Optimizing Pension Risk within a Corporate Risk Budget

Abstract

Defined Benefit (DB) pension risk management has traditionally focused on achieving a balance between the risks associated with the liabilities and the expected returns on investments. This approach does not capture the fact that a DB pension plan is part of running an overall business and must compete for capital against alternative investments the corporation can make. Pension funding strategies should be assessed against other corporate cash uses and strategies, such as investment in productive capacity, research and development initiatives, share or debt buybacks, or potential acquisitions. Considering pension funding relative to potential corporate actions within the same net present value (NPV), internal rate of return (IRR) or similar analytical framework, a company can optimise the use of available cash resources and balance alternative strategies against each other.