EDHEC-Risk Concept Industry Analysis Featured Analysis Latest EDHEC-Risk Surveys Features Interviews Indexes and Benchmarking FTSE EDHEC-Risk Efficient Index Series FTSE EDHEC-Risk ERAFP SRI Index EDHEC-Risk Alternative Indexes EDHEC IEIF Quarterly Commercial Property Index (France) Hedge Fund Index Research Equity Index Research Amundi "ETF, Indexing and Smart Beta Investment Strategies" Research Chair Rothschild & Cie "Active Allocation to Smart Factor Indices" Research Chair Index Regulation and Transparency ERI Scientific Beta Performance and Risk Reporting Hedge Fund Performance Performance Measurement for Traditional Investment CACEIS "New Frontiers in Risk Assessment and Performance Reporting" Research Chair Asset Allocation and Alternative Diversification Real Assets Meridiam Infrastructure/Campbell Lutyens "Infrastructure Equity Investment Management and Benchmarking" Research Chair Natixis "Investment and Governance Characteristics of Infrastructure Debt Instruments" Research Chair Société Générale Prime Services (Newedge) "Advanced Modelling for Alternative Investments" Research Chair CME Group "Exploring the Commodity Futures Risk Premium: Implications for Asset Allocation and Regulation" Strategic Research Project Asset Allocation and Derivative Instruments Volatility Research Eurex "The Benefits of Volatility Derivatives in Equity Portfolio Management" Strategic Research Project SGCIB "Structured Investment Strategies" Research ALM and Asset Allocation Solutions ALM and Private Wealth Management AXA Investment Managers "Regulation and Institutional Investment" Research Chair BNP Paribas Investment Partners "ALM and Institutional Investment Management" Research Chair Deutsche Bank "Asset-Liability Management Techniques for Sovereign Wealth Fund Management" Research Chair Lyxor "Risk Allocation Solutions" Research Chair Merrill Lynch Wealth Management "Risk Allocation Framework for Goal-Driven Investing Strategies" Research Chair Ontario Teachers' Pension Plan "Advanced Investment Solutions for Liability Hedging for Inflation Risk" Research Chair Non-Financial Risks, Regulation and Innovations Risk and Regulation in the European Fund Management Industry Index Regulation and Transparency Best Execution: MiFID and TCA Mitigating Hedge Funds Operational Risks FBF "Innovations and Regulations in Investment Banking" Research Chair EDHEC-Risk Publications All EDHEC-Risk Publications EDHEC-Risk Position Papers IPE EDHEC-Risk Institute Research Insights AsianInvestor EDHEC-Risk Institute Research Insights P&I EDHEC-Risk Institute Research for Institutional Money Management Books EDHEC-Risk Newsletter Events Events organised by EDHEC-Risk Institute EDHEC-Risk Smart Beta Day Amsterdam 2017, Amsterdam, 21 November, 2017 EDHEC-Risk Smart Beta Day North America 2017, New York, 6 December, 2017 Events involving EDHEC-Risk Institute's participation EDHEC-Risk Institute Presentation Research Programmes Research Chairs and Strategic and Private Research Projects Partnership International Advisory Board Team EDHEC-Risk News EDHEC-Risk Newsletter EDHEC-Risk Press Releases EDHEC-Risk in the Press Careers EDHEC Risk Institute-Asia EDHEC Business School EDHEC-Risk Executive Education EDHEC-Risk Advances in Asset Allocation Blended Learning Programme 2017-2018 Yale School of Management - EDHEC-Risk Institute Certificate in Risk and Investment Management Yale SOM-EDHEC-Risk Harvesting Risk Premia in Alternative Asset Classes and Investment Strategies Seminar, New Haven, 5-7 February, 2018 Investment Management Seminars Contact EDHEC-Risk Executive Education Contact Us ERI Scientific Beta EDHEC PhD in Finance
Features
Institutional Investment - March 23, 2011

The Elephant in the Room: Accounting and Sponsor Risks in Corporate Pension Plans

As part of the AXA Investment Managers research chair on regulation and institutional investment, EDHEC surveyed corporate pension funds, their sponsors, and advisers to assess how sponsors manage pension risk and how pension funds manage sponsor risk. There are 100 respondents to the survey; they manage pension funds assets of more than €730 billion (the assets of sponsoring companies are greater than €5.5 trillion).

Sponsors that give their employees pension plans are subject to the risk of having to make additional contributions to make up for shortfalls in pension funds as well as to a more specific accounting risk that arises because of the arbitrary accounting assumptions that differ from those typical of financial economics. In a traditional defined-benefit (DB) pension plan, all of the financial and biometric risks in pension funds are borne by the sponsor (unless it goes bankrupt). Plan assets, however, are managed independently from the sponsor by pension trustees, and the separation of powers prevents trustees from managing these assets in the best interest of the sponsor, which can find it difficult to hedge pension risks in its own balance sheet. It is because of this separation of powers that many sponsors fail to manage pension risks at all; it also contributes to the termination of many traditional defined-benefit plans. Pension plans are subject to the risk of the guarantee from their sponsor disappearing when the sponsor goes bankrupt or is in distress. In most countries, this risk is covered only partly by pension insurance, but the levy charged by the pension insurance scheme would not be reduced if pension funds hedged this risk themselves, in which case the pension fund would in effect pay twice the cost of protection.

Dutch regulation has relied solely on strong funding requirements to protect pension benefits, and only recently has it become clear that this regulation offered only partial protection. In most countries, the risk of either a bankrupt sponsor’s leaving an underfunded pension plan or a financially weak sponsor’s leading to pension curtailments means that pension funds should hedge the risk of deterioration of the health of the sponsor. Such a hedge, however, is seldom considered by respondents, most frequently because it would be seen as an aggressive move by the sponsor. We argue, however, that the sponsor can also benefit from such a hedge if its contributions are reduced when its health is weaker.