Praise for "Pension Finance": ""Pension Finance" is a comprehensive, integrated, and self-contained offering on the structure, management, and oversight of defined benefit pension plans, carefully composed by a prime observer and practitioner in the defined benefit pension world ...an important and most needed contribution to defined benefit pension knowledge. Whether a prime academic researcher, experienced public policymaker, seasoned private-sector practitioner, or novice student of retirement finance, the reader is in for a treat: bon appetit!" (Robert C. Merton, MIT). "This book is a major advance in the literature of pension finance, breaking much new ground in the market value approach to pension finance. Thorough and hard-hitting, Waring warns that many will consider his blunt views to be 'controversial' or even 'heretical'. But his approach sheds a much-needed bright light on the fundamental nature of pension liability. There are also many valuable suggestions about how to structure an asset portfolio that addresses these now more clearly defined liabilities, given a specific fund's risk tolerance, contingent reserves, back-up resources, and payment schedule". (Martin Leibowitz, Managing Director, Morgan Stanley). "The value of "Pension Finance" is not in propounding any new or novel finance ideas, but in systematically explaining the guts of the actuarial process, and then restating the process in sound terms. After reading this book, those involved in the pension arena will understand the causes of the pension crisis and appreciate how easy the 'right answers' are once those causes are understood". (Frank Fabozzi, Professor of Finance, EDHEC Business School and Editor, "The Journal of Portfolio Management"). ""Pension Finance" is now the seminal work on the subject and should be required reading for policymakers, practitioners, and plan fiduciaries. Waring makes a compelling and persuasive case that the only way to ensure the long-term viability of defined benefit plans is to accurately measure the true costs and risks of providing the benefits and provisioning accordingly". (Bradley D. Belt, former Director, Pension Benefit Guaranty Corporation, and Senior Managing Director, Milken Institute). ""Pension Finance" draws cross-disciplinary lessons learned the hard way to set in motion a much-needed overhaul of the U.S. defined benefit pension system. Waring's risk management approach will help guide corporate and public plan sponsors to better measure, pay for, and manage their pension assets and liabilities using modern financial principles. Chock-full of examples and sometimes sad lessons from the pension trenches, this book will set the terms of debate for corporate boards and public plan trustees, consultants and actuaries, unions and financial advisors, and most of all, policymakers seeking to return the U.S. retirement system to health". (Olivia S. Mitchell, Professor of Insurance & Risk Management/Business & Public Policy, The Wharton School, University of Pennsylvania).
List of Figures xiii List of Propositions xv Foreword xxi Preface xxv Acknowledgments xxxiii CHAPTER 1 Achieving Long Term Health for Pension Plans Using Improved Managerial Accounting Tools 1 Perspectives on DB Plans 2 What Is Economic or Market Value Accounting? 4 What the Following Chapters Provide 5 CHAPTER 2 Today's Conventional Pension Finance Practices 11 Why Managers Need to Adopt the Economic Accounting Perspective 11 Where Are We Today? 12 The Accounting Always Follows the Economics 17 Historical Context: The Actuaries' Contribution to the Existence of Pensions 21 Conclusion 24 CHAPTER 3 Measuring Meaningful Present Values 27 What Is the Right Discount Rate to Use? 27 The Liability-Matching Portfolio: General Perspective 30 Risk-Free Rate vs. Expected Return on Assets 33 "If We Can Earn 7.5 Percent Per Year Over The Long Term": Happy and Unhappy Asset Return Distributions 35 The Employer's Experience 44 The Discount Rate Is in Fact the Same on Both Sides of the Full Economic Balance Sheet, But That Doesn't Mean That the Liability Changes Its Value with Changes in Investment Strategy! 46 GASB's White Paper and Public Employee Fund Discount Rates 48 Conclusion: Discount Rates 52 Appendix: Are There Market Values for Pension Plans? 53 CHAPTER 4 The Full Economic Liability: The Off-Book Starting Point for Management of Pension Costs 55 The Liability: Inherently an Economic Entity 55 A Newly Formed Pension Plan 58 Multiple Correct Measures of the Accrued Portion of the Liability but Only One PARENT Measure 63 Building a Pension Budget Identity 65 CHAPTER 5 Core Principles of Pension Accounting: The Full Economic Liability Meets Accrual Accounting and Normal Costs 67 Full Economic Normal Cost 68 Enter the Matching Principle: Normal Costs Accruing Over Time 69 Normal Costs and Retirees, Active Employees, and Future Employees 72 Allocating Pension Costs to Current Employees 73 Payment Patterns Other Than Level Payments 82 Illustrating Normal Costs and Accrued and Total Liabilities over Time 86 Comparing Normal Cost Methods 90 Normal Costs and Contributions: Multiple Measures? 92 Normal Cost and Agreed Levels of Benefit Security: An Accrual Method Not Reliant on the Matching Principle 94 Balance Sheet with Accruals of an Economic Measure of Periodic Normal Cost 100 Updating the Beginning-Period Pension Budget Identity 102 Summary of Discussion of Normal Costs 103 Appendix: Computing Level Payment Contributions and Normal Costs with a Handheld Calculator in Order to Gain Understanding of the Nature of the Problem 105 CHAPTER 6 Credit Risk and the Discount Rate 107 Two Useful Views of the Liability's Value 107 Termination and Default Risk 107 Conclusion 114 CHAPTER 7 Paying for the Plan 117 Pension Expense and Contributions 117 Other Components of Pension Expense in Addition to Normal Cost 117 Distinguishing Economic from Conventional Supplemental Costs 119 Strict Economic Pension Expense 120 Economic Pension Expense in an Accrual System 122 Contributions to the Asset Pool, and the Sponsor's Credit Risk 123 Investment Returns on Contributed Assets 124 Benefit Payments 125 The Components of Economically Determined Contributions 126 An Example Immediately Usable in the Boardroom: Analyzing Contributions for the Aggregate Plan with an HP 12c 129 The Volatility Of The Deficit Is Equal To The Volatility of Contributions 133 Conclusion 134 CHAPTER 8 Investment Strategy I: Liability-Relative Optimization 135 Investment Policy and Strategy for Investors with Liabilities 135 The Augmented Balance Sheet: Optimizing on the Combined Risks of the Sponsor and the Plan 139 Brief Review of the Theory of Surplus Return and Surplus Asset Allocation 140 The Elephant in the Strategic Asset Allocation Room 145 CHAPTER 9 Investment Strategy II: Managing Risks to the Plan's Surplus, to Pension Expense, and to Contributions Using the Liability-Matching Asset Portfolio 147 Show Me the Money: Risk Control Through the Liability-Matching Asset Portfolio 1
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