The industry of pension funds has been undergoing many changes during the past few years. Recently, the Japanese suffered due to weak economic conditions. New regulations are now in place to provide security for pension funds. The way which we deal with pension fund risk is by simply knowing how it is defined by us. Corporations have previously defined pension fund risk as a sort of trade off between the risk and the return on the assets, weighing them against the expenses of the fund.
Many companies give the employees who are about to retire, at least partial protection against inflation. If the company invests its entire pension fund in long-term bonds for instance, then it will likely not address the problem of variable as opposed to fixed returns on the investment. It is important to have a stable pension fund surplus because of its impact on the profitability and on the balance sheet of a company. Management usually involves measuring and assessing of pension fund risks with all the components of the funds make up, so as to keep the risks within the guidelines of the objectives of the fund. Most retirees only want to be assured of one thing, benefit security.
The pension fund risk shifts between the asset values and the liability values. Focusing on this can be complex. Too much attention could be placed on the interest sensitivity of any surplus in the pension fund. Sometimes the pension fund risk arises because the assets of the fund grow to where they become the bulk of the company’s assets. A very important question to ask is whether a discount rate variable should be the most important consideration when one is defining pension fund risk.
It is the responsibility of senior management, when hedging pension fund risk, to consider all the advantages as well as the disadvantages of all their assets. This may mean having fixed income assets fund any fixed dollar obligations where the liability has been estimated as being precise. It will also mean having variable income assets fund variable dollar obligations where the liability has been estimated as being imprecise.
With the focus on the future, what seems to be the most popular approach to pension fund risk analysis would be to focus mainly on the risk of the assets themselves and to ignore the correlation with the risk of the liabilities. The pension fund can, in essence, act as a tax-deferred savings plan if there is a sizable surplus. The company will then have something left over to help make up for any reduction in contributions during times when earnings may be weak.