In the past, running a pension fund
seemed like a relatively straightforward
proposition. Contributions were
invested in the equity and bond
markets and then dutifully administered.
After thirty years or so, when
an employee retired, the money had
grown sufficiently to finance the
promised benefits. When market
volatility caused asset and liability
values to diverge, it was assumed that
the passage of time would help to
narrow any gaps. In rising equity
markets, the pension fund might even
have earned some additional money
above and beyond its obligations to
retirees.
Now, declining interest rates, increasing
life expectancy and the growing
cost of servicing pension funds have
resulted in the value of the liabilities of
many corporate pension plans
significantly increasing in relative size.
In some cases, they even dwarf the
market value of the companies
themselves. Also, regulatory changes
in many countries have increased the
focus on the short-term financial
health of plans, increasingly imposing
corrective actions if a plan’s funding
ratio (the ratio of plan assets to its
liabilities) deteriorates significantly.
Compounding matters, the relatively
low level of interest rates in the past
five years has raised liability valuations
(liability values move inversely to
interest rates), while the equity market
volatility of the late 1990s and early
2000s has created widespread
awareness that many plans are overly
reliant on equity market returns.
Of course, corporations always have
the option to place more money into
the plan whenever needed to improve
the funding ratio. But this approach
can be expensive and, for some companies,
simply not financially viable. As
a result, pension funds are looking for
ways to better manage their funding
ratios and the associated risk. UBS has
recognized and responded to this by developing a sophisticated investment
approach to help clients meet the
current challenges. In simple terms,
this means buying assets that generate
the returns needed to pay out
employee retirement benefits while
still carefully managing the risks of
shorter-term fluctuations in plan
funding ratios. Pension strategies need
to be designed and managed in
conjunction with plan liabilities, taking
into account the plan’s structure, its
projected outflows, and the valuation
of liabilities under changing accounting
rules.
Understanding the specific objectives
and risk tolerance of each plan is
critical. These are affected by the
funding ratio, as well as other factors,
such as the maturity of the plan or the
corporation’s ability and willingness to
contribute additional money. Based on
these factors, the next step is to
design solutions that better meet the
plan’s goal by efficiently taking risks
relative to the plan’s liabilities. Typically
this is done by utilizing sophisticated
interest rate and inflation management
techniques to better align asset
and liability returns, while at the same
time improving the structure and
diversification of the asset portfolio.
The asset management business calls
this approach Asset Liability Investment
Solutions (ALIS). The ALIS team
is staffed by former pension plan
representatives, pension consultants,
actuaries, derivatives experts as well as
a broad group of investment specialists.
It is one of many components of
the collaborative, cross-functional
global pension initiative that UBS
currently has in place, allowing it to
bring to bear a wealth of expertise
and resources to help sponsors and
trustees measure, analyze, manage
and implement a variety of pension
solutions – and to adapt to the
changing environment in which they
operate.
