"Efficient Gain and Loss Amortization and Optimal Funding in Pension Plans," M. Iqbal Owadally and Steven Haberman, January 2004

North American Actuarial Journal, Apr 2004 by Gold, Jeremy, Cowling, Charles, Exley, Jon, Hudson, Nick, Et al

In short, because the plan assets are generally available to the shareholders of the sponsoring corporation on the same terms as they are to the plan, and are thus hedgeable, the entire exercise is wasteful from the perspective of the firm's owners. Under the reduced-form model, employees have no interest in the matter. Under a more comprehensive model (such as that alluded to in section S), the mismatch of plan assets and liabilities exposes employees to risk. This exposure will, in a transparent model, result in increased compensation costs that must, again, be borne by shareholders.

SECTION 5

Owadally and Haberman have considered methods for amortizing "unforeseen economic experience" in DB pension plans without justifying why anyone should ever voluntarily expose themselves to such experience. It seems that those who advocate equity investment in DB plans continue to tell us that it lowers the cost of defined benefits. This view, although still apparently held by a majority of practicing actuaries, is now all but bankrupt intellectually. Even though it remains the case that various regulatory regimes for statutory funding and corporate accounting reward such equity investment, economic science rejects it.

The Society of Actuaries' motto says "The work of science is to substitute facts for appearances and demonstrations for impressions." To this, we should now add, paraphrasing Exley (2003): It must further be the duty of scientists to apply tools that are appropriate to problems that are well denned.

1 Except as justified by external (e.g., PBGC) guarantees and weak funding (Harrison and Sharpe 1983).

2 The immediate model ignores any insolvency risk to employees and, thus, so do I.

3 I agree with the authors that such default risk is beyond the general scope of the reduced form model discussed herein. Thus, I am not arguing about this aspect of the model but rather about their characterization of the purpose of funding, especially their view that smoothing employer cash flows is a significant economic reason to fund.

REFERENCES

BADER, LAWRRNdK N. 2003a. "The case Against Stock in Corporate Pension Funds,"Pension section JVeios (February): 17-19.

_______. 2003b. Financing Corporate Pension Plans. Working paper presented in Proceedings o/ t/te Giitmann Symposium, Vienna, December.

BLACK, LAWRBNCR N., AND JKRKMY GOLD. 2003. "Reinventing Pension Actuarial Science," The Pension Forum (January): 1-OS.

BLACK, FiS(UiKR. 19SO. "The Tnx Consequences of Long-Run Pension Policy," FinancictZ .Analysts Jwtrnaf (July-August): 21-28.

EXLEY, JoN. 2003. "a Modern Perspective on Institutional Investment Policy," in Asset and Z/iabiZity Management Toofs, edited by Bernd Scherer. London: Risk Waters Group Ltd.

HARRISON, MiCHAEL J., AND WiLLiAM. F. ShAReK. 1983. Optimal Funding and Asset Allocation Rules for Oenned-Benent Pension Plans. In Financial Aspects oF the DeJnitcd States Pension System, pp. 91-105. Kditcd by Zvi IJodie and John Shuvun. Chicago: University of Chicago Press. Online at http:// gobi.stanford.edu/faeul tybios/l)io.asp?Il)-6 1.