The Blind Side: Managing Downside Risk
in Corporate Defined-Benefit Plans

Abstract

Following the recession of the early 2000s, defined benefit corporate pension plans faced dramatic funding challenges. They had barely recovered before the recession of 2008 to 2009 sent funding ratios tumbling once again. Many plan sponsors must now make larger contributions than they originally budgeted, in order to bring their plans back to full funding. This article aims to deepen the current discussion of risk reduction in the context of defined benefit plans. It investigates two key issues. First, its authors analyze the effect of non-normality of asset returns on a defined benefit pension plan’s liabilities. They argue that analytical frameworks that assume normality can lead to an underestimation of downside risk, a concern with regard to contributions. Second, the authors develop a multi-dimensional risk-management framework for managing contribution risk.

TOPICS: Pension funds, financial crises and financial market history, VAR and use of alternative risk measures of trading risk