The organization was faced with a significant funding shortfall within their DB pension plan and wanted to consider the advantages of pre-funding the plan to 100% using various borrowing strategies. The analysis was framed around three key questions. Should the pension plan be pre-funded? If so, from what source of capital should funding come from? And, how should the plans assets be managed in post-funding environment. The required baseline assumptions included the amortization rate for the unfunded liability, the pension plans expected return on assets, the plans actual return, the organizations weighted average cost of capital, current funded status, and if the plan is frozen or not. Variable and fixed debt options were modeled with various amortization time periods. Consideration was given to the organizattions overall credit rating before and after the funding.

Critical analysis focused on the the net present value benefit, improved accounting earnings, improvement to net funded position and posative balance sheet impact.

Based on the assumptions it was determined that pre-funding would be economically beneficial on a net present value basis. The benefit exists for any rate below X and a term longer than Y. Accounting benefits were posative. The use of debt with a borrowing rate below the pension amortization rate is beneficial. Additional benfits include stabilization of cash flows, lenghening of the repayment period, targeting pension risk management towards termination(if frozen) versus funding shortfall, elmination of the PBGC variable premium and swapping variable debt for fixed rate(bond).

Post-funding, there is an asymmetrical outcome on investment returns: the organization has little ability to recover surplus that emerges from risk-bearing activities but deficits must be fully funded. In addition, the removal of the asset smoothing for funding has mitigated the appeal to risk bearing with in the plan. Therefore, de-risking the plan by reducing the equity exposure over time and increasing the fixed income exposure and credit/duration match to liabilites will reduce the risk of the plan to the organization.

The presentation will detail the potential investment options within the fixed income asset class that corresponds to the de-risking approach.