Pension Investment Risk Disclosure - What Don't You Know?
Do you feel comfortable about the amount of risk in your pension plan? Like the partially submerged truck, are you seeing only half the truth or are you completely unaware of investment risks lurking in your plan's portfolio?
If you're like the typical participant or shareholder (investing in a company with a defined benefit plan), the outlook is grim. A dearth of information makes it nearly impossible for an interested party to understand when a pension fund is taking on too much risk. That also means that one can never be quite sure about how a pension plan manages asset-liability risk, if at all. Scary stuff indeed!
FASB to the rescue? Perhaps.
At its August 29, 2007 meeting, the staff announced its plan to address three areas, including "disclosures about risks in plan assets, for example use of derivatives." The scuttlebutt is that disclosure about hedge fund investments and other alternatives may be a separate initiative.
This blog's author has long been an advocate of increased transparency, while noting that more disclosure does not necessarily mean better disclosure. Click here to read some past posts on this topic. Though no investment can be said to be absolutely "good" or "bad" (facts and circumstances are key), it is noteworthy that so little is known about such a large and important segment of the capital markets - the $10 trillion pension investor market.
When invited to speak with FASB pension team members on the topic of disclosure, I laid out what I thought would be "problem areas" in terms of disclosure and interpretation. Here are a few thoughts.
- There are multiple ways to measure leverage. Which one is best?
- How do you get people to look beyond traditional (and arguably limited-use) metrics?
- What rules discourage "gaming" of the system and instead focus attention on economic risk analysis (rather than accounting compliance)?
- Is there a chance of information misuse?
- Will periodic statements be sufficient to ward off potential problems (an oft-cited criticism of Form 5500 reports)?
- Could reporting requirements backfire and discourage plan sponsors to "play it too safe?" (Risk-taking is not necessarily a wrong move but certainly uninformed risk-taking spells trouble. Ditto for being "too" cautious if it means that a plan falls further behind in its ability to meet its obligations.)
On the disclosure front, reporter Diya Gullapalli writes that mutual fund managers are voluntarily providing information about their exposures, in hopes of minimizing investor angst. "Among the rare disclosures are precise percentages of mortgage-related holdings and lengthy explanations of losses." (See "Fund Firms Draw Back the Curtain, Wall Street Journal, September 6, 2007.)
Related to this notion of "need to know" is the SEC's announcement that three hunded letters are on their way to various companies, seeking details about executive compensation levels and the underlying rationale for alleged largesse.
A discernible trend towards increased disclosure is upon us. The critical question is whether the marketplace is ready.
