SUMMER 2002 THE JOURNAL OF PORTFOLIO MANAGEMENT 1 T

he objective of a defined-benefit pension fund is to fully fund accrued pension liabilities at the lowest cost to the plan sponsor, subject to sensible risk. This should be the function of the pension assets rather than pension contributions (added costs) coming from the employer and employees, or, in the case of public funds, current or future taxpay-ers. In “best case ” scenarios, pension holidays may be achieved by growing the asset portfolio in excess of the liability portfolio (pension surplus). Plan sponsors run the risk of higher contributions if the asset portfolio is not constructed to match both the present value of liabilities (cash flows) and the volatile interest rate behavior of liabilities. Fluctuations in the pre-sent value of assets versus liabilities (funding ratios) rep-resent high financial risk for all plan sponsors.1 Yet, because of actuarial and accounting smooth-ing of financial statements, most plan sponsors are unaware of this danger. Plan sponsors become focused instead on the return on assets (ROA) assumption rather than assets versus liabilities. And, in establishing asset allocations across major asset classes and in setting forth investment guidelines and objectives for in-house and external money managers, the liability structure is typically ignored. The purpose of this article is threefold. First, we dis-cuss the recent performance of defined-benefit corpo-rate pension plans (in 2000 and 2001) and the implications for future corporate earnings. Second, we address the issues associated with measuring pension liabilities. Finally, we suggest solutions for dealing with the problem of mea-suring pension liabilities. RONALD J. RYAN is presi