Executive Summary
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Pension schemes are often the most overlooked part of a company’s balance sheet, despite the large hidden and complex risks they can pose. Some of the unique risks within pension schemes are exposure to interest rates, inflation, market risk, and longevity.
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The problem is particularly acute for defined-benefit pension schemes—common in many developed countries—where the benefits are predetermined, are often index-linked, and can be passed on to dependents. The present cost of bearing these risks has risen sharply in recent decades, and many companies have closed their pension schemes to new members.
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In the short term, changing economic, financial, and demographic perceptions can materially alter the valuation of a pension scheme’s assets and liabilities from one day to the next, potentially leaving many finance directors with an uncontrolled liability on otherwise well-managed balance sheets.
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The waters can be muddied further by another fundamental problem: for most schemes, liabilities are calculated infrequently using ad hoc or out-of-date assumptions, which can often present a less than prudent valuation of the true costs.
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Options to manage and even reduce these uncertainties are now appearing. The key is to have a proactive and realistic approach to the risks that are being carried on the balance sheet.
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