Bethlehem Case Study 1. Many U.S. corporations have offered defined-benefit (DB) pension plans. Who are all the stakeholders in this U.S. corporate defined-benefit system
In a corporate defined-benefit (DB) system, the sponsor (employer) has committed to make fixed monthly payments, similar to annuities, to plan participants (current or former employee and to surviving spouses) from retirement to death. he benefits be nefits !ere based on a formula that !as typically a function of salary, and length of service. In a funded DB plan, the sponsor sets aside funds to!ards a pension asset, !hich should typically have funds matching or exceeding the liabilities ("#$ of future payments). If a company is unable to pay out the pension benefits, it can ask for bankruptcy protection and the #ension Benefit %uaranty &orporation (#B%&, a government agency) !ill take over o ver and supply the benefits to the participants. !. "or #hat type of firms and instit$tions does offerin% a DB pension plan still make sense today Why
'or most firms, defined contribution (D&) plans are much less costly and thus it makes sense to offer D& plans to their employees like *+(k). In these plans, the risk of investment lies !ith the employees and the firm can have a policy of matching some fixed percentage of employees contribution. But there are certain firms and institutions for !hich DB plan still makes sense. 'or example, firms and institutions that provide high level of training to their employees can offer DB pension plans because such plans encourage loyalty. ince the benefits are defined and are a function of the years of service, the longer the employee stays at a company, the higher !ill be the benefits. lso since all of the risk of managing the pension fund is borne by the sponsor, benefits are kind of guaranteed for the employees. uch firms do not !ant to !orry about training the employees and then losing them to another firm soon after. DB pension plans !ill motivate the employees to stay at the firm. /ther firms, firms, or government institutions !hich have lo!ers salaries can offer DB plans to attract employees. 'or example, armed forces such as military and marines can offer DB plans to compensate for the lo! income by providing stable retirement benefits. &. 'o# sho$ld firms invest their DB pension plan assets #hat #o$ld be a desirable portfolio allocation Does yo$r ans#er to this $estion depend on the financial health of the firm or is yo$r investment advice so$nd re%ardless of the financial health of the firm
0ust like individual portfolio management, firms should diversify their pension plan investments to include both bonds and stocks. he investments in the market could yield high returns !hich could help the firm in lo!ering their contribution to the pension funds. /f course, there is also a risk of losing a lot of money, so to hedge against that, firms should further diversify their e1uity investments to lo!er the overall risk (variability) of their portfolio. In my opinion, they should invest in value stocks rather than gro!th firms to lo!er their risk. he desired pension plan assets should at least e1ual the liabilities, if not more than that.
he above strategy can be follo!ed by any firm, no matter their financial health. If a firm is financially healthy, they can reap the benefits from their diverse portfolio and invest in other good pro2ects to gro! the company, instead of making higher contributions to the pension funds. *. +he top of ,hibit 1 %ives the pension plan portfolio of Bethlehem Steel at the end of !. /ssess the appropriateness of this allocation from the perspective of the follo#in% %ro$ps0 Bethlehem Steel lo#er-level #orkers Bethlehem Steel shareholders and the U.S. %ov2t.
s given in 3xhibit +*, Bethlehem teel has invested more in corporate e1uities than in fixed income securities. lso, the portfolio beta is +, that is, the portfolio is as risky as the market. Because of market fluctuations, the fund lost around 45** million in one year (+666 to 7***). "or lo#er-level #orkers , their main concern is that they might not be able to get the promised benefits !hen they retire. he risk of not receiving the pension benefits is also confirmed by looking at the total assets and liabilities !hich are off by about 4+ billion. Bethlehem Steel shareholders !ould prefer to invest more in the corporate e1uities to be able to get a high return so that the company doesnt have to contribute as much to the pension funds. hey !ould also be concerned about the image of the company if liabilities exceed the assets by too much and the company seemed unable to deliver the benefits to its employees. his might affect the Bethlehems stock prices. +he %overnment2s main concern is that #B%& !ill have to cover the employees benefits if the company is unable match the liabilities and the plan remains underfunded. hus, the government !ould like to see more fixed income security investments to ensure the ability of the company to pay current liabilities.
3. Sho$ld #e have a 4ension Benefit 5$aranty 6orporation (4B56) Do #e need to provide ins$rance to #orkers receivin% DB pension plans from firms 7f so do #e need this ins$rance to be provided by the federal %overnment or co$ld a private ins$rance company do a better 8ob
8aving #B%& insure the corporations pension plans !as a good idea back in the +69*s, as this provided security and peace of mind for the employees. But no! !ith the gro!th in big private insurance companies, the market should be open to private insurance companies. 3ven though #B%& doesnt utili:e tax dollars at the moment, !ith all the companies abusing the insurance by terminating the pension plans, #B%& might not be able to cover all the liabilities !ith 2ust the premiums collected from the corporations. hese DB plans !ere based on the concept of risk reduction for employees. ;hile the government !orks to ensure that principal, the private sector can bring greater expertise and thus can add more value than !hat the government can on its o!n. 9. /t the end of ! #hat is the theoretically appropriate disco$nt rate for Bethlehem Steel to $se #hen disco$ntin% its f$t$re pension liabilities (for%et vario$s acco$ntin% and re%$latory r$les) :$stify yo$r ans#er. To determine whether the pension fund assets match the future liabilities, the future pension liabilities will have to be discounted back to the current time period. For that we would have to determine what interest rate we can obtain on these
assets. Therefore the appropriate discount rate is determined by calculating the weighted average of the returns expected from dierent sources of funding!s such as e"uities, corporate bonds, and treasury bills. The below data is taken from #xhibit $ and #xhibit %& and then the weighted average cost is calculated'
Amount of Investm ent Cash Fixed Income Securitie s Corporat e Equities Total
()%*
Weight of Investmen t *+
Return +
(%,**
)/+
/./)+
(*,&%;
;&+
%%.&&+
(6,;)6
%&&+ Weighted Average
9!"#
Comments -ssuming that the cash is invested in money market 0ro1rated for 2S treasury bills 34/5%*6786.*6+9 and Corporate5:nternatoinal bonds 34$/)5%*678;.*$+9 -ssumption
Thus the appropriate discount rate for Bethlehem!s future pension liabilities is .6/+.
