Corporate America began to really take notice of the looming
retirement crisis in the wake of the dot-com crash, when companies in major
industries went bankrupt in large part because of their inability to meet their
pension obligations. The result was an acceleration of America’s shift away
from employer-sponsored pension plans toward defined-contribution
plans--epitomized by the ubiquitous 401(k)--which transfer the investment risk
from the company to the employee. With that transfer has come a dangerous shift
in investment focus, argues Nobel Laureate Robert C. Merton. Traditional
pension plans were conceived and managed to provide members with a guaranteed
income. And because that objective filtered right through the scheme, members
thought of their benefits in those terms. Ask a member what her pension is
worth and she’ll reply with an income figure: “two-thirds of my final salary,”
for example. Most DC schemes, however, are designed and managed as investment
accounts with the goal of accumulating the largest possible pot of savings.
Communication with savers is framed entirely in terms of assets and returns.
Ask a saver what his 401(k) is worth and you’ll hear a cash amount and perhaps
a lament to the value lost in the financial crisis. The trouble is that
investment value and asset volatility are simply the wrong measures if your
goal is to secure a particular future income. In this article, Merton explains
a liability-driven investment strategy whose aim is to improve the probability
of achieving a desired retirement income rather than to maximize the capital
value of the savings. [ABSTRACT FROM AUTHOR]