A funding shortfall is when the market value of pension assets is less than the market value of pension liabilities. Although this is a concern to sponsors of pension plans a bigger problem is thought to occur due to the asset liability mismatch which is when the pension assets are invested in equities while the pension liabilities have fixed income debt like characteristics. Asset liability mismatch is a bigger risk for several reasons: 1) the balance sheet does not reflect the asset allocation of the pension assets whereas the balance sheet would indicate whether or not the pension plan was underfunded, 2) if the equity markets decrease in value while interest rates decrease the pension assets will also decrease while the pension liabilities will increase in value, 3) it’s not uncommon for a company’s pension assets to be larger in value than the overall market value of equity of the firm and if those assets are invested in equities this will contribute a significant amount of risk to the firm. |
