1.
© 2013 SEI 1
Pension plan sponsors take into consideration a
host of factors when creating long-term
investment strategies. Sophisticated financial
models use capital market assumptions to
develop a range of expected outcomes for
projected asset returns and volatility, and
correlations between asset classes. Based on
this output, plan sponsors evaluate the trade-
offs between the various asset allocation
strategies designed to fulfil the pension
promise.
However, a crucial element is often missing
from this exercise – determining the impact of
the same capital market assumptions on
corporate financial performance and the
resulting ability of the plan sponsor to meet the
financial demands of the pension plan.
Effectively managing plan asset volatility and
funding unexpected contribution demands
require a tailored investment strategy that takes
into account the sponsoring organization’s risk
profile and performance under different market
scenarios.
Companies with high degrees of capital
liquidity, stable cash flows and modest-sized
pension plans relative to the overall balance
sheet and market capitalization, typically exhibit
lower pension risk. Thus a higher allocation to
asset classes designed to generate excess
returns relative to pension liabilities is not only
acceptable, but appropriate. On the contrary,
companies that are capital-constrained, with
volatile revenue streams, high fixed costs and
large pension plans, are likely to be more
severely impacted by volatile pension assets.
As such, more emphasis should be given to
risk-focused asset classes that are designed to
match the duration, term structure or credit
profile of liabilities, versus those asset classes
designed to generate returns.
SEI conducted a study to search for asset
allocation consistencies among organizations
with similar financial risk metrics such as five-
year beta, free cash flows, debt leverage, and
pension assets to total corporate assets or
credit ratings. The study examined the
investment strategies of more than 1,200 U.S.
public companies with pension assets over
$10million and revealed no such consistencies
(details can be found in the Appendix). Despite
the lessons of the past decade the analysis
suggests there is little evidence to show that
pension investment strategies are customized
based on the sponsoring organization’s unique
risk profile.
Corporate Risks Impacting the Asset
Allocation Decision
An initial step to creating investment strategies
that are tailored to manage plan asset volatility
and fund unexpected contribution demands
requires an evaluation of three critical risk areas
– operational, financial and pension
investments.
1. Operational risk can be evaluated through
multiple approaches. At a high level the
focus is on the stability and visibility of free
cash flows and the risks and key drivers
associated with top line performance.
2. Financial risk is measured by liquidity, and
defined by surplus cash and available
credit, tenor and covenants associated with
the existing debt structure, refinance risk
and potential contingent liabilities.
3. Pension risk is a function of the size of the
pension assets and liabilities relative to the
corporate sponsor, and measured by
multiple metrics including:
› Pension Assets/Market Capitalization
› Pension Assets/Adjusted Corporate
Assets
› Pension Assets/Book Value
› Unfunded Pension Obligation/Adjusted
Balance Sheet Liabilitiesi
› Pension Expense/Corporate Income
Enterprise Pension Risk
Assessing Corporate Risk Profiles When
Setting Long-Term Pension Strategies

2. © 2013 SEI 2
Thresholds of risk tolerance will vary
significantly by industry and corporate
circumstances. For example, a high margin, low
capital expenditure branded food manufacturer,
with highly stable cash flows and low leverage,
will have a high degree of tolerance for
variability of even a large pool of pension
assets. In economic and market downturns, the
organization will be minimally impacted by
increases in required contributions.
Conversely, a thin margin industrial distributor,
with performance closely tied to the
macroeconomic business cycle, will potentially
be severely impacted by unexpected pension
funding requirements. The company could face
potential market and lender consequences from
a compressed book equity value, at the same
time its available capital is most constrained by
financial performance.
Expanding the Financial Modeling
Process Improves the Output
Understanding historical correlations between
the drivers of pension asset and liability
changes – market returns and interest rates –
and the drivers of corporate financial
performance will aid in creating a tailored
pension portfolio strategy that addresses an
organization’s risk tolerance, it’s ability to
support cash contributions, and ability to
manage swings in balance sheet values.
Using these historical relationships and
additional multivariate financial drivers,
organizations can project performance
scenarios for both the pension (assets and
liabilities) and corporate financials, under
matching economic environments.
The ability to stress test the pension
portfolio alongside corporate financials
provides a dynamic view of how pension
volatility and corporate performance
interact. The benefits include a thorough
understanding of the downside risk
associated with pension allocation
alternatives in the context of a corporation’s
balance sheet, income statement and cash
flows.
What plan sponsors should seek to avoid in the
pursuit of pension plan returns is to take on an
unacceptable level of pension risk that could
financially constrain the corporation in the face
of a market downturn. In pursuit of an additional
50-150 basis points in annual returns, plan
sponsors can often find themselves required to
contribute a significant portion of their available
cash flows to the pension plan at times of
declining earnings due to market losses in the
pension portfolio.
An approach to expanding the financial
modelling process is illustrated in the following
charts which model two pension allocation
alternatives for XYZ Company. The
organization is a large integrated metals
company with a sizeable pension plan, and its
core business highly correlated to market
indices. Rather than evaluate the trade-offs
associated with varying asset allocations based
exclusively on return and variance within the
pension plan itself, corporate performance over
this same time period is modeled as well.
Overlaying the results identifies potential stress
points, and crystallizes the corporate risk posed
by aggressive pension investment approaches
in certain poor performance scenarios.
In the downside scenario for this particular
organization, an overweight to equities could
cause the pension to consume significant
operating cash flows at a time of financial stress
and limited access to capital. Knowing this, the
organization could look at modifying the
portfolio through fixed income options to better
match assets and liabilities and ultimately
cushion risks posed by the pension plan,
without significantly changing projected mid-
point funding levels.

3. © 2013 SEI 3
XYZ Company: Three-Year Corporate & Market Performance
XYZ Company Current
Mid-point Performance
Projection
Downside Scenario
S&P Return (CAGR) 8.0% -10.0%
Revenue $1,294.9 $1,590.8 $1,014.9
Revenue Growth (CAGR) 7.6% -9.2%
EBITDA $257.4 $292.3 $128.1
XYZ Company: Corporate & Pension Model Projection – 2013
Pension Allocation Overweight Equity Portfolio Modified Portfolio
Pension Metrics
XYZ
Company
Current
Mid-point
Performance
Projection
Downside
Scenario
Mid-point
Performance
Projection
Downside
Scenario
Pension Assets / Adjusted Corporate Assets 16.2% 17.8% 14.4% 17.2% 17.9%
Pension Assets / Book Value 92.2% 51.7% 56.5% 60.9% 70.5%
PBO / Adjusted Balance Sheet Liabilities 26.1% 32.1% 24.9% 33.4% 33.4%
Pension Expense / Corporate Income 25.1% 7.0% 78.3% 8.8% 47.4%
Contributions / Operating Cash Flows (3 yrs) 19.7% 90.2% 7.1% 64.6%
Funded Status 75.1% 84.9% 57.7% 81.8% 72.0%
Funding Gap (Surplus) $90.2 $57.0 $169.0 $68.9 $111.9
Leverage Metrics
Debt/EBITDA 2.4X 0.4X 2.4X 0.4X 2.4X
Unfunded PBO / EBITDA 0.4X 0.2X 1.3X 0.2X 0.4X
Debt + Unfunded PBO / EBITDA 2.8X 0.6X 3.7X 0.7X 2.7X
Coupling the evaluation of operational,
financial, and pension risks with the expansion
of the financial modelling process, creates an
outcome that may lead plan sponsors to take a
different course of action in setting their long-
term pension strategy than they would
otherwise implement. Stress testing the pension
portfolio in conjunction with corporate financials
offers a view of the risks associated with asset
allocation alternatives in the context of the
sponsoring organization’s balance sheet,
income statement and cash flows. Only by
carefully evaluating the variability of pension
investment strategies in tandem with the
potential variations in sponsor corporate
performance, can plan sponsors identify their
tolerance for risk. This approach will lead to a
more tailored pension investment strategy for
the corporation’s specific financial
circumstances.
i
In order to appropriately measure a pension plans impact on the balance sheet the GAAP statements need to be
adjusted by adding the full value of the pension assets and pension liabilities to the balance sheet, rather than the
net funding gap or surplus.

4. © 2013 SEI 1
APPENDIX I
The research below was completed by SEI Institutional Group in July 2012 and studied asset
allocations of pension plans for more than 1,200 U.S. public companies. All organizations had pension
assets of at least $10 million and the figures were from fiscal year 2011. The charts below show a
sampling of results using a random selection of 250 of those companies in each chart. The intention is
to illustrate the lack of correlation between the two factors in each chart.
5-Year Beta – Beta is defined as the correlation of specific corporate plan equity performance with the
overall market. Companies with higher Betas might want to consider somewhat lower equity
allocations, as their overall risk factors are likely to be more heavily impacted by a downward
movement in the market. These companies could be faced with the need to make additional
contributions to their pension plans at a time they could be most challenged to do so.
0
1.0
2.0
3.0
4.0
5.0
0 10 20 30 40 50 60 70 80 90 100
5-YearBata
Percentage of Plan Assets Invested in U.S. Equities (Latest Annual)
Correlation of Plan Equities vs. 5-Year Beta
Free cash flows (Operating cash flow – CAPEX / revenues) – Companies with high free cash flows
have greater flexibility to make additional contributions to their pension plans if they become
underfunded due to adverse market conditions.
-40%
-25%
-10%
5%
20%
35%
50%
0 5 10 15 20 25 30 35 40 45 50 55 60 65 70 75 80
(CashfromOps-CapEx)/TotalRevenue
Percentage of Plan Assets Invested in U.S. Equities (Latest Annual)
Correlation of Plan Equities vs. (Cash from Ops - Cap Ex) / Total Revenue
Source: SEC Filings and Standard and Poor’s Capital IQ
Source: SEC Filings and Standard and Poor’s Capital IQ

5. © 2013 SEI 2
Debt Leverage (Net Debt/EBITDA) – Highly leveraged companies are typically more challenged in
making up pension shortfalls without constraining other strategic uses of capital. A company with
limited available cash and access to credit should have a more strategic allocation to avoid unexpected
new capital claims.
0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
4.5
5.0
5.5
6.0
0 5 10 15 20 25 30 35 40 45 50 55 60 65 70 75 80
NetDebt/EBITDA[LTM]
Percentage of Plan Assets Invested in U.S. Equities (Latest Annual)
Correlation of Plan Equities vs. Net Debt / EBITDA
Pension Assets/Total Corporate Assets & Pension Assets/Market Capitalization – A company
with a larger pension plan relative to its corporate balance sheet and its market cap will have a lower
tolerance for variability of pension assets, as the impact on the overall capital structure and valuation
will be significant.
0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0 5 10 15 20 25 30 35 40 45 50 55 60 65 70 75 80
PensionPlan/TotalAdjustedAssets
Percentage of Plan Assets Invested in U.S. Equities (Latest Annual)
Correlation of Plan Equities vs. Pension Plan / Total Adjusted Assets
(Total Assets + Pension Assets)
This information is for educational purposes only. Not intended to be investment, legal and/or tax advice. Please consult your financial/tax
advisor for more information. Information provided by SEI Investments Management Corp., a wholly owned subsidiary of SEI Investments
Company. ©SEI 2013
Source: SEC Filings and Standard and Poor’s Capital IQ
Source: SEC Filings and Standard and Poor’s Capital IQ