Defined-benefit (DB) pension plans are an endangered species; they are perceived
as too risky and costly. But the emerging substitute, the defined contribution
plan, has many shortcomings. The risk of DB plans can be controlled, first, by
modeling the liability in terms of its market-factor exposures through surplus
(asset minus liability) optimization. Then, sponsors may hold the minimum-risk
position (a liability-defeasing portfolio) or they may move up on the efficient
frontier—taking equity and other risks. The economic cost of a DB plan
also needs to be managed, but it is a matter of managing the size of the pension
promise; it is not an asset allocation problem.