In response to soaring liabilities and record-low funding levels, most large U.S. companies are taking active steps to reduce their overall pension risk by changing the way they fund, invest and design their pension plans, according to Hewitt's 2009 Global Pension Risk survey.
The consultancy found that among the 153 large U.S. companies surveyed:
• Most U.S. companies (83 percent) expect to make additional contributions to their defined benefit pension plans.
• Among these companies, 11 percent indicate that the additional contributions will have a significant impact on their business, and more than half (51 percent) say the impact will be material but manageable.
• Two-thirds of surveyed companies (66 percent) expect to fund their pension plans to at least an 80 percent funded level to meet the new threshold requirements under the Pension Protection Act (PPA) of 2006 and avoid triggering benefit limitations.
Risk-Reduction Strategies
In addition, the survey found that:
• There is growing interest among U.S. companies to implement dynamic asset allocation strategies to "de-risk" their pension plans as their plan’s funded ratio improves.
• The number of U.S. companies considering closing and/or freezing their plans in the future almost tripled compared to the prior 18 months.
• U.S. companies are five times more likely than a year earlier to consider delegating their entire investment policy to professional advisers.
These findings represent a shift from the previous year’s survey, where U.S. employers recognized the importance of managing pension risk but took only small and conservative steps to protect themselves from volatile economic conditions. “Risk related to pension plans is having a significant impact on company performance and has become a board-level agenda item for many U.S. companies. Still, many plan sponsors felt unprepared for the most recent wave of funded status volatility and couldn’t respond in a timely and productive manner,” says Ari Jacobs, Hewitt’s North American retirement solutions leader. “Successfully managing pension risk requires a balanced and integrated approach that incorporates all aspects of plan management—from investment and funding policies to benefit plan designs. This year, we’ve seen a significant shift toward this approach as companies seek to mitigate costs and ensure the long-term health and stability of these benefits.”
Aligning Pension Assets and Liabilities
In response to the recent market turbulence, the survey shows, U.S. employers are adjusting their investment policies, with almost 40 percent reducing their equity (stock) exposure. In addition, many organizations are increasing their fixed income (bond) allocation with assets that match liabilities better, such as corporate bonds (37 percent) and/or treasury bonds (19 percent).
Moreover, a growing number of U.S. companies (15 percent) are implementing an asset rebalancing strategy that changes as the plan's funded ratio improves. “While still an emerging trend, more companies are looking at a rules-based approach to de-risking their pension plans,” says Joe McDonald, Hewitt's North American risk services leader. “Dynamic investment policies integrate a plan's asset allocation decision with its funded ratio, so companies can better protect their balance sheets from volatile swings in the funded position of their pension plans.”
Benefit Reductions
According to Hewitt’s survey, U.S. companies are thinking more seriously about reducing their future commitments as cost obligations and associated risks become harder to bear:
• 31 percent of U.S. companies said they were now more likely to consider closing their plans, up from 11 percent in 2008.
• 50 percent of companies were more likely to consider freezing their plans to existing participants, up from just 17 percent in 2008.
Plan Management Approaches
As a result of the more complex regulatory and economic environment, U.S. employers are showing a growing interest in using professional advisors to help them make investment decisions. According to Hewitt’s survey, more than half (51 percent) of companies have outsourced the performance monitoring of their investments or are more likely to do so compared to18 months earlier. Forty-one percent said they have outsourced liability-hedging strategies or are more likely to do so compared to 18 months earlier. Further, companies were five times as likely to consider delegating their entire investment policy to professional advisors, from 4 percent in 2008 to 20 percent in 2009.
“Many U.S. companies simply don’t have the knowledge or time to develop a strategy for maximizing asset returns, controlling volatility and decreasing risk in their pension plans,” comments Jacobs.
“Delegating these responsibilities to an outside provider has become an increasingly attractive option because it can reduce a company’s pension plan costs and enable organizations to devote more resources toward other corporate finance risks and business-critical activities,” he adds.
Risk Monitoring and Measurement
In the past year, U.S. companies have recognized the need to take a more active role in monitoring the risk associated with their pension plans. Compared to 18 months earlier, Hewitt found that more than three-quarters (78 percent) have started to monitor the financial risk in their pension plans or have increased how often they measure it.
However, most companies still focus on asset-only benchmarks to measure how successfully they are managing their plan assets. Pension plan liabilities generally receive far less attention and are rarely reviewed as frequently or consistently as asset-only benchmarks. Hewitt’s survey found that just 12 percent of companies use the growth in their liabilities as the primary way they measure success of their plan’s assets.
“While there is a significant increase in the number of U.S. companies monitoring risk, many organizations are still in danger of making suboptimal decisions if they focus only on the asset side of the equation,” notes McDonald. “Companies need to give equal attention to both asset and liability results, as it is the funded position—or assets less liabilities—that is recorded on company balance sheets and directly influences cash contribution requirements and income statement charges. By focusing on funded status, companies gain a clearer understanding of the risks associated with both sides of the pension balance sheet and how they interact. This enables them to make decisions that optimize risk and return from a PPA and mark-to-market perspective.”
Stephen Miller is an online editor/manager for SHRM.
Related Article:
Pension Tension: Seven Critical Questions Facing Plan Sponsors, SHRM Online Benefits Disciplines, August 2009
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