An increasingly prevalent view among corporate CFOs is that defined benefit (DB) pension plans represent a growing financial risk to their organizations because of the size and volatility of plan liabilities, said Craig Rosenthal, a partner at the Mercer consultancy, who testified before the U.S. Department of Labor's ERISA Advisory Committee (EAC) on behalf of the American Benefits Council, a national trade association representing plan sponsors.
Rosenthal testified June 5, 2013, that the legislative and regulatory environment for pension plans has made sponsorship increasingly difficult over the past few decades. He described the key motivations that have caused many employers that sponsor DB pension plans to consider reducing their liabilities by “de-risking.”
At a high level, de-risking takes two forms, he explained:
- Sponsors can retain liability and associated assets and attempt to coordinate assets with liabilities in such a way as to align movements to minimize volatility. This is often referred to as liability-driven investing (LDI) and frequently takes the form of investing a portion of plan assets in fixed-income securities with similar characteristics as the liabilities.
"In many situations this approach can work very well,” said Rosenthal. “But there are certain situations where an LDI approach does not address the core problem, since it does not do anything to address the size of the pension liability or [Pension Benefit Guaranty Corp.] premium issues."
- Sponsors can also transfer liability to a third party, generally, either to an insurer, through an annuity purchase, or directly to the participant, through a lump-sum offer.
"These are not exclusive decisions either, as sponsors can employ multiple techniques to manage the overall plan risk,” Rosenthal explained.
“If funding and accounting obligations can be stabilized and the spiraling up of PBGC premium obligations can be reversed, there would be far less reason for companies to de-risk,” Rosenthal told the panel. “There is no one-size-fits-all answer as to why some companies adopt de-risking approaches and others do not, nor is there a simple answer as to why companies that do de-risk do so in different ways. As the EAC formulates its recommendations to the U.S. Department of Labor on this subject, we urge its members to consider that the best way to preserve defined benefit pension plans is to mitigate the complex financial challenges imposed on pension plan sponsors."
There has been a long-term fundamental change in perception about the importance of pension risk, concurs the 2013 MetLife U.S. Pension Risk Behavior Index (U.S. PRBI), a study of 126 corporate plan sponsors from some of the largest U.S. DB pension plans.
During the five-year period, plan sponsors have shifted away from an asset- and returns-centric approach to a more balanced strategy that takes into account both the asset and liability sides of the pension risk management equation, according to the report.
"At a time when benefit obligations are climbing due, likely in large part to the persistently low interest rate environment, and many plan sponsors may be grappling with how best to maintain minimum funding levels, the recent de-risking moves by several major U.S. corporations may be paving the way for additional companies to consider a similar approach for their DB pension plans," MetLife found.
Among the study’s key findings: 38 percent of plan sponsors report that they have already taken, or are planning to take, action to de-risk their plans, either through a partial risk transfer, pension buyout or some other risk-mitigation strategy. A discussion of these solutions is included in the study.
Stephen Miller, CEBS, is an online editor/manager for SHRM.
Related SHRM Articles:
De-Risking Pension Plans, HR Magazine, May 2013
Risk-Management Q&As for HR Professionals Who Oversee Pension Plans, SHRM Online Benefits, November 2011
Related External Article:
Pension Plan De-Risking – A Closer Look at DB Plan De-Risking Options, Osler, Hoskin & Harcourt LLP, June 2013
SHRM Online Benefits page
SHRM Online Retirement Plans Resource Page