The percentage of U.S. defined benefit pension plans holding so-called "alternative investments" is up significantly over the previous two years. And so is the number of frozen plans, according to a poll by SEI, a wealth management firm.
The 2010 poll saw an increase to 65 percent of pension executives who said their pension portfolios invested in alternatives to stocks and bonds, up from 51 percent in 2008 and 53 percent in 2009. Real estate, private equity, funds of hedge funds and single-manager hedge funds were the most common alternatives being used, according to respondents.
Use of alternative investments among pensions with more than $300 million in assets was significantly higher than those with less; 84 percent vs. 53 percent.
Nearly all pension executives viewed improved funded status as a benchmark more important than increasing absolute returns, the poll found. Of the major concerns impacting pension executives, more respondents (88 percent) chose managing funded status than any other issue.
Top priorities going forward were:
• Improving funded status.
• Creating a long-term pension strategy.
• Stress-testing the portfolio.
• Increasing due diligence.
• Defining the role of consultants and investment professionals providing advice to pensions.
“Funding deficiencies are getting the attention of various stakeholders in companies and, as a result, boards and senior management are looking for long-term strategies,” said Jon Waite, chief actuary for SEI’s Institutional Group. “A plan’s funded status is the top priority as liabilities are being managed within a larger, organizational, risk management framework. In particular, alternative investments are being integrated into the portfolio as another channel for mitigating overall risk while providing additional return,” he noted.
In response to economic conditions and changing priorities, some pensions are frozen: They're closed to new entrants, and accruals are ended for current participants (see box below). More than half (53 percent) of poll respondents had frozen their pension plans, a roughly 10 percent increase compared to a similar survey conducted in August 2009.
Respondents were asked whether they would look to terminate their plan if it were fully funded. Of those that had frozen their plan, nearly three-quarters (73 percent) said they would look to terminate the plan. Of those with active plans, 75 percent said they would not look to terminate it.
The poll was completed by 85 pension executives overseeing assets ranging in size from $25 million to $10 billion. Of the respondents, 36 percent oversee more than $300 million in assets. None of the respondents was an institutional client of SEI, according to the firm.
Freeze vs. Terminate
Some plan sponsors seeking to "retire" their defined benefit plan might prefer to terminate the plan, but their liabilities won't allow them to do so (i.e., the present value to terminate the plan exceeds the value of the assets on hand). They might therefore decide to "freeze" the plan. Freezing, rather than terminating, also is typically easier to communicate to currently vested employees.
Among the 1,000 largest U.S. companies, only 378 were sponsors of actively accruing defined benefit (DB) pension plans with no frozen plans in 2010,according to a Towers Watson report. Between 2004 and 2010, the percentage of DB plan sponsors with one or more frozen pension plans rose from 7 percent to roughly 36 percent.
In the past, most companies that froze their DB plan were in financial distress. More recently, pension freezes have spread across all sectors, although some industries experience higher freeze rates than others, Towers Watson found.
When companies freeze defined benefit plans, the plan continues but new hires are not eligible to vest. Under some partial plan freezes, existing employees (or workers over a certain age, or with longer service, or who meet an age-plus-service formula) may continue to accrue benefits. But under a full plan freeze, current employees accrue no further benefits so that increased tenure no longer leads to higher payouts.
In a standard termination, if the company terminates the defined benefit plan, the accrued benefits (including all unvested benefits) must be paid out to participants as a lump-sum equivalent or the plan must purchase a commercial annuity from an insurance company.
Terminating the defined benefit plan provides the plan sponsor with the immediate transfer of liabilities. In addition, it provides predictable cash flows and eliminates exposure to plan volatility while eliminating expenses associated with keeping a plan (including a frozen plan) alive.
Stephen Miller is an online editor/manager for SHRM.
Pension Freezes Continue Among Fortune 1000 Companies in 2010, Towers Watson, September 2010
U.S. Pension Plan Funding Hits Historic Low, SHRM Online Benefits Discipline, September 2010
Retiring a Defined Benefit Plan: Freeze vs. Terminate, SHRM Online Benefits Discipline, July 2007
Expert: How to Weigh Alternatives for Defined Benefit Plans, SHRM Online Benefits Discipline, April 2007
Pension Plans: Freeze 'Em and Forget 'Em Is Not a Practical Strategy, SHRM Online Benefits Discipline, February 2006
SHRM Online Benefits Discipline