Pension Tension: Seven Critical Questions Facing Plan Sponsors

By Jonathan Waite, SEI Institutional Solutions Aug 17, 2009
Jonathan Waite

Investment volatility, asset losses, lower funded levels and an increased focus on fiduciary obligations are creating unprecedented difficulties for U.S. financial executives managing defined benefit pension plans, according to research by SEI, a global provider of asset management services. Over recent months, the firm has sponsored a series of interactive roundtable meetings in a variety of U.S. cities, featuring more than 350 financial executives affiliated with the Pension Management Research Panel, to determine the most critical and commonly misunderstood topics currently on the minds of pension plan sponsors.

Throughout the roundtables, several recurring themes and challenges came to the forefront of the panel's discussions. These are summarized below as seven questions and answers intended to help financial executives manage their defined benefit pension plans better.

Question 1
How will the organization benefit from legislatively provided funding relief?

The Worker, Retiree, and Employer Recovery Act (WRERA), signed into law in December 2008, provides some modest funding relief for pension plan sponsors. The WRERA contained new relief measures and technical corrections to the Pension Protection Act (PPA) of 2006. The relief will come in two parts:

Many plans that were more than 80 percent funded in 2007 won’t have to fund to 100 percent as previously expected. Instead, certain plans will need to fund only to 92 percent in 2008 (94 percent in 2009 and 96 percent in 2010), reducing mandatory contributions.

If benefit accruals would be frozen in 2009 because of a decline in funded status below 60 percent, the prior year’s funded status may be relied upon if that will enable accruals to continue.

That is the relief that has been legislated. Additional relief is in the congressional proposal stage but as of August 2009 had not been passed. Not all plans actually received relief. One of the relief provisions above was to ease the transition rule in PPA for plans to fund to 100 percent; however, this relief specifically excludes plan sponsors that made deficit reduction contributions for 2007. This would include any plan that was under 80 percent funded in 2007 as well as many plans that were 80-90 percent funded.

Along with this legislation, the Internal Revenue Service (IRS) has provided relief in the form of regulation or guidance to:

Permit asset valuation methods to be changed for the 2009 year without IRS approval. This means that market value of assets could be used for 2008 and a "smoothed" value for 2009.

Permit a change to the interest rate selection method for the 2009 year without IRS approval and, for years beginning before final regulations are issued, to permit the spot rate for any of the five months preceding the 2009 valuation date to be used—potentially lowering liabilities significantly.

Question 2
With the above relief in place, how are the cash costs impacting businesses?

While U.S. pension plans are expected to fund to 92 percent for 2008, that has provided little help in an environment where businesses have seen reduced revenues and are operating with limited cash.

In a few cases relief has provided contribution costs that are in line with or lower than 2008. However, that does not help if companies have lost revenue and cannot afford even the prior year cost. A more common scenario is that the relief lowered the exorbitant contribution somewhat, yet left it well above 2008 levels. This means that companies already strapped for cash are being asked to contribute more than they budgeted for during 2008.

Question 3
What happens if the company does not have the cash to make the required contributions?

This is a very real issue for many organizations as the business environment has impacted revenues and available cash negatively. If additional relief is not provided, some organizations will not have the required cash. In the worst-case scenarios, bankruptcy might be considered and cash available for pension contributions will be determined as part of the proceedings. For these plans as well as those in a marginally better position, there is an option to petition the IRS for a funding waiver. This can spread the contribution out over several years. This provides only short-term cash flow relief, as the waived contribution will have to be made eventually, as will normal contributions in coming years.

Question 4
What is the trend among U.S. companies for offering a defined benefit plan?

U.S. financial executives' responses from a recent poll conducted by the Pension Management Research Panel showed that:

46 percent of U.S. participants said the recent market conditions have increased the likelihood the organization will take steps to terminate the pension plan as soon as possible.

Only 54 percent of U.S. plans are active and open to new entrants.

34 percent have closed the pension plan to new entrants.

10 percent have closed to new entrants and frozen accruals.

2 percent have started the termination process

An up-to-date list of U.S. companies that have announced the freezing of accruals for pension plan participants is available on the Pension Rights Center web site.

Freezing or closing the plan might not be an option for all pension plan sponsors; however, all financial executives should be setting their retirement benefit strategy now as they develop business plans for the next few years. At the very least, the organization should review the reasons why the organization offers employees a defined benefit plan, what others in their industry or geographic region are doing, and whether a pension plan is a necessary benefit to recruit and retain the best employees.

The benefit effects of any change should be considered along with the organization’s financial expectations and how the options might change those projections. As financial executives try to develop strategies for improving funded status while controlling costs, it is extremely beneficial to have a solid understanding of the long-term direction of the pension plan.

Question 5
What changes are pension plan sponsors making to their overall investment management strategies?

The enormous losses in pension asset values over the past year and the volatile investment environment have created the largest set of questions facing financial executives in recent history. In its simplest form, sponsors are grappling with “where to go from here” when it comes to the investment strategies being used for the pension plan.

Plan sponsors generally are looking to move their attention to the strategic decisions regarding asset management. This means understanding the primary risks facing their plan (interest rate risk and market risk) and the tools and methods to be used to manage these risks:

On the interest rate side, sponsors are trying to understand the pros and cons of liability-driven investing (LDI) strategies and the viability of tactics used within these strategies. For example, given the wide credit spreads in the market, the use of Treasury investments and interest rate swaps is not ideal.

Plans using these tools during 2008 might have benefited substantially as the credit spreads expanded, but as they contract these implementations will result in funding status losses to the plan. Therefore, sponsors are using corporate bond implementations for hedging interest rate risk, although they need to balance the level of interest hedge with their desire to pursue absolute returns on their portfolio; more interest hedging often means less return opportunity at this point. They are looking to align themselves with experts that can monitor the hedging tools and alert them to market changes and opportunities for alternative interest rate hedging approaches, which are expected in the next year or two.

Regarding market risk, plan sponsors are struggling to keep up with the rapidly changing pension asset management landscape in addition to their normal jobs. Sponsors have a renewed appreciation for the advantages of diversification on the portfolio, style and manager levels and are revisiting asset/liability analyses to understand the opportunities available to them. Many plans are revising their asset allocations to take advantage of tactical opportunities in the market as well as new and developing asset classes. The attention to the alternative investment space has been driven by the low expected correlations with traditional asset classes and the potential to provide absolute return in the new market scenarios being predicted for the foreseeable future.

Additionally, sponsors are investigating relationships that provide access to best practices and innovative solutions during these turbulent times that will help them take advantage of short-term events. An example of this occurred in late 2008, when changes in a plan’s investment policy regarding rebalancing to target allocations could be extremely beneficial. Many sponsors are looking to ensure that they will not miss chances such as this as the market turbulence continues.

Question 6
What about the investment management process needs to change moving forward?

While just about every pension executive has experienced some level of pain over the past year, the extent depends on how their plan is being managed. The expectation is that the investment management process will become even more rigorous and that organizations are preparing to stay competitive by looking at their process for researching and selecting investment managers.

Some issues involve looking at whether or not the necessary internal resources are in place given staff reductions and the increased workload to satisfy due diligence needs. Many executives who use external consultants feel that the approach did not perform well during the recent market turmoil as communications were slow and the ability to respond dynamically was limited.

Additionally, recent investment scandals led to the questioning of fiduciary roles and where the duty to perform certain fiduciary functions lies.

Moving forward, plan sponsors are learning about other investment models and how they fit into their organizational structure. There is an increased need for oversight, and accommodation of that need is a question many plan sponsors are now concerned with.

Question 7
How important is it to align pension finance with overall corporate/organizational finance?

Over the past few years, new legislation and accounting guidelines increased the visibility of pensions within the broader picture of overall corporate finance. Until now, most plan sponsors could manage their plans relatively easily, as the plans were fairly well funded and the immediate consequence of the pension’s impact on the company’s financial statements was limited.

However, the need to align pension finance and corporate finance effectively became critical with the overall economic downturn and the enhanced transparency requirements. The under-funding of pension plans is highly visible as a significant deficit on the balance sheet and a significant cash drain. This could create additional obstacles with borrowing, credit ratings and business operations and growth plans.

Consider a recent industry report stating that the S&P 500 companies have over $425 billion of unrecognized losses on their U.S. pension plans (Pension Review 2009Fallout from Funded Status Decline Just Beginning, Goldman Sachs, June 2009). The report emphasized that this could continue to impact earnings per share negatively for several years as the losses work through income statements.

Overall corporate earnings and profitability as well as cash holdings are being reduced as a result of these pension losses. These reductions and the decrease in shareholder equity are getting the attention of analysts, and finance executives are being required to manage the pension within the broader corporate finance process. It is more important now than ever before to understand pension finance clearly and to find ways to forecast and communicate the pension’s impact on corporate finances accurately.


The past year has created a series of challenges for financial executives overseeing pension plans. At the end of 2008, as one of the most volatile investing years in history came to a close, financial executives overseeing pension plans were already prepared for the worst. Assets decreased drastically, and funded levels were expected to be lower, with contributions expected to be large. While some funding relief to PPA requirements has been provided by the U.S. government, the numbers are still staggering.

As 2009 has progressed, many plan sponsors know they need to begin the process of planning and making strategic and sound decisions. It will take a number of events over a period of time to correct some of the problems being faced, but the steps taken today will have an impact. Financial executives are evaluating overall processes for optimal plan management and will need to make short and long-term decisions with a full understanding of the ramifications.

Started in 2004, SEI’s Pension Management Research Panel is an independent group of more than 350 executives handling their organizations’ defined benefit plan. The panel looks to conduct research in an effort to provide its members with best practices and tactical, real-world strategies for dealing with the critical issue of managing defined benefit pension plans. The panel is hosting seven additional roundtable events around the country in the next few months. For more information, visit

Jonathan Waite, director for investment management advice and chief actuary for SEI’s Institutional Group, is the facilitator for the roundtables. His responsibilities focus on providing advice regarding asset allocation considerations, retirement benefit plan design, actuarial methods and assumptions, and funding policies for SEI’s corporate and multiemployer defined benefit relationships.

© SEI 2009 Reposted with permission

This information is for educational purposes only. It is not intended to be investment, legal or tax advice.

Related Articles:

Pension Funding Declined in July 2009, Despite Asset Gains, SHRM Online Benefits Discipline, August 2009

Pension Plan Freezes Continue at Steady Pace, SHRM Online Benefits Discipline, July 2009

Bond Markets Deal Fresh Blow to Underfunded Pensions, SHRM Online Benefits Discipline, July 2009

Liability-Driven Investing Strategies Proved Worth, SHRM Online Benefits Discipline, February 2009

Pension Funds Slash Expectations for Investment Returns, SHRM Online Benefits Discipline, February 2009

Countering Pension Risk Myopia, SHRM Online Benefits Discipline, February 2009

Pension Plan Deficits Hit Record; Many Revisit Funding Strategies, SHRM Online Benefits Discipline, January 2009

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