Five Key Pension Risk Management Tips

Pension Protection Act funding targets will mean a substantial increase in cash funding in 2012

By Stephen Miller, CEBS Jan 12, 2012

Continued stock market volatility, a sluggish economy and an uncertain regulatory environment have altered the defined benefit pension landscape significantly in the U.S., prompting plan sponsors to evaluate more deeply the risks and liabilities facing their pension plans.

“Pension deficits and the impact on the financial health of their organizations are a key concern in many boardrooms and C-suites, and the time to act is now," advised Jonathan Barry, a partner in consulting firm Mercer’s retirement, risk and finance business. “With market volatility, plan sponsors need to be nimble to take advantage and put in place a robust risk management plan,” he added.

The most important pension risk management steps for U.S. pension plan sponsors, according to Barry, are:

1. Review the plan’s funded status as part of your regular plan reporting.

Most plan sponsors review investment performance on a quarterly basis. With the increased linkage between assets and liabilities, consider including a review of the plan’s funded status. This type of funded status monitoring involves not merely looking at the ratio of assets to liabilities but also a reconciliation of funded status from period to period, attributing any movements in funded status to factors such as interest rate and credit spread movements, equity performance and contributions, and benefit payments. “Frequent funded status monitoring is the foundation for understanding the overall health of your plan,” said Richard McEvoy, Mercer's U.S. leader for dynamic de-risking solutions.

2. Understand the range of possible outcomes to which the pension plan exposes your organization.

With high market volatility, it's a critical time for plan sponsors to forecast the potential outcomes of their plan’s funded status on key financial measures, such as cash, expense and balance sheet adjustments. Full funding targets under the 2006 Pension Protection Act (as amended by the 2008 Worker, Retiree, and Employer Recovery Act) will mean a substantial increase in cash funding in 2012.

3. Develop a formal de-risking plan.

There have been several opportunities since 2000 to take risk off the table as funded status improved. Yet most sponsors failed to take advantage of these opportunities, as they had no plan to know when to reduce overall plan risk, nor did they have the time, resources and specialized investment expertise. Sponsors should develop a roadmap to de-risk the plan that can be followed quickly as opportunities arise.

4. Explore liability transfer strategies.

Lump-sum cash-outs for terminated vested participants, annuity buy-ins and buy-outs are viable options for many plan sponsors. However, analyzing and implementing these strategies takes collaboration from the finance and HR sides of the organization. Sponsors looking to implement these strategies in 2012 or 2013 should be planning now to help maximize the effectiveness of the program.

5. Review your governance structure and decision-making process.

Developing a plan is easy, but executing and implementing investment decisions is difficult. Market volatility can create opportunities that last for only a couple of days. Consideration of the appropriate governance model for each plan sponsor is critical and might include delegation to a third party that can measure asset and liability values daily and act quickly to take advantage of them. “It is important to focus both on strategy and execution and to ensure that internal obstacles do not get in the way when the time is right,” said Nick Davies of Mercer’s investments business.

Three Key Trends to Watch

Three key trends will provide the framework for defined benefit plan management over the next several years, according to Cynthia Mallett, vice president in the corporate benefit funding area of financial services firm MetLife:

The low interest rate environment.The fact that interest rates have remained low for a sustained period has resulted in pension funding levels holding steady or dropping even when rates of return have increased.

The move to “mark-to-market” accounting.In anticipation of the adoption of an International Accounting Standards Board (IASB) proposal, which would move U.S. companies to international accounting standards, several major blue-chip corporations have made the move to mark-to-market accounting, which leads to more transparency. This should encourage plan sponsors to focus even greater attention on de-risking their pension plans.

The impact of Dodd-Frank.Swaps transactions are used widely by plan sponsors and their investment managers to hedge against market risk, reduce volatility and make funding obligations more predictable. However, proposed rules implementing the Wall Street Reform and Consumer Protection Act ("Dodd-Frank") would limit the use of swap transactions greatly, creating uncertainty for qualified retirement plans. Unless amended, Dodd-Frank regulations might preclude swap dealers from entering into swap transactions with plans subject to the Employee Retirement Income Security Act (ERISA).

Stephen Miller, CEBS, is an online editor/manager for SHRM.​

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