While the final goal for defined benefit and defined contribution plans may be the same — retirement savings that workers can use to support themselves when their working days are over — those plans operate in different environments and with different priorities.
On Dec. 19, Mercer released its list of 10 priorities for defined benefit plans to address risk management in 2014. The firm released simultaneously a list of 10 steps that defined contribution plans need to undertake to secure retirement outcomes for participants.
Mercer noted that as of Nov. 30, defined benefit plans at companies included in the S&P 500 had an aggregate funded status of 93%. A quarter of those plans were funded at over 100%. Now’s a good time, then, for those plans to examine ways to manage risk without increasing costs.
The double-digit equity returns and rising interest rates of 2013 have yet to trickle down to workers in defined contribution plans, though, according to Mercer. With plan participants shouldering more of the responsibility for retirement through DC plans, plan sponsors need to ensure plans are designed to help them achieve the best possible outcomes.
Risk Management Priorities for Defined Benefit Plans: 1-5
1) De-Risking Strategies for Glide Paths
Mercer recommended DB plans incorporate interest rate triggers into their glide paths, in addition to funded status triggers. Mercer anticipates an increase in interest rate volatility as the Fed begins tapering in 2014.
Mercer also expects to see more time-based triggers in DB plans as employers look to terminate pension plans.
2) Growth Assets in De-Risking Glide Paths
If DB plans reduce allocations to growth assets as they de-risk glide paths, the expected return will decrease as well. To compensate for this decrease, they should allocate to other growth assets than equities.
3) Liability-Driven Investing Benchmarks
DB plans should make sure their bond benchmarks are aligned with their liability characteristics, especially if they have a substantial allocation to liability hedging assets.
4) LDI and Derivatives
Plans that use LDI have increased their exposure to hedging assets, Mercer noted. Mercer anticipates more DB plans will use interest rate derivatives in 2014, as physical securities may not be an efficient way to manage interest rate risk or capital.
5) Tailoring LDI Strategies
As DB plans begin tailoring their liability-driven investment strategies to their own needs, they may specify interest rate durations to match liability cash flows. Mercer expects to see more DB plans developing these strategies next year.
Risk Management Priorities for Defined Benefit Plans: 6-10
6) Discretionary Contributions
The Moving Ahead for Progress in the 21st Century Act, or MAP-21, included a provision for DB plans to fund pensions at lower levels. However, Mercer said that some plans have opted to make discretionary contributions to jolt funded status. Plans that are on a de-risking glide path but have a funded status lower than the first trigger point are prime targets for these discretionary contributions.
7) Managing Surpluses
Believe it or not, some DB plans have a surplus. Mercer suggested those surpluses might be managed by merging underfunded plans into overfunded plans through mergers and acquisitions or by shifting certain benefits.
Mercer expects to see more DB plans delegating investment responsibilities like glide path monitoring, trade executions and manager selection, contracting and oversight to third parties.