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5 myths of derisking DB plans

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Although plan sponsors are more interested these days in derisking defined benefit plans, they’re being held back from doing so by five myths.

That’s according to a new white paper from Prudential Retirement, a business unit of Prudential Financial, Inc. Reducing Pension Risk: The Five Myths Holding Back Plan Sponsors spells out each of five common beliefs it has identified as acting as deterrents to derisking and debunks them one by one.

Regulatory and accounting standards changes, funded volatility risk and awareness of longevity risk have driven an increase in sponsor interest in derisking. In 2012, there was an increase in pension risk transfer activity in the U.S., with General Motors and Verizon leading the way.

According to the white paper, “… General Motors reached an agreement to transfer certain salaried retiree benefit obligations to Prudential as part of a plan to reduce pension obligations by approximately $26 billion. Verizon Communications quickly followed … by completing their own buyout transaction with Prudential, settling approximately $7.5 billion in pension liabilities. In addition, companies invoked other measures (lump sum offers to former vested participants and retirees) to reduce the size of their plan obligations. In aggregate, settlement activities for the Milliman 100 universe totaled $45 billion. Clearly, the risk transfer standard had been set, and the U.S. marketplace appears primed for a groundswell of derisking.”

Plan sponsors would have a greater ability, beyond current limits, to derisk their defined benefits plans.

However, that groundswell never occurred. Despite the availability of options to lower risk, companies are not acting.

The white paper chalks that up to the following five reasons:

  1. Partial liability-driven investment strategies have significantly reduced DB risk;
  2. Delaying risk management solutions to benefit from further financial market improvements is prudent;
  3. Risk transfer solutions can only be executed once a DB plan reaches or exceeds full funding;
  4. Transferring DB risk to an insurer is too expensive; and
  5. Reducing DB risk, though prudent, reduces shareholder value.

“It’s important for plan sponsors to understand how to frame potential outcomes and evaluate alternatives in a risk management context, while considering correlations with risks that also affect one’s core business,” said Scott Kaplan in a statement. Kaplan, senior vice president and head of global product and market solutions for Prudential Pension & Structured Solutions, at Prudential Retirement, continued, “In doing so, more plan sponsors will have a better understanding of the broad range of options available when formulating long-term pension strategies.”

The white paper is available on Prudential’s website.