North American retirement plan sponsors are increasingly seeking to reduce or remove the innate risks in their defined benefit pension plans, according to a recent report.
“There’s no doubt that pension de-risking has become a major focus for corporate plan sponsors,” according to a report from Prudential and Fidelity titled Pension Plan De-Risking, North America. “Average fixed income allocations are around 40%, up from 25% 5 years ago. With a $3 trillion corporate pension market and an average allocation expected to reach 70% to 80% over the next 5 to 10 years, we anticipate around $1 trillion of money movements. Even a conservative estimate of $500 billion would represent a sizable shift.”
The report, which was carried out by independent publisher Clear Path Analysis, surveyed 123 U.S. pension professionals to better comprehend their outlook on pension de-risking in the current economic landscape.
According to the survey, more than half were either very likely or considering transferring their risk to a third-party insurer or implementing a lump sum program for defined benefit participants.
The next 12 months could see a greater wave of corporations looking to transfer risk as a result, according to Alexandra Hyten, vice president of pension risk transfer at Prudential Retirement.
“With the variable [Pension Benefit Guaranty Corp.] premium going up to 4.1% of [a] pension’s schemes unfunded liability and with interest rates being as low as they are, many plans are at least considering borrowing,” Hyten states in the report. “They feel they need to fund-up their plan to eliminate that portion, so many corporations are at that trigger point right now.”
According to Hyten, one of the main drivers for the increase in de-risking activity is that the total cost to maintain a pension plan has increased.
This is largely due to an increase in premiums paid to the PBGC. The fixed per person premium is $64 in 2016, but the new bill will increase the fixed premium to $80 in 2019.
“To put this into perspective, the fixed premium was $35 as recently as 2012 and $19 as recently as 2005, just 10 years ago,” according to Hyten.
The variable premium, which is the amount paid per $1,000 of unfunded liability, will also increase from the already scheduled $30 in 2016 to $41 by 2019. According to Hyten, this premium was $9 as recently as 2013 and did not exist prior to 1998.
The Bipartisan Budget Act of 2015, passed in November, is the third bill in four years to increase the PBGC premiums.
As a result of these increases, a number of plan sponsors are now looking for solutions to de-risk their plans. According to the survey, the recent premium increases have led 20% of those surveyed to “transfer some or all of the risk to a third-party insurer.” Meanwhile, 14% said they would implement liability-driven investing strategies and 12% would implement a lump sum program for plan participants. Increasing awareness of longevity risk and its effect on pension liabilities is another essential trend identified within the survey.
According to the report, The Society of Actuaries in 2014 released a new recommended mortality standard, which accounted for an increase in longevity. After adopting these tables, plans saw on average a 6 to 7% increase in their pension liabilities, according to the report.
According to the survey, nearly 45% of all respondents have a high or very high level of understanding about the impact increasing longevity is having on their pension obligations.
When analyzed by plan size, the survey finds that 57% of plan sponsors with more than $250 million in assets under management indicated they have a high or very high level of longevity risk awareness, while 34% of plan sponsors with $250 million or less AUM said the same.
Globally, market volatility has meant that U.S. interest rates have stayed low, meaning that many pension schemes have turned to issuing debt as they strive to fund deficits.
According to the survey, 15% of respondents have issued debt in order to make voluntary plan contributions.
According to 51% of those surveyed, sustained low interest rates were the largest challenge in successfully implementing a de-risking plan.
A majority of respondents, 76%, also said the movement of interest rates would either slightly or greatly impact their decision to de-risk through a liability-driven investment strategy.
As Rohit Mathur, senior vice president and head of global product & market solutions at Prudential, writes in the report, “Challenged by enduring marketplace volatility, escalating longevity and mounting guaranty corporation premiums, plan sponsors are recognizing the significant risks caused by their pensions — and the detrimental effects these plans can have on shareholder value.”
The survey respondents included senior finance, pension, treasury and human resources professionals. More than half of the group (54%) had less than $250 million in plan AUM and the remaining had anywhere from $250 million to more than $15 billion. While a majority (67%) of the participants’ plans were open to all employees, 11% said their plans were closed to new entrants, 15% there were no further DB accruals for existing employees, and 7% said existing employees continue to accrue pension benefits.
— Check out The Golden Age of Investing Is Over: McKinsey on ThinkAdvisor.