The funded status of pension plans has been on a wild ride since 2008, experiencing major declines in 2008, 2010 and 2011. The drops were due to the "double whammy of declining equity markets and lower interest rates," said Jonathan Barry, Mercer's U.S. Retirement Risk & Finance DB Risk Leader, during a recent webinar.
How plan sponsors manage that pension risk volatility was the subject of a joint Mercer/CFO Publishing study, "Redefining Pension Risk Management in a Volatile Economy."
Mercer conducts a monthly analysis of the S&P 1500. At the end of November, it found that aggregate S&P 1500 defined benefit pension plans were underfunded by $391 billion, which means they were funded at 75 percent. This was down from a funding ratio of 88 percent in April 2011, Barry said.
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And while the markets have experienced volatility in years past, this time was different because "many of the smoothing techniques and funding relief options to defer the pain of downturns were no longer available," he said. Barry predicted that companies would have to increase their contributions going into 2012 with significant profit and loss impact, which could adversely affect the financial performance of many organizations.
CFO Research Services surveyed 192 senior finance executives for the study. It asked them how their organizations viewed the management of pension risk among economic uncertainty, close regulatory scrutiny and shifts in employer and employee expectations. All of those surveyed were from companies with large defined benefit pension plans, with at least $100 million in assets. The majority, or 87 percent, were from companies with more than $1 billion in annual revenue, said Sam Knox, vice president and director of research for CFO Research Services and author of the study.
The survey found that market volatility, low interest rates and stricter regulatory requirements have drastically affected the future of defined benefit plans and have impacted companies' policies regarding defined benefit plan funding, risk management and investment.
Most plan sponsors surveyed said that managing that volatility is a primary focus moving forward.
A majority recognized that their defined benefit plans can have an impact on the broader enterprise. "More than half saw some or a substantial impact on profitability," said Nick Davies, principal and senior investment consultant at Mercer Investment Consulting in Washington, D.C.
Many companies have made design changes to their DB plans in the hopes of mitigating their risk moving forward. During the past five years, many have closed their plans to new employees, all employees or converted to a hybrid plan.
Not many companies have terminated their DB plans in the past five years, only 13 percent, Barry said. "Given the funded status and the high cost of plan termination, this is not a surprising result. Plan termination activity could increase substantially in the next few years," he added.
Defined benefit plans aren't as attractive to a "mobile workforce," Barry said. "This lends support to the design changes sponsors have made and expect to make going forward. It will be interesting to observe over the next several years if there is any impact on workforce management as the group of employees dependent on DB plans gets closer to retirement."
A high percentage of respondents stated they are not in favor of adopting an aggressive investment strategy to try and make up the losses in their plans over the past few years. More than half said aggressive return seeking is at least "somewhat unsound" and 27 percent said it was "very unsound," according to the study.
When asked about liability-based asset management, one in five respondents said their companies already have an initiative to match the duration of fixed-income investments to DB-plan liabilities underway. The report also found that another 50 percent are likely to undertake that initiative in the next two years.
Fourteen percent of those surveyed said they have a plan in place to increase their plan's allocation to fixed-income investments, while 57 percent said they are likely to do the same.
"Dynamic de-risking strategies and settlement (for example, offering lump sums to terminated, vested employees) similarly met with favor," the report stated.
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