Pension plans have been fraught with volatility in both the equity and interest rate sectors. While the last two years have seen relatively solid growth in equities, interest rates have been quite a different story to the downside.
It is because of these two diverging market moves, notes Matt McDaniel, partner and business leader in the retirement practice with Mercer, that pension plan funded status was relatively high in 2013 at about 94%. With interest rates falling, funded status dropped in 2015 to 74%. Weve made up some of that ground since then, but it continues to be a bumpy ride, he says.
Mercers most recent pension risk survey of about 200 plan sponsors shows that current median funded status ranges between 85% and 95%. One of the interesting responses in the survey, according to McDaniel, is that after years of wanting to conserve cash and put in as little into the pension plan as possible, now 70% of sponsors are willing to contribute in excess of whats minimally required.
One of the key reasons for this is the rise of Pension Benefit Guaranty Corporation premiums. By 2016, the PBGC tax on every dollar of underfunded pension amounts to three percent, says McDaniel. This means there is significant incentive for plan sponsors to fund the pension plans more quickly on a PBGC basis to avoid these premiums. The survey shows that 55% of plan sponsors are actively looking to increase contributions.
Those that cannot afford to put money back into the plan are looking to borrow the funds. While debt is essentially transferred from one part of the balance sheet to another, the depth and increasing cost of the PBGC premiums makes this capital structure a compelling one for many plan sponsors. The survey shows that 45% are looking to borrow funds as part of their overall pension funding strategy.
As far implementing a de-risking strategy, 85% of plan sponsors say they have implemented or will implement some sort of plan. Things have become quite mainstream for plan sponsors where they have some kind of de-risking plan [and] they intend to reduce the risk in the investments relative to the liabilities as funding status improves, says Jay Love, partner and senior consultant with Mercer. He adds, however, it took about seven to 10 years to get to this point.
Also, because there is an expectation of interest rates rising sometime in the near future, 70% of plan sponsors have taken steps to change their fixed income investments. This is not surprising but shows the general acceptance of the driven risk management approach, explains Love. Things like duration of investments have been altered and there has been a reduction in equity investments, which has been shifted to fixed income, according to the survey.
Transferring risk has also been accomplished by plan sponsors making lump sum payments to participants with nearly 60% of those surveyed saying they have used this method within their plans. This has become a very mainstream and prevalent strategy to transfer risk off the balance sheet at an attractive price, says McDaniel.
Overall, plan sponsors that had taken action to manage risk, notes McDaniel, were generally happy that they had done so, partially because of volatility but also because it allowed them to avoid regret related to future events.
Joel Kranc is a freelance writer based in Toronto.
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