UpFront | Published in May 2012

Lessons of Experience

DB sponsors can learn about de-risking from others 

By Rebecca Moore | June 2012
Illustration by Jesse Tise

North America’s first pension buy-in deal last May led many to predict a boom in the pension de-risking market.

Yet while the number of sponsors eager to reduce the risk of their pension liabilities takes an upward curve, plan sponsors continue to question whether they should be more cautious than their counterparts in the U.K. and Europe. 

A Clear Path Analysis survey found that 98% of North American pension plans and their company sponsors believe that if the de-risking market is to see significant growth, providers must undertake a full strategy analysis, so they can understand and immunize their liabilities effectively. However, liability-driven-investing (LDI) fund managers and longevity-hedging providers argue that it is more important to consider developments in other countries and learn from their mistakes.

Clear Path’s report “Pension Plan De-Risking, North America” describes current trends in the marketplace and the options available to them. Scott Gaul, senior vice president at Prudential Retirement, considers the growth potential in the market. “From what we see, many companies are holding a disproportionate amount of risk in their pension plans, and we feel it is prudent for businesses to begin the process of de-risking and aligning risk, towards their core investments.”

Valter Viola, head of Pension Risk Solutions at Algorithmics, an IBM Company, warns, “To avoid repeating past mistakes, DB [defined benefit] pension plans need an effective and thorough process for making risk decisions. While an aging population provides a good reason to de-risk these days, other reasons for doing so may be worrisome.”  

The recent financial crisis and the “perfect pension storm” that preceded it—with falling stocks and falling interest rates—has been a catalyst for de-risking, Viola says, explaining that the response to those extreme events may be an overreaction to recent pain and indicates that certain risks need to be better understood, despite evolving accounting standards that make some of them more transparent.  

“DB plans need a risk framework to define risk parameters,” he says. “Articulating risk appetites is not easy and the first challenge is that many people do not understand the language of risk very well.” He recommends that DB plans adopt a practical framework, which will develop an explicit risk budget, report risks more frequently and set policies at acceptable levels of risk. “By doing that, they are less likely to repeat past mistakes. As Keynes warned us, however, this is easier said than done!”