is no secret that market volatility, low interest rates and the underfunded
status of many defined benefit (DB) pension plans are having a significant
influence on the way plan sponsors approach de-risking such plans.
With uncertainty about the financial and regulatory
environments, many plan sponsors have been taking a “wait and see” approach
with regard to devising and implementing pension risk management strategies.
However, there may be strategies that sponsors can pursue now to avoid
unanticipated contributions and prepare to de-risk when the time is right.
Greg Falzon, senior vice president of Retirement &
Benefits Funding at MetLife; Edward Root, vice president and actuary of U.S.
pensions at MetLife; and Jason Richards, senior consultant at Towers Watson’s
Retirement Risk Management group, recently discussed how the current
environment—coupled with the recent actions taken by some large plan
sponsors—may affect how and when different de-risking strategies are viewed and
considered. They also discussed how some “hidden costs and hidden risks” facing
their defined benefit pension plans may help inform plan sponsors’ de-risking
strategies, moving forward.
PS: Are low interest rates and the underfunded status of
many plans affecting the way that plan sponsors view de-risking strategies?
Falzon: There’s little doubt that the funded status of DB
plans and the current low interest rate environment are impacting sponsors’
view of de-risking.
Funded status is the best indicator of the cost of the plan.
The lower the funded status, the more costly your plan is going to be. Funded
status is also an indicator of what types of de-risking activities are
available to a plan at any given time.
If you look back 10 years ago, many plans were extremely
well-funded—some even overfunded. At that time, there were unlimited
opportunities to de-risk but little desire. Ten years later, after plan
sponsors have weathered two serious economic downturns, we see many underfunded
plans where the cost is increasing. Desire to de-risk appears to be high, but
there may be fewer options for doing so with a plan that isn’t well-funded.
This catch-22 highlights the need for plan sponsors to look
at funded status volatility as a risk in its own right. It is impossible to
predict the future, and plan sponsors cannot assume that the economy will pick
up, interest rates will rise and funded status will improve.
Therefore, plan sponsors can refresh their strategic view of
the plan and go back to first principles. Determine what it is you are trying
to accomplish with your plan and how you can achieve those goals in light of
the macroeconomic environment and in a way that satisfies both the
organization’s strategic focus and the needs of the plan participants.
Opportunities for de-risking should be much clearer with that backdrop in mind.
PS: How have plan sponsors’ views of de-risking shifted over
the past 10 to 15 years? Does this influence the way they view their plans
Richards: Two periods of prolonged economic challenges in
the past 10 years are leading plan sponsors to alter their thinking around
de-risking. They understand that it is very difficult to predict when and how
the market will react. Furthermore, they understand they will experience
significant losses when the market is bad, regardless of the plan’s holdings.
This kind of economic pain in such a short period of time is
pushing plan sponsors to think about taking action, despite what some say is a
low market environment. Additionally, a combination of factors, such as lower
borrowing costs, improved business performance and major market movers, are
also leading plan sponsors to be more proactive.
At the same time, the rules have changed. The Pension
Protection Act of 2006 [PPA] dramatically altered funding requirements for
qualified DB pension plans. As a result, plan sponsors may now have to make
large contributions to their plans.
The combination of external economic forces and new
regulations is forcing plan sponsors to consider their de-risking options now,
despite low funded status and low interest rates.