Analysts Spot Shift in How Companies View Their Pension Funds

The conversations John Lowell has with plan sponsors today about their defined benefit pension plans are markedly different from past discussions. Many companies used to plan on eventually terminating their traditional pension plans. These days, Lowell, a Woodstock, Georgia-based partner in October Three Consulting, is apt to hear from companies focused on maintaining—and even expanding—their pension plans more strategically to find an approach that matches their company’s broader goals.

“There is no standard answer. That’s what I tell a lot of the younger people that I work with: ‘Don’t go in with an answer; go in with a bunch of questions and get ready to think,’” Lowell says. “Everything is potentially on the table.”

Pension funding has increased dramatically in recent years, to an average fully funded ratio of 99% this year, up from 77% in 2008 during the global financial crisis, according to Russell Investments’ calculations based on public company filings. Reflecting these gains, consultants and analysts see a shift in how pension funds and their potential surpluses are being managed. They also report a new appreciation for the range of options that can be considered when a plan is fully funded or is posting a surplus.

A Recent History of Volatility

Jared Gross, head of institutional portfolio strategy at J.P. Morgan Asset Management in New York City, says improvements in pension management helped lead to a range of new choices for companies to consider. Prior to the global financial crisis, Gross notes that many portfolios relied on core fixed-income investments as an anchor. However, that approach introduced a lot of volatility and risk when it was managed against very long-term liabilities. The volatility became evident first during the dot-com bust in 2001 and later during the global financial crisis of 2008 when interest rates fell quickly.

“Pension funds for most of the last two decades—even a little more than that—have experienced a rollercoaster ride of funded status,” Gross says. “That has, in turn, led to significant volatility for plan sponsors in terms of their balance sheets, in terms of their income statements, in terms of cash contributions, credit ratings, analyst scrutiny—you name it. … Some of the volatility was self-inflicted as a result of investment decisions.”

It also sparked a generally pessimistic view of defined benefit pension plans.

“That broad environment … created a sense of negativity and a certain amount of scar tissue among the decisionmakers of plan sponsors as to what they can do and should do with their pension plans,” Gross says.

Surplus Position Provides More Options

The same challenges, however, eventually led to new strategies for more effectively managing risk. Gross credits the current approach—better matching the bond portfolio to liabilities—one which generally requires more fixed income and longer-duration fixed income. At the same time, some companies seek to preserve investment return to allow the plan to become better funded over time, he adds.

Now, with many plan sponsors in a surplus position, there are additional tangible benefits. Gross points to a leveraging effect that allows the plan to not only stay fully funded, but to accelerate its funding strength. He sees growing pension funding levels leading to several options for plan sponsors, which include reopening the plan and using the defined benefit plan as the primary vehicle for delivering retirement income benefits to a company’s workforce.

Lowell also sees pension plan analysis focusing increasingly on individual companies’ preferences. Their goals range, he says, from some public companies that see the pension surplus as highly desired in reporting corporate earnings to others that are eyeing acquisitions and intend to apply their surplus to supplement the acquired company’s pension plan.

Justin Owens, based in Seattle as a Russell Investments senior director and co-head of total solutions, similarly says he is observing a shift in how companies regard their pension plans.

“Things have changed more dramatically than I’ve ever seen,” Owens says. “Instead of plan sponsors thinking, ‘We need to fully fund this plan and then just get rid of it,’ it’s been, ‘How can we make the best use of this fully funded plan?’”

Recently, Owens has had conversations with plan sponsors whose pension plans have large surpluses, prompting the companies to consider increasing benefits or reopening plans that had previously been closed or frozen.

While a rising-interest-rate environment may offer some additional attraction to those interested in terminating a plan, Owens sees that approach appealing mostly to small firms or to companies looking to initiate a selective pension risk transfer to offload a portion, particularly the benefits for participants with small balances. In addition, the possibility of federal legislation that could permit plans to allocate a pension fund surplus to a defined contribution plan means many pension plans prefer to maintain some flexibility going forward.

“It’s not the law yet, but just the possibility that that could exist in the future is an exciting consideration for plan sponsors,” Owens says. “It makes them start to think, ‘Maybe,’ rather than just getting … into what’s been called hibernation mode—maintaining a funded position with a very high allocation to fixed income. [They’re thinking,] ‘Maybe we introduce a little bit more return potential, so it opens up our options in the future.’”