Since 2010, the S&P 500 increased by over 200% but barely kept pace with defined benefit (DB) plan liability growth due to discount rates falling more than 250 basis points and longer life spans as reflected in a new mortality table, Vanguard notes in a report about its 2019 survey of pension sponsors.
It points out that pension plan sponsors also faced three revisions to the funding regulations introduced by the Pension Protection Act of 2006 (PPA), a quadrupling of Pension Benefit Guaranty Corporation (PBGC) premiums, and the growth of the pension risk-transfer business from approximately $1 billion per year to $25 billion per year. “These changes have caused plan sponsors to rethink the way they operate their pension plans, especially in the areas of plan design, asset allocation, investment policy, risk management and fiduciary partnerships, Vanguard says.
About one-third of plans are open and active (33%), frozen with no future benefit accruals (34%) and closed to new entrants (32%). Compared with 2010, significantly more pension plans are closed to new entrants and frozen to future benefit accruals in 2019, Vanguard found. However, the percentage of closed and frozen plans in 2019 is similar to that of 2015. The firm says this leveling off of the closing and freezing of pension plans shows that those plans that remained open and active following the global financial crisis, through the introduction of the more stringent funding and marked-to-market reporting requirements, and despite the increases in PBGC premiums are more likely to be dedicated to keeping that plan open in the future.
Nearly two-thirds of respondents stated they intend to make a change to their pension plan, but only 15% expect to make a plan design change where they would either close or freeze their pension plans. Nearly half of those surveyed are expected to execute a risk transfer, meaning they expect to purchase annuities for retirees, offer lump sums to terminated vested participants or terminate the plan. Reducing plan costs (68%), reducing the plan’s impact to the company’s financials (55%) and reducing cost volatility (52%) are the top reasons cited.
Thirty five percent of DB plan sponsors surveyed said their primary financial objective is minimizing volatility in plan contributions and funding ratio, while 30% said it is minimizing the long-term cost of the pension plan, and one-quarter reported it is obtaining full funding.
Investing to meet objectives
Given their concerns and objectives, Vanguard expected somewhat of a shift in their portfolios’ asset allocations from 2015, but this was not the case. The overall average asset allocation reported nearly mirrored that reported in Vanguard’s 2015 survey: 48% invested in equities, 39% in fixed income, 2% in cash, and 11% in alternatives such as hedge funds, private equities, and commodities. In the 2019 survey this shifted slightly to: 43% invested in equities, 38% in fixed income, 4% in cash, and 16% in alternatives.
In response to risk, Vanguard found DB plans are lengthening bond durations. The reported long-term bond allocation increased from 38% in 2015 to 44%, while the allocation to short- and intermediate-term bonds decreased by a similar percentage. Also, with respect to the fixed income sub-allocation, the corporate to Treasury allocation reported showed a slightly higher allocation to Treasury bonds than in 2015 (38% compared to 35%). Other Vanguard research has found that a long Treasury allocation of 20% to 35% combined with a long corporate allocation of 65% to 80% has the highest historical correlation and regression fit to the FTSE Pension Liability Index (FPLI).
The most common planned investment policy change was continuing to decrease the allocation to return-seeking assets, such as equity, and the increase of liability-hedging fixed income allocations.However, some providers in the DB plan market believe allocations to return-seeking assets should not be decreased but rather more diversified.
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