DB Plan Sponsors more Concerned with Risk than Returns

February 24, 2011 (PLANSPONSOR.com) – Defined benefit plan sponsors appear more concerned about risk and plan costs than returns, according to a new Vanguard survey.

Eighty-five percent of respondents rated pension risk as “very” or “extremely” important. The importance of risk increased with a plan’s asset size relative to company size, according to a press release.   

The two risk concerns most cited by plan sponsors were interest rate risk (85%) and uncertainty in the equity markets (nearly 80%).   

The survey found DB sponsors are managing risk by making changes to plan design and investment strategy. A majority of respondents said they intended to “derisk” their plan by implementing liability-driven investing (LDI) strategies, increasing their portfolio’s fixed income allocation and duration, and decreasing their equity allocation.   

Perceptions of risk influence sponsors’ decisions, Vanguard said. Respondents who rated their plans as more risky were more likely to make changes to investment strategies to include LDI and dynamic asset allocation. They were also more likely to alter plan design, such as freezing or terminating the plan or making benefit changes.   

Sponsors recognize that minimizing risks through asset management can help control the volatility of plan costs. For instance, 81% of respondents manage assets to control the impact on company financials and 72% change asset allocation based on funding level, a liability-driven approach to asset management that affects pension plan cost volatility. In contrast, only 56% were focused on meeting a return hurdle.   

Compared with historical pension plan asset allocations, respondents’ equity allocations have declined dramatically and bond allocations have increased to attempt to match assets to liabilities.

Many Loyal to DB  

Over the past two decades, the number of open and active defined benefit plans has declined substantially. The new Vanguard survey results reflect this trend, with 40% of all plans in the survey already frozen or set to be frozen over the next several years.   

Still, a significant number of respondents (42%) expect to keep their plan open and active over the next few years.  Most reported that they have kept the plan open because employees value the benefit; the next most-cited reason was a desire to provide a secure retirement for employees. Of the entire group with open and active plans, 33% of respondents expect to make changes at some point.   

Eighty-nine percent of all respondents reported that their plans are underfunded. Mid-sized plans were the most underfunded, with four in 10 reporting funding status below 80%—generally the level at which a plan is considered “at risk” and thus subject to accelerated funding requirements. 

Vanguard conducted the survey in the summer of 2010. Nearly 160 pension plan sponsors responded to the survey, primarily representing mid-sized plans. A majority (63%) of the respondents’ plans were open and active at the time of the survey.