DB Sponsors Focused on Managing Risk

Nearly two-thirds of respondents (63%) said they will more likely focus on reducing investment risk rather than seeking higher returns. Only 14% of plan sponsors place a greater focus on higher returns.   

To address investment risk, a better alignment of plan assets and liabilities (liability-driven investment) is the most favored strategy, chosen by 66% of respondents. Respondents are divided on the likelihood of using alternative risk strategies. Some plan sponsors will likely perform a liability redesign (40%) (e.g., changes in plan type or benefit formula), pursue long-term investment opportunities (44%), governance structure improvement (32%) or liability transfer (32%).  

According to the survey report, while a majority of respondents use various financial instruments to manage pension risk, no single instrument is used by a majority of companies. For instance, slightly fewer than 40% of plan sponsors use interest-rate swaps and futures, and about 30% use credit derivatives.   

However, more than a third of current users expect to further increase the use of interest-rate swaps, futures or option-based strategies. Some plan sponsors that are not currently using these financial instruments expect to adopt them in the future.  

Private equity is a prevalent part of asset portfolios for the majority of plans (62%). Other types of assets, including private real estate, private infrastructure, company stock and alpha-seeking strategies utilizing short selling or derivatives, have lesser prevalence in portfolios.  

According to the survey, four out of 10 large pension plans are significantly underfunded (less than 80%) on an accounting basis. Most of the rest are in the range of 81% to 100% funded.  

Plan sponsors are taking actions to reduce the size of DB obligations. Annuity purchases are not currently prevalent for settling DB obligations on a wholesale basis. However, more respondents expect their companies to take lump sum and annuity routes over the next two to five years.  

In the wake of the financial crisis, many pension sponsors are managing their plan contributions more tightly and are striving to achieve explicit funding targets. Specifically, fewer sponsors today (7% of plans versus 12% before the crisis) are contributing the maximum tax-deductible amount, and fewer sponsors (20% versus 26% before the crisis) aim to fully fund their plans. More plan sponsors (29% versus 21% before the crisis) choose to make the minimum required contributions.  

A growing number of sponsors are formalizing their funding policies. Only about 8% of sponsors make ad hoc funding decisions, down from 15% before the crisis. More sponsors (36% versus 26% before the crisis) choose to set explicit funding targets and contribute just enough to achieve them.  

DB Plans Will not Disappear  

The Towers Watson-Forbes Insights 2010 Pension Risk Survey shows that most sponsors of active DB plans will continue to provide retirement benefits, although many will cut back on benefits, and some are seeking to close or freeze their plans.  

More than half of the pension plans in the survey are active; 32% are closed to new hires, and 14% are frozen to all employees. The majority of plan sponsors expect open plans to stay open in the next five years. Nearly half (49%) of respondents with active DB plans say no changes are currently planned for their DB program. Twenty-nine percent said benefits accrual will continue for existing and new employees, but the benefit formula will likely changed or modified to reduce cost or risk. Fifteen percent of respondents said their companies are actively seeking alternatives to their DB plans for existing/new employees, and 1% their companies are actively seeking to terminate their DB plans.  

Among respondents with closed DB plans: 

• 47% said no significant changes are currently planned to the DB regarding existing/new employees; 
• 16% indicated accrual will continue in the DB plan for existing/new employees, but the benefit formula will likely be modified to reduce cost or risk; 
• 22% reported their company is actively seeking alternatives to its DB plan for existing/new employees; and 
• 7% said their company is actively seeking to terminate its DB plan. 

According to respondents, the impact of DB plans on cash flow tops all other concerns listed in the survey. Impacts of the DB plan on the income statement and balance sheet are ranked the second- and third-highest concerns, respectively. Following them are concerns about attraction and retention of workers, and conforming to regulatory requirements.  

More than half of respondents said the financial crisis has caused their DB plan to have a negative impact on their companies’ cash flows, financial statements, DB plan finances and long-term commitment to DB plans. Four out of 10 executives also noted that the crisis has increased employees’ appreciation of their DB plans.