Administration October 13, 2008

Many Sponsors Still Shy about Using Derivatives

October 13, 2008 (PLANSPONSOR.com) - A quarter of plan sponsors who don't use derivatives as a risk-management tool show a lack of understanding of how the derivatives can be used to fulfill their fiduciary responsibility to hedge asset risks, according to a new report.
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The report, “Pension Risk Management: Derivatives, Fiduciary Duty and Process”, said respondents to a survey conducted by Pension Governance LLP and the Society of Actuaries found that plan sponsors that shied away from derivatives also cited   Perception of Excess Risk (31%); Considered Too Complex (23%); Prohibition Against Possible Leverage (19%); and/or “Defined Benefit Plan Risk Not Considered Significant” (28%).

According to the survey, larger plans are more likely to use derivatives than their smaller counterparts. Some 39% of users managed plans larger than $5 billion versus 14% of non-users at plans larger than $5 billion.

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While respondents seemed to be doing a good risk management job, the study found, there was more room for improvement.

“In answering broad questions, a majority of surveyed plan sponsors describe themselves as doing all the right things to manage investment, fiduciary and liability risks,” the study said. “However, answers to subsequent questions – those that query further about risk procedures and policies at a detailed level – do not support the notion that pension risk management is being addressed on a comprehensive basis by all plans represented in the survey sample. “

The news release said the survey results also included:

  • A majority of derivatives users (64%) and non-users (48%) have had discussions about the concept of a fiduciary duty to hedge asset-related risks. A smaller number say they have discussed the concept of a fiduciary duty to hedge liability-related risks.
  • When asked if their organization has or is planning to hire a Chief Risk Officer, 57% (64%) of users (non-users) answered "No."
  • Defined benefit plan design does not appear to be a looming priority, with 68% (58%) of users (non-users) answering "No" when asked if changes are imminent.
  • Fifty-two percent (57%) of users (non-users) say they review external money managers' valuation policies.
  • Sixty-eight percent (61%) of users (non-users) include questions about the use of derivatives and risk management as part of the Request for Proposal (RFP) process.
  • Survey respondents seem to rely mainly on elementary tools to measure risk. Eighty-three percent (64%) of users (non-users) rank Standard Deviation first in importance. Seventy-nine percent (63%) of users (non-users) rank Correlation second.

A total of 162 retirement plan decisionmakers in the United States and Canada were respondents. The full report is available here .

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