Nearly Half of Corporate Pensions Considering Lump-Sum Payouts

While a majority of plan sponsors are hedging interest rate exposure using LDI strategies, many are also turning to lump-sum distributions to reduce the absolute size of pension liability, a survey found.

Following U.S. lawmakers’ move to increase the variable rate premiums charged by the Pension Benefit Guaranty Corporation (PBGC), nearly half of America’s pension plans are considering lump-sum payouts. 

This is according to the 2016 Defined Benefit Plan Trends Survey by investment consulting firm NEPC.

For those plan sponsors considering other risk reduction measures, 27% said they plan to issue annuities. Twenty-five percent are considering higher contributions. Thirty-nine percent of respondents weren’t planning any changes at the time the survey was taken.

“The real game changer was what occurred at the end of last year with the PBGC rate premium decision, and plan sponsors have been scrambling on what to do ever since,” observes Brad Smith, partner in NEPC’s Corporate Practice. “Our expectation is that this anxiety about the rate premiums will continue, regardless of who is in the White House. We continue to advise clients on best approaches to improve or maintain their funded status in a low-yield environment, even with a slight rate increase expected before the end of the year.”

As projected, longevity increases are affecting pension funding. In 2016, the number of defined benefit plans with a funded status less than 80% increased to 28%, from 21% in 2015. Forty-three percent of plans have a funded status of at least 90%.

Thirty-four percent of respondents considered issuing debt to improve funded status; 47% of these plans have a funded status of less than 80%.  

The firm also points out that while a majority of plan sponsors (69%) are hedging interest rate exposure using liability driven investing (LDI) strategies, many are also taking action to reduce the absolute size of the sponsor’s pension liability by offering lump sum distributions to participants. The 38% of plans not pursuing LDI say they are waiting for interest rates to rise (34%) or are maintaining a total return approach as the plan remains open (29%).

In the past six years, plan sponsors using LDI have materially increased their LDI allocations—36% have an allocation greater than 50% or more today, versus nine percent in 2011, the survey finds.

The firm also discovered that Treasury STRIPs and other zero-coupon bonds are standing out among LDI strategies gaining popularity. Forty-five percent of funds that allocate to LDI invest in these products, versus just 10% in 2012. Long-duration government/credit bonds are the most popular LDI investment, with 62% of LDI investors using them today versus 46% in 2012.

“The only lever plan sponsors have to pull is to try and shrink the size of their liability and many still stand pat,” Smith warns. “If you look at this issue through the lens of the interest rates story, you’ll see that those plan sponsors who rejected an LDI approach as they waited for rates to rise, saw their DB plans suffer. And they’re still waiting for that entry point as equity markets continue to perform well.”

The NEPC concluded that alternative investment strategies still remain in favor, with 79% of respondents expecting to maintain their current allocation to private equity and hedge fund managers, among other opportunities. The results also show that of those plans invested in alternatives, 37% allocated between 10-25%, and eight percent allocated between 25-50% of assets.

Other key findings include: 

  • 51% of plan sponsors have a bullish outlook on the stock market for the next 12 months, while 49% are bearish. 
  • Legislative/actuarial changes to liability valuations are the greatest concern followed by low interest rate and return environment. 
  • Double-digit equity returns were not enough to stem the negative impact that lower discount rates had on pension plans.