Providers Respond to DB Sponsors' Need for Risk Management

According to Aon’s Pension Risk Management Global Survey, respondents identified the following issues as the major risks facing DB pension plans:

• Interest rates (58%),
• Longevity (21%),
• Equity market (15%), and
• Inflation (6%).

Respondents also said longevity and equity market risk are the two risks that are most difficult to remove and the two most significant risks pension plans face globally.

The survey found that over the last few years, providers of financial services have responded to DB sponsors’ need for risk management by increasing the quantity and complexity of investment, insurance, and financial products for more effective pension risk management. Seventy-one percent of respondents said in the past 12 months they have provided solutions addressing interest rate risk, and 68% have provided solutions addressing equity market risk.

Fifty-nine percent said in the past 12 months they have provided solutions addressing credit risk, 51% inflation risk, and 20% longevity risk.

Over the next 12 months, respondents say they expect sponsors to seek to remove mainly interest rate (73%), inflation (60%), and equity market (54%) risks. Survey respondents also expect the greatest increase in demand from pension plans over the next three years for risk management of interest rates (56%), inflation (44%), equity market (44%), and longevity (37%).

According to the survey report, increasingly, plan sponsors are looking at the use of glide paths to reduce risks over time or when specific events occur. Seventy-one percent of respondents currently provide or will provide glide paths or trigger points to assist plan sponsors in managing pension risks. The most commonly used triggers include funded status, specific dates, equity market indices monitored daily, and bond market indices monitored daily.

Respondents said that in many cases, plan sponsors have not removed all pension plan risk for a number of reasons including insufficient current funding and lack of understanding of the risks.

They cited the most significant factors influencing DB pension plans’ ability to manage their overall risks over the next three years as:

• The knowledge and understanding of fiduciaries (e.g., trustees) and plan sponsors (23%);
• Strength of equity market performance (17%);
• Accounting or regulatory impact (e.g., moves to international accounting standards, which will increase balance sheet volatility and impact of pension plans on plan sponsors) (12%).

Global Differences

Equity market risk ranked greatest by U.S. respondents to Aon's Pension Risk Management Global Survey (70%), while interest rate risk ranked first by respondents in the UK (67%) and Canada (73%). U.S. respondents also said equity markets risk was the most challenging to manage, while respondents in the UK chose longevity, and Canada tied equity markets, inflation, and longevity as most challenging.

Among U.S. and Canadian respondents the two areas of risk management expected to be in greatest demand over next three years are interest rates and equity markets, while UK respondents chose longevity and inflation.

U.S. respondents said an increased desire to reduce funding and financial statement volatility (100%), improved funded status (100%), and the improved financial condition of plan sponsors (89%) will increase the demand for pension risk management.

In the U.S., the most popular approaches to managing equity risk are diversified funds of alternatives (86%) and portable alpha strategies (71%). Physical long duration bonds are the preferred approach to managing interest rate risk.

Aon said the survey results have reinforced three key guiding principles for pension plan sponsors:

• All plan sponsors should measure and monitor all risks being taken in managing their plans and make conscious decisions to take only those risks that are required and are expected to have positive results.
• Risk varies depending on plan design, plan maturity and funded position. A prudent course of action avoids micromanaging against average pension fund asset mix or median pension fund returns and, instead, sets asset mix and structure that suit specific plan design and individual needs.
• To manage all these risks effectively, sponsors must ensure that they and the plan fiduciaries (e.g., trustees) have solid skills and knowledge of risk management best practices, or else be required to delegate strategy implementation to managers and consultants.

The survey was conducted in November 2009, and survey respondents included 41 companies from the financial services industry, including investment managers, insurance companies, and investment banks. Sixty-seven percent of the respondents are multinational firms, and 66% have assets under management in excess of $50 billion.

The survey report is here.