As companies still fortunate enough to offer pension programs have recently been focusing on cutting the risks that impact their corporate balance sheets, human resources firm Mercer offers 10 tips that plan sponsors should keep in mind for their defined-benefit plans in the new year.
Use interest triggers and fund status triggers to de-risk glide-paths. Given the tightening by the Federal Reserve in 2014, more plan sponsors are expected to adopt triggers based on funded status as well as interest rate triggers for their glide-paths. With these in place, plan sponsors can lock in interest rate increases as they happen. For plan sponsors that anticipate cutting their pension plans by a certain time, they are now using time-based triggers.
Evaluate the ideal liability-driven investment levels. If a pension plan has considerable allocation to liability hedging assets in its portfolio, the plan sponsor should determine if the bond benchmarks fit the liability characteristics. In the next year, more plans are expected to set the benchmark to the plan liabilities.
Use interest-rate derivatives. For pension plans with LDI, they have heightened their exposure to liability hedging assets now that funded status has improved. Despite this, physical securities are not necessarily enough to manage interest rate risk. They could even be an inefficient use of capital, and Mercer anticipates seeing more plan sponsors using derivatives.
Optimize growth assets. When de-risking is used to lessen the allocation to growth assets, the expected return on assets also drops. Risk can be reduced without lowering returns by adding asset classes and other investments besides equities. With a diversified growth portfolio, the risk level is up to a one-third lower than a portfolio with only equities.
Determine if a completion manager is appropriate for the plan. When a plan creates its LDI strategy, it goes from using long-bond benchmarks to evaluating based on its own liabilities, which can include identifying interest rate durations to better meet liability cash flows. This fills in possible gaps that are ignored during duration matching strategies.
Consider accelerating contributions. As allowed by MAP-21, many plans fund at lower levels, but they are also making discretionary contributions to enhance the pension plans funded status. This is particularly true for a de-risking glide-paths with funded statuses under the first trigger point. By accelerating contributions, plan sponsors can cut their PBGC variable rate premiums for an effective return of approximately 2% to these assets.
More looking to pension surplus planning. As plans funded statuses have grown, more plan sponsors are facing surplus management, which can be managed by integrating underfunded plans into overfunded plans.
Confirm governance structures. After choosing a strategy, a plan sponsor should decide on the proper implementation approach. To meet implementation objectives, the strategy needs integrated governance structures. This is often outsourced to a third party, particularly among plan sponsors sparse on resources.
Examine financial benefits of a cash out. In 2015, PBGC premiums are estimated to increase to $57 per participant, and that figure jumps to $67 in 2016. These numbers are significant increases over 2014s $49 per participant. With these large increases, next year could be the right time to cash out terminated vested participants. This keeps plan sponsors for paying these annual premiums for the entirety of these participants lives. New mortality tables are also projected to increase liabilities by 2%-3%, and cashing out before these tables are in play could also help save on cost.
Consider purchasing an annuity. For the average retiree group, purchasing an annuity could be about the same cost as keeping the participants in the plan. According to the Mercer U.S. Pension Buyout Index, buying annuities for a retiree group from an insurer takes up 108.3% of a typical balance sheet liability as opposed to 108.2% for holding liabilities in the plan with an allowance for future retention costs and a reserve for gains in life expectancy.
