Corporations will continue to transfer risk from their defined benefit pension plans in 2016, a trend that was very popular in 2015.
“Meager investment returns and low interest rates made 2015 a challenging year for many defined benefit plans, with funded status rising only modestly. Many plan sponsors took proactive steps to reduce their liability through lump sum offerings and some major annuity buyout transactions,” says Matt McDaniel, U.S. head of defined benefit risk at Mercer. “Looking ahead, we believe the path to improvement will be through taking actions when opportunities present themselves, and not waiting for a slow melt up in markets and rates.”
On the investment side, most plan sponsors aren’t fully terminating their DB plans but whittling away at the liabilities through risk transfer.
“They are looking closely at what the right level of investment risk is to be taking,” he says.
Mercer recommends that DB plan sponsors prepare for opportunities in 2016. As pricing volatility continues into the New Year, plan sponsors have the “potential to materially improve their outcomes if they are able to take advantage of attractive terms when they appear,” the company said in its 2016 outlook for DB plans.
To do that, they should consider doing the prep work in advance, making sure all employee accounts are clean, so that if a market opportunity arises, they are ready to take advantage of it immediately.
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“Sitting back and hoping for the best is not the best investment strategy. Having a better strategy and timeline of how to get there really is important,” McDaniel says.
Plan sponsors should also figure out if it would benefit their plan to borrow money to fund it.
“The cost to maintain an underfunded pension plan has risen due to increases in the PBGC Variable Rate Premium due to the passage of the Bipartisan Budget Act of 2015,” Mercer said in a statement. “By 2019, the VRP is anticipated to be 4.4% of the unfunded liability. In today’s low interest rate environment, accelerating the funding of pension debt (along with reducing or eliminating the VRP) may increase overall economic value.”
Plan sponsors need to take the time to plan for where they would like their pension plan to end up, says McDaniel. That could mean freezing it or taking measures to make sure the plan still exists when the last retiree stops taking benefits 30 years down the road.
If a plan expects it might want to terminate someday, it needs to move in that direction. That means “taking steps to coordinate their investment strategy with the plan’s liabilities. Long maturity bonds are the best liability match and lowest-risk investment for most DB plans, so there can be a natural progression of increasing a plan’s allocation to long bonds as funded status improves,” the company said.
Mercer recommends that plan sponsors consider increasing growth asset allocation to improve long-term asset growth, which it points out could create some “short-term risks because of the higher level of funded status volatility, which can present larger balance sheet swings, more material declines in funded status, and potentially higher cash funding requirements.”
The extension of funding relief in the budget act could temper the short-term volatility on cash funding, allowing time for investment risk to earn positive results, Mercer says.
Paula Aven Gladych is a freelance writer based in Denver.
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