Consider the Market Before De-Risking DBs

Market conditions like those seen in 2013 benefited those plan sponsors that had not yet moved to de-risk their defined benefit (DB) plans.

Milliman’s “2014 Pension Funding Study” found that during 2013, a 7.5% decrease in plan liabilities from higher discount rates and 9.9% average return on plan assets combined to produce a $198.3 billion improvement in the funded status deficit from year-end 2012. Plans with high allocations in equity investments came out as the big winners in 2013.

The study reveals not all DB plan sponsors adopted a liability-driven investing (LDI) strategy to de-risk their plans. Some continued to maintain an equity-heavy asset mix, awaiting a more opportune time to carry out de-risking. In 2013, say the authors of the study, that strategy paid off as equity investments surged and interest rates rose, giving those plans with a higher equity allocation a boost in funded status. The study also found DB plan sponsors that adopted an LDI strategy after 2009 have not seen much improvement in funded status as those plans that made use of more traditional asset allocation.

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“2013 was actually a very good year for taking risks, since the equities market offered such positive returns, Zorast Wadia, a principal and consulting actuary with Milliman in New York, and one of the authors of the study, tells PLANADVISER. “During 2013, there was obviously some rebalancing going on, with plan sponsors trying to make their liabilities less volatile. We saw the effect of that rebalancing in that fixed income did poorly in 2013.”

The rise in interest rates during 2013 definitely impacted DB plans’ decisionmaking process on whether or not to de-risk, says Wadia. “Plans were hesitant to de-risk because risks, in terms of equity investments, were actually being rewarded, while the value of fixed income investments was dropping.”

When to De-Risk 

However, Wadia says now may be a good time to de-risk, with the funded status of plans having improved to a level that is better than those seen since the onset of the 2008 financial crisis. He points to 18 companies studied by Milliman that are already at surplus funding levels. 

In addition, he says, DB plan sponsors need to keep in mind that Pension Benefit Guaranty Corporation (PBGC) premium rates will be increasing in the near future. “Plans can lower their rates by increasing their funded status,” he says. 

In addition, new life expectancy tables released by the Society of Actuaries, still being reviewed by the Internal Revenue Service, will probably be approved and adopted in the near future, says Wadia. Once they are, this will probably mean liability increases for plans, since people living longer lives means their pension payments will have to be paid over a longer period of time. 

As for what DB plan sponsors should be doing to improve their plan’s funded status, Wadia says, “A company’s strategy depends on their plan’s current funded status and their ultimate funded status goal.” DB plan sponsors need to ask over what time period they want to achieve this goal, as well as how much risk they want to undertake. Wadia explains, “For some plans, a glide path strategy could be useful, with investments gradually transitioning from equities to fixed income. Sponsors also need to factor in their comfort level within the equity space. And if the plan is underfunded, sponsors may want to pursue downside risk protection.” 

For DB plans that have surplus funding, what plan sponsors need to do is to remove the possibilities of funding deficits in the future, says Wadia. For those plans that currently have 110% or higher in terms of funded status, sponsors may want to investigate a lock-in strategy, he says. This allows companies to maintain an ongoing plan, which can have its advantages, especially with regard to employer contributions, giving companies a longer time period over which to pay these employer contributions, compared with a more condensed time frame called for in defined contribution plans. 

The results of the study are based on the pension plan accounting information disclosed in the footnotes to the companies’ Form 10-K annual reports for the 2013 fiscal year and for previous fiscal years. These figures represent the generally accepted accounting principles (GAAP) accounting information that public companies are required to report as per standards from the Financial Accounting Standards Board.

The study report is at http://us.milliman.com/PFS/.

DC Participants Less Active Traders in March

March was a light trading month for defined contribution (DC) plan participants, according to Aon Hewitt’s 401(k) Index.

The index found the overall daily transfer volume in March averaged 0.021% of the total daily balances, slightly lower than February’s value of 0.023%. In addition, there were zero days in March with above normal transfer activity levels, marking the first month of zero above normal trading days since August 2013. Total transfer activity across the index was low, at $244 million (0.15%).

In this context, the normal levels are defined by the index as when the net daily movement of participants’ balances, as a percent of total 401(k) balances within the index, equals between 0.3 times and 1.5 times the average daily net activity of the preceding 12 months.

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When DC participants did trade in March, they favored fixed income funds. Fifty-seven percent of trading days were fixed income oriented. Overall, net transfer activity moved away from diversified equities (equity assets excluding company stock) by $160 million (0.10%).

The asset classes that experienced net inflows during March include premixed portfolio funds, with gains of $70 million (29%), and bond funds with a gain of $36 million (15%). Next in line were international funds, with $29 million (12%) of the monthly inflows, and small cap U.S. equity funds received $23 million (10%). Company stock funds again lead the net outflow activity, with $208 million (86%) transferring out, followed by GIC/stable value funds, with $13 million (6%), and money market funds, with $12 million (5%) transferring out.

On average, participants’ overall equity allocation remained at 65.5% at the end of March, unchanged from the value in February. Employee discretionary contributions to equities, another measure of participant sentiment, were also virtually unchanged at 66.6%, compared to 66.5% in February.

Aon Hewitt noted that emerging equity markets outperformed the developed equity markets during March. The MSCI Emerging Markets Index posted strong performance for the second consecutive month, returning 3.1% during March on top of its 3.3% gain in February. Equities, both U.S. and non-U.S., also had positive performance as the S&P 500 Index returned 0.8% and the MSCI All Country World ex-U.S. Index gained 0.3%. The fixed income markets, as measured by the Barclays U.S. Aggregate Index, decreased by 0.2% during March.

For the first quarter of 2014, $393 million total net transfer activity moved into diversified equities. As a percentage of total participant balances, the quarter totaled 0.25%.

During the first quarter, the S&P 500 Index hit a series of record closing highs and posted a return of 1.8%. Non-U.S. equities, as measured by the MSCI All Country World ex-U.S. Index, also delivered positive performance over the first three months of the year, gaining 0.5%. Two consecutive months of positive performance for the MSCI Emerging Markets Index were not enough offset the rough start it had in January, with the MSCI Index having an overall return of -0.4% during the quarter. The Barclays Capital Aggregate Bond Index returned 1.8% during the quarter, as the yield on the 10-year Treasury fell by more than 25 basis points.

More information about the March results for the Aon Hewitt 401(k) Index can be found here.

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