Consider the Market Before De-Risking DBs

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.

“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/.