The Markets June 8, 2016

Current Environment Not Conducive to DB Plan De-Risking

Advisers to DB plans should consider how the market and funding relief have affected the attractiveness of de-risking.
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“We’ve been big proponents of derisking [pension plans], such as using LDI strategies that reduce risk as funded status rises,” says Tom Harvey, director of the Advisory Team within SEI’s Institutional group in Oaks, Pennsylvania.

However, he tells PLANSPONSOR that, depending on plan size, now is not the time for most defined benefit (DB) plan sponsors to de-risk or annuitize their plans.

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In a Q&A on SEI’s website, Harvey explains that “the goal of de-risking strategies is to minimize volatility between the investment asset pool and the pension liabilities, based on how pension liabilities are calculated for accounting and funding purposes. Reducing the swing between these two measures creates more certainty for both the projected funding gap and required contributions. Currently, these two measures—generally accepted accounting principles (GAAP) and Employee Retirement Income Security Act (ERISA) funding—have diverged. This has created an environment for most plan sponsors where surplus volatility against the liability doesn’t trigger additional contributions, thus reducing the value of the LDI strategy.”

Add to that new funding relief that lowers required contributions for DB plans, and Harvey says DB plans’ funding status is going down. “If plan sponsors haven’t been using LDI aggressively in the past, now is not time to do that or to annuitize because now they will have to pay an insurer more to move assets,” he says.

NEXT: Pursue greater returns

According to the Q&A, the current environment “allows plan sponsors pursuing return-oriented strategies to continue those strategies without the near-term potential of being required to make funding contributions.” Harvey tells PLANSPONSOR DB plan sponsors need to think more about other assets classes they may have been skittish about. It is a necessity to evaluate whether they need to bring in more equity—private equity, long/short strategies, or international funds. “They need to prop up returns without increasing overall plan volatility,” he says.                       

“In the current environment, a plan sponsor pursuing an LDI strategy most likely needs to make supporting discretionary contributions to the plan—and forego the benefits of deferred funding. For most plan sponsors, that may not be optimal, as there’s likely a better use of their capital than pension plan contributions,” the Q&A says. However, Harvey notes that SEI is not suggesting all plan sponsors need to unwind their LDI strategies. It depends on the size of the plan, the size of the plan liability relative to market capitalization of the plan sponsor, as well as the plan sponsor’s specific risk management goals.

“Most plans should have a combination of a degree of funded status at which they can afford to de-risk and a normalized interest rate environment on corporate bonds. When they see these triggers, they can jump to annuitize,” Harvey concludes.

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