DB Risk Management Increasingly Focused on Liabilities

Plan sponsors of the largest U.S. defined benefit (DB) pension plans are deepening their risk-management focus on plan liabilities.  

According to the 2012 MetLife U.S. Pension Risk Behavior Index (PBRI) Study, DB plans are also increasingly viewing plan assets in the context of liabilities.

The rankings of the most important risk factors in the 2012 U.S. PRBI Study are very close to those of the 2011 results, indicating that plan sponsors are holding true to a core set of risk factors. The top four risk factors—underfunding of liabilities, asset & liability mismatch, asset allocation and meeting return goals—are identical to the 2011 rankings. In addition, the relative importance rankings for eight of the 18 risk items remained unchanged from 2011.   

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The 2012 Index value is 85 out of 100, its highest level to date, up from 81 in 2011. Data from the survey is used to calibrate the importance that the companies surveyed ascribe to managing each of the 18 risk factors, their reported success at implementing comprehensive practices to manage each risk and the consistency between the two. Ideally, there should be consistency over time between the level of importance that plan sponsors ascribe to certain risks and how successfully they believe they are managing them. The increased index value demonstrates that consistency between importance and success has improved.   

The increase in the index value is also indicative of the sustained level of engagement plan sponsors have with risk management, and that plan sponsors are developing some commitment to a new course of risk management.

“There is a heightened interest among plan sponsors and senior finance executives in gaining a better understanding of the pension plan environment and its relationship to the overall financial performance of their business,” said Cynthia Mallett, vice president, Corporate Benefit Funding, MetLife. “What has become clear over the past several years is that managing pension liabilities can be a difficult challenge for even the most sophisticated financial executive. Because plan sponsors can’t rely on traditional asset allocation models to ensure they can meet their liabilities, what is emerging are more integrated pension risk management frameworks that are carefully devised and frequently reviewed.”

 

Measuring Success  

In 2012, the self-reported successful management of pension risks is at its highest level in the four year history of the U.S. PRBI Study.  Among the 18 risk factors presented to plan sponsors in the study, 83% of all ratings indicated success (i.e. plan sponsors rated them a 4 or a 5, with 5 equaling highest success), compared to 75% in 2009, the first year the study was conducted. Liability measurement retained its position as the most successfully managed risk for the third year in a row, indicating that plan sponsors feel comfortable with their liability valuations and understand the drivers that contribute to their plan’s liabilities.   

Despite high success ratings overall, some risks continue to present challenges for plan sponsors. Underfunding of liabilities and asset & liability mismatch—the top two risks by importance—are ranked 11th and 12th in reported success, respectively, consistent with the 2011 results.   

“We believe that the economic and regulatory environment will sustain a more prudent and integrated approach to funding strategies, investment policy decisions and de-risking activity among plan sponsors.” Mallett added.   

The 2012 U.S. PRBI Study, which surveyed 156 corporate plan sponsors, measures plan sponsors’ aptitude for managing—and attitudes about—18 investment, liability and business risks to which their plans are exposed. A full copy of the report can be downloaded at http://www.metlife.com/pensionrisk.

 

Funding Shortfalls Increase for Largest Pensions

Liabilities still outpaced the growth in assets for the 16 publicly listed U.S. corporations with pension liabilities of more than $20 billion, according to an analysis conducted by Russell Investments.

The group that represents nearly 40% of the pension assets and liabilities of all U.S. listed corporations now has a combined shortfall of worldwide pension assets below liabilities of $173 billion on their balance sheets, up from $121 billion last year.  

According to Bob Collie, chief research strategist, Americas Institutional, at Russell Investments, the single largest cause of this deterioration in the funding position was a decrease in the discount rate used to value future benefit payments, causing a higher value to be placed on liabilities.  

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To help eliminate some of this shortfall and to satisfy the requirements built into the Pension Protection Act of 2006, cash contributions are expected to be sizeable not only in 2012, but in subsequent years. While the contributions made by these 16 corporations from 2005 to 2011 totaled $114 billion, after incorporating the shortfall at the end of 2011 to the cost of new benefit accruals expected over the next seven years, the total over the next seven years may well be closer to $250 billion.  

“Pension risk matters a great deal. Both interest rates and asset values can change quickly, so it’s a very fluid situation,” Collie said. “But unless market conditions prove exceptionally favorable, we are likely to see sponsoring corporations continuing to make significant contributions for several years to come.”

The responses to this challenge that are recommended by Russell include de-risking, diversifying and focusing on total portfolio outcomes via multi-asset portfolios.  

A copy of the research is available at http://www.russell.com/Institutional/research_commentary/shortfalls-20-billion-club.asp.

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