Data & Research October 21, 2009

Employer Spending on Retirement Benefits Declining

Employers' investment in workers’ retirement benefits, measured by benefit values as a percentage of pay, has dropped consistently over the last decade, according to research by Watson Wyatt.

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A Watson Wyatt analysis of 183 employers found that the total value of retirement benefits (defined benefit (DB), defined contribution (DC), and retiree health care) provided to employees decreased from 7.8% of pay in 2002 to 6.9% of pay in 2008, according to a press release. For the 79 companies that maintained DB plans throughout this period, the value of the overall benefits declined from 9.4% to 8.6% of pay, mostly due to a significant cut in post-retirement health benefits.

In the same time period, the 61 companies that provided only a DC plan saw a small increase in overall benefits value—from 5.3% to 5.6% of pay—due to enhanced employer contributions.

The remaining 43 companies in the sample transitioned from DB to DC-only coverage between 2002 and 2008. Although these companies increased their DC benefit values by an average of 2.7%, this gain covered only approximately half of the DB value loss that was incurred by closing or freezing plans. For these companies, overall investment fell substantially, from 8.7% of pay in 2002 to 5.5% of pay in 2008.

“The tumult of the last decade, with its market bubbles and crashes, two recessions, rising health care expenses and compensation pressures, has caused employers to scramble to look for savings,” said Jim Shaddy, North America retirement practice director at Watson Wyatt. “As a result, a number of employers have pushed some of the risk and cost in their retirement plans onto employees’ shoulders.”

According to the announcement, an analysis of a larger data set of more than 600 companies found that some industries, such as manufacturing, transportation (including the airline sector) and communications, experienced declines greater than 30% in value of their retirement offering from 1998 to 2008. Other more profitable industries, such as chemicals, drugs and pharmaceuticals, had a smaller decrease in the same time frame.

The study report can be obtained from www.watsonwyatt.com/employercommitment. A free registration is required.

The Markets October 21, 2009

Callan Offers Lessons on Managing Risk

A new Callan report provides what is says are 10 lessons for managing risks and the next steps institutional investors may want to take.

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Looking back at prior financial crises, the first lesson offered by Callan is to assume liquidity is not there when you need it. Callan suggests that to prepare for the next liquidity crisis, investors should define their ongoing short to medium-term liquidity needs and budget for them accordingly. According to the paper, this process identifies the reliable sources of cash flow from investments (i.e., interest income, stock dividends, maturing high-grade paper) that do not depend on selling long-term capital at risk, like long-duration credits or equities.

Callan says this risk-budgeting exercise should be an integral part of a strategic asset allocation policy, and adjusted to reflect current market conditions. Defining one’s risk budget requires consideration of the investor’s liquidity needs and liability structure, and investors should not simply use someone else’s asset allocation as a benchmark.

The paper also points out that systemic equity risk is not diversifiable. “Given the inherent risk of systemic equity exposure, fund sponsors less able to endure such risk should consider strategically lower allocations to equities, however diversified,” the paper said.

Another key lesson from financial crises past is that rebalancing only works with liquidity. The paper points out that in the most recent market crisis, investors had to postpone or limit their rebalancing programs to avoid extraordinary costs until the needed liquidity returned. Callan noted that fiduciaries should document the decision to postpone rebalancing.

“Given the wildly divergent views on the economic outlook and their potentially volatile effects on market prices, adopting wider rebalancing ranges, however temporary, may be appropriate,” the paper said. Callan suggested investors consider rebalancing strategies using exchange-listed futures.

Other topics covered in the paper include leverage, securities lending, fixed income and bond portfolios, the illiquidity premium, hedge fund alpha, and CIO and Board decisions.

The report, “The Odyssey of Risk: Find your Compass,” can be downloaded from Callan’s home page, www.callan.com.

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