De-Risking Rife and Not Going Away, Study Says

By John Iekel • March 05, 2018 • 0 Comments
Pension de-risking is increasingly widespread, according to a new a study commissioned by the Pension Benefit Guaranty Corporation (PBGC).    The study, conducted by Mercer at the PBGC Participant and Plan Sponsor Advocate’s request, also looks at the reasons behind de-risking. The results are included in the PBGC Participant and Plan Sponsor Advocate 2017 Annual Report.

“This overall de-risking trend is undeniable,” the PBGC says. It notes that “plan sponsors do understand the value that defined benefit plans bring to an organization,” but at the same time the merits of having a plan “in many cases are outweighed by financial volatility and the increasing costs of PBGC premiums.” The result, the study says, is plan sponsors considering de-risking activities.

Pursuing at least some steps to de-risk a pension plan is “extremely common” today, Mercer found — to the tune of an average of 86% of plan sponsors. It says that “decision makers in most organizations” likely are undertaking de-risking now, or are considering how they should do so. And not only is de-risking prevalent, the researchers report that there are no signs of its rise slowing.

More precisely, strong majorities of the plan sponsors the researchers studied were taking at least some de-risking steps. Regardless of industry sector:

Industry Sector             % of Plan Sponsors Taking
            At Least Some De-Risking Steps
Automobile/Industrial/Manufacturing                                    94
Health Care                                    92
Energy/Utilities                                    82
Food/Beverage/Consumer Package Goods                                    76
Financial Services/Real Estate                                    73

Why?

De-risking may be rife, but that doesn’t necessarily mean organizations are flip about it. The “decision to implement pension de-risking is not one made lightly,” the study says. But why are they taking the leap?

“Eliminating benefit obligations and participant headcount allows sponsors to capitalize on short term and ongoing savings while simultaneously reducing risk,” says the report. Mercer cites “a confluence of factors” explains the growing phenomenon, including:

  • the evolution of funding and accounting rules;

  • growth of liabilities as the pension system matures, which leads to an increase in plan size relative to the overall financials of sponsoring organizations;

  • volatile funded status, driven by falling interest rates and turbulent equity markets;

  • competitive pressures as other employers switch from DB plans to defined contribution plans;

  • PBGC premiums; and

  • the desire to stop offering a DB plan, which the researchers found is especially the case for frozen and closed plans.

The report goes into more detail about the role increasing PBGC premiums play. “These increases have served as a significant catalyst for de-risking, specifically via risk transfer activity. The increased PBGC premiums have ‘tilted the scales’ to make risk transfer look like a more cost-effective approach compared to in-plan solutions such as LDI,” it says.

Taking the Leap

The forms of risk reduction can be more broadly defined as out-of-plan de-risking, also known as risk transfer, and in-plan de-risking. These entail:

Risk transfer:
lump sum payouts, insurance contract buyouts, full plan termination

In-plan de-risking: liability-driven investment strategies, plan design changes, plan closure, plan freeze

Growth in risk transfer activity vastly outstrips the growth of in-plan de-risking solutions. This is an indication that plan sponsors are now more likely to remove obligations from their plans rather than maintain and manage liability and risk within their plans – leading to large numbers of liabilities and participants being transferred out of DB plans.

Mercer found that 55% of plans it studied consider a lump-sum based risk transfer likely or very likely in the next two years. Slightly more than that — 56% — of them consider it likely, if not very likely, that there will be a retiree annuity buyout.

Implications

The growth of risk transfer has implications beyond the plans and participants it directly affects. Among them, researchers say, are implications for governments and regulatory bodies. These include:

 An anti-selection problem. This refers to healthier plans eliminating their obligation and risk, which leaves larger shares of poorly funded plans in the DB system, increasing overall risk to the PBGC. 

Harm to the private DB system. The report says that de-risking reduces the overall size of the private pension system, which it argues can raise questions about its sustainability.

Exposing participants to additional risks. The rise of de-risking can expose participants to additional risks, including longevity risk and that of inadequate retirement income.

Potential change to how private pensions are insured. The report says that the rise of de-risking “represents a fundamental change to the dynamics of how private pensions are insured in the U.S.” This, it says, is because PBGC premiums are set by statute, but its financial projections generally are based on the pension landscape remaining relatively stable and do not anticipate future risk transfer activity.

“The exit of plans — either in full or in part — reduces future premiums and threatens to undermine the ongoing viability of the insurance program. Even worse, it is often plans that are well-funded that are more likely to fully terminate or implement risk transfer strategies, potentially leaving the PBGC to insure an increasingly unhealthy pension universe with a shrinking premium base,” warns the report. “Furthermore,” the report says, “a declining defined benefit universe threatens the very mission the PBGC was set out to accomplish.”





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