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Eschewing Pension Risk

Pension risk transfer is firmly entrenched, and for a variety of reasons. Some recent analyses offer their perspectives on the practice.

“For several decades, corporate America had been looking for ways to shed the increasing costs and performance risk of sponsoring traditional, defined-benefit pension plans,” writes Chris Schmidt in CFO. He notes that freezing plans had been popular as a way to control those costs, but that did not alleviate lingering responsibility for the benefits that already had accrued and the plans from which they were distributed.

Schmidt notes that freezing plans had been popular as a way to control those plan costs, but that did not alleviate lingering responsibility for the benefits that already had accrued and the plans from which they were distributed.

The answer, to a growing number of employers, is de-risking. In a study CFO recently conducted with Prudential Financial, almost half of the senior finance executives surveyed reported that their companies have transferred their pension risk. Mercer in “Step by Step: Managing Pension Risk, This Year and Next” reports similar findings. It says that 42% of the respondents in a survey of plan sponsors it conducted with CFO reported that they have a dynamic de-risking strategy, and another 40% do not have such a strategy but are considering putting one in place.

And if costs alone are not enough, there are additional factors driving employers to de-risk, as well.

Low Interest Rates

Low interest rates may be good news for some parts of the economy, but they complicate pension plan managers’ efforts to match assets and liabilities, says Mercer. Among the effects: worsening underfunding and heightening liabilities.

Premium Pressure

Premiums charged by the Pension Benefit Guaranty Corporation (PBGC) serve as an additional catalyst to de-risk, Prudential Financial Senior Vice President and actuary Peggy McDonald told Chief Investment Officer. Not only are fixed-rate premiums increasing yearly (at least through 2019), plan sponsors also must pay a variable rate premium — a percentage of their unfunded liabilities — and those premium rates are rising as well. Those rates matter, McDonald indicates, because some plan sponsors are more likely to pursue a pension or risk transfer for those with small balances, since they may conclude it is not worth it to pay an amount in PBGC premiums that could be equal to the annual benefits paid to some individuals.

CFO’s survey bears McDonald out. The senior finance executives who said in its study that their companies had completed a risk transfer cited increasing PBGC premiums as one of the reasons they took that step. Not only that, says Schmidt, “A common annuity purchase strategy is to target liabilities for retirees first, since they’re the least expensive group to annuitize, and to then focus on retirees who are receiving low monthly payments. Because PBGC premiums are charged on a per-capita basis, rather than on the amount of the benefit, significant pension risk can be mitigated by annuitizing retirees who receive small benefits.”

Selected Approaches

Among the companies that have been pursuing de-risking is International Paper, which began doing so well over a decade ago. Chief Investment Officer reports that when the company closed its pension plan to new entrants in 2004, it began the process. And ice is encasing the plan more and more — on New Year’s Eve 2018, the plan will be frozen for current employees, too. International Paper isn’t stopping there, either — it has a voluntary team-vested buyout program, which last year resulted in the plan size shrinking 10%. Prudential will officially begin making benefit payments to some of International Paper’s retirees on Jan. 1, 2018.

International Paper, according to slides it provided to Chief Investment Officer, and DTE Energy, according to Mercer, share some risk reduction approaches. For instance, they both look to hedging strategies as well as broadening their investment strategies.

International Paper and DTE, differ, however, regarding fixed income investments; the former plans to reallocate current fixed income investments to longer-duration maturities, while the latter pursues adding more fixed income investments. The stance of FedEx, which has pension plan assets of $24 billion, regarding fixed income investments is similar to DTE Energy’s; according to Mercer, it has doubled such investments in the last six years.