Like it or not, CFOs frequently find themselves cast in the role of pension managers, dealing with a host of economic, regulatory, and environmental factors outside of their control. Faced with these variables, what decisions are finance chiefs making about their pension plans to manage risk and meet the financial needs of employees and retirees?

Funding choices are near the top of the list. For companies with defined-benefit (DB) pension plans, it’s an opportune time to retire funding shortfalls to avoid increases in costs. An increase in discount rates and positive equity markets raised the aggregate funding level of pension plans sponsored by S&P 1500 companies by 1%, to 83% funded status, according to Mercer numbers for September 2017.

But in a recent survey of 175 senior finance executives in the United States (conducted biennially by CFO Research in collaboration with Mercer), sponsors are not just relying on the math for help. Nearly three-quarters of respondents to the survey said they were either considering increasing their pension contributions (33%) or had already done so (40%), to reduce the premiums they pay to the Pension Benefit Guaranty Corporation (PBGC).

17Dec_FieldNotes_Fig1Steadily increasing levies imposed by the PBGC on unfunded, unvested benefits are a big motivator. Among respondents, 22% ranked PBGC premiums as most likely to cause their companies to modify their pension funding policies and practices over the next two years — second only to “expected market returns” (27%). (See Figure 1.) The benefit of bringing up funding levels is so great that more than one in five companies (22%) that are prefunding plans are borrowing to do so — an increase over prior years.

The prospect of lower federal corporate taxes also has survey respondents considering prefunding their DB plans in 2017 to a greater extent than they have in past years (42%) or contributing beyond the minimum amount they did in 2016 (35%). Overall, companies are funding their plans at higher levels than in 2015, the time of the last survey.

Closing Time?

In concert with the push to fund plans, many sponsors are weighing freeing themselves — partially or fully — of the obligation. DB plans remain active and intact in some industries, in some cases owing to a strong union presence. A majority of survey respondents (58%) reported having DB plans that were open and accruing benefits for all eligible employees.

But the number of open traditional pension plans offered by employers has been on the decline for years. A significant chunk of surveyed sponsors, 42%, said that their DB plans were either closed to new employees or in some stage of being frozen. Nearly half of respondents whose plans were open and accruing benefits for all eligible employees said that it was either “very likely” (27%) or “likely” (19%) that they would close their DB plans to new hires in the next two years. Slightly more than one-third of those respondents, 35%, planned to go further — closing their DB plans and freezing accruals for all employees.

For sponsors, developing a pension exit strategy involves designing a step-by-step process that requires changing asset allocations to lower risk as frozen plans move closer to termination. Plan sponsors also want to avoid volatility in their financial statements, which is why more than 8 in 10 respondents said they either have a “dynamic de-risking strategy in place” (42%) or “are currently considering one” (40%). Common de-risking maneuvers include employing liability-driven investment strategies, offering lump-sum payouts, and purchasing annuities.

17Dec_FieldNotes_CalloutAmong survey respondents using a dynamic de-risking strategy, a strong majority of those who either increased their DB plan’s allocation to fixed-income investments or adjusted the duration of fixed-income investments as a hedge against liabilities were satisfied with their actions (91% and 86%, respectively). More than half of all respondents (53%) said they were likely to increase their allocation of fixed-income investments in the next two years, almost the same proportion who said it was likely that they would adjust the duration of their fixed-income investments to match liabilities (50%).

Transferring the Risk

Successfully terminating a defined-benefit plan isn’t merely the outcome of a big decision; it’s the culmination of a carefully planned transition. Once a DB plan is frozen, its power to attract and retain workers is diminished. For the sponsor, it becomes a legacy obligation that weighs heavily on the balance sheet.

The careful question of whether, and when, to terminate it requires considering several factors: the cost of maintaining it (including PBGC premiums), the degree to which it is funded, and the price of purchasing an annuity to settle plan-related liabilities.

Why do it now? Besides the PBGC premium hikes, the proposed regulations updating mortality tables, scheduled to go into effect in 2018, will for most sponsors increase DB plan contribution budgets. That gives sponsors an incentive to, among other options, make lump-sum offers to former employees sooner rather than later. By making the offer, companies hope to transfer some pension liabilities off their books to plan participants.

Nearly 75% of survey respondents said they have already offered lump-sum payments to certain participants since 2012 — up from 59% two years ago. Almost 90% say they were satisfied with the result of offering those one-time payments. And more than 50% considered it likely that their companies would take some form of lump-sum risk-transfer action in the next couple of years — for many of those sponsors, this will be the second or third lump-sum offer they have made.

17Dec_FieldNotes_Fig2A significant number of sponsors surveyed have gone the other route — implementing an annuity buyout for some pension participants. In that kind of transaction, an insurer assumes responsibility for the sponsor’s retirement liabilities. Among survey respondents, more than half (55%) had either completed such an annuity buyout or were considering it. The vast majority of those buyouts, 81%, have been aimed at all retirees.

As survey respondents made clear, monitoring the many moving parts of a pension plan — from interest rates to mortality tables to equity markets — isn’t simple. Among survey respondents, 55% said they agreed that they “struggle to find the time and expertise required to fully meet [their] obligations related to overseeing the investment strategy of [their] organization’s pension plan.”

This stress that such planning puts on the time and expertise of internal staff has led more and more plan sponsors to delegate the execution of their investment strategies to outside experts. Ideally, such a service provider offers know-how, not only about investment strategies but also compliance concerns and other aspects of fiduciary oversight. More than half of survey respondents said their pension governance operates under an outsourced chief investment officer structure, with equal proportions doing so either “partly” (27%) or “fully” (26%). (See Figure 2, above.)

While outsourcing won’t suit every sponsor, it is evidence that the hard and “soft” costs of DB pension plans require a hard look from CFOs. The market performance so favorable to plan funding over the last two years won’t last forever.

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