Capital Markets

Better Safe Than Underfunded

Some pension sponsors are hitching their investments to actual liabilities rather than to dreams of huge returns.
David KatzJune 1, 2008

Rather than chase big gains in the stock market, a new study finds, many corporate sponsors of traditional pension plans are adopting a lower-risk strategy of pursuing returns that match plan liabilities.

For years, companies have taken their cue from bull markets, hitching pension-plan assets to Wall Street’s tail. Now, however, some are resetting their investment targets to “market-based liabilities,” says pension-investment consultant Paul Morgan, rather than “an expected return of 8 percent” or thereabouts.

Pension actuarial firm Milliman Inc. reports that companies are moving toward a more bond-based strategy. The percentage of pension-plan assets invested in stocks dropped from 60 percent to 55 percent during 2007, representing a shift of almost $60 billion worth of plan assets from equities into fixed-income and other investments, according to the firm’s study of the 100 U.S. public companies with the biggest defined-benefit pension assets. Indeed, $60 billion seems to be something of a magic number, since that was about how much the pension plans of those same companies gained on stock investments in 2007, and subsequently lost in the single month of January 2008.

The big switch from equity to fixed income represents a shift in thinking among a fair chunk of big corporations to a liability-driven investment attack for their pension plans, which seeks to curb the future volatility of their funded status, according to Milliman consultants. One motivation may be a Financial Accounting Standards Board requirement, begun last year under Financial Accounting Standard No. 158 (Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans), that requires plan sponsors to put the pensions’ funded status (assets minus liabilities) on the sponsors’ balance sheet.

Also fueling the movement toward liability matching may be the Pension Protection Act of 2006, which cut the number of years over which pensions can “smooth” their results.

The trend has legs, experts say. “These are not tactical shifts,” says Morgan, who is also the director of capital markets and modeling for Evaluation Associates, a company owned by Milliman. “We believe these trends are permanent.”

Ironically, the Pension Benefit Guaranty Corp., the nation’s pension insurer, announced in February that it was making a big shift from bonds to stocks. “PBGC is moving in an opposite direction, but toward the same point” that corporate plan sponsors are, says John Ehrhardt, a Milliman consulting actuary, who explains that the pension insurer’s equities allocation has been extremely low for years.

The 100 largest corporate pension plans moved away from equities in 2007