By Cyril Tuohy
Financial engineering and alternative investment approaches are out of favor compared with basic, sound fixed-income and “plain vanilla” risk transfer strategies as senior executives and pension managers move to shore up their pension plans.
To hear John Merino, corporate vice president and chief accounting officer at FedEx tell it, the company has improved the asset side of its defined benefit pension plan obligations with “much more fixed-income concentration and fixed-income investment that match the duration of our liabilities.”
Then there’s Bruce Swain, chief financial officer and senior vice president of the insurance claims management company Crawford & Co., who talks about the importance of a “glide path” as a means of leaving underfunding and pension volatility in the rearview mirror.
“We think of our strategy as a glide path, in that it systematically reduces our investment in equities, or risk-bearing assets, over time and converts them into fixed-income investment and hedging assets,” Swain said. “Those better match the underlying pension liabilities that we’ve got.”
Or how about Bill Gieseker, controller at Greyhound Lines, echoing Swain’s comments about striking an optimum glide path for his company’s defined benefit pension recipients.
“If you don’t have a glide path that will tell you when to move into liability-driven investments, the temptation will be to delay as the markets improve,” Gieseker said. Liability-driven investment strategies gradually move in a direction in which all future and current liabilities are paid for by stable, fixed-income portfolios.
All three executives are among those cited in a recent report titled “Evolving Pension Risk Strategies: The Journey to Risk Transfer and Outcomes-Based Objectives,” issued by CFO Research in conjunction with the consulting firm Mercer.
The analysis – an update to a similar survey conducted in 2011 – looks at the steps companies have made in managing defined benefit plans and their paths forward. Glide paths govern how plan sponsors change their asset allocations following defined parameters, not unlike target-date mutual funds.
“This year’s survey confirms what we have seen in working with our clients: continued support for risk management strategies such as dynamic de-risking and, more recently, increased plan sponsor interest in risk transfer opportunities,” Jonathan Barry, partner with Mercer, said in an introduction to the report.
More than two-thirds of respondents, (67 percent) are somewhat or very likely to offer cash buyouts to former employees, and nearly half (48 percent) are somewhat or very likely to transfer liability to a third party – an insurance company, for instance – via an annuity purchase over the next two years, the survey found.
As much as $100 billion worth of annuity purchases could be made by U.S. corporate pension plans in the next two to three years, the survey also found.
A total of 32 percent of respondents said they would increase the allocations of their defined benefits plan to fixed-income investments in the next two years, and 46 percent said they were “somewhat likely” or “would consider doing so,” the survey found.
Survey data were collected from 177 responses from finance executives employed at companies and nonprofit organizations with $500 million or more in annual revenue and defined benefit plans with $100 million or more in assets.
Corporate pension plans took a huge hit with the Great Recession leaving companies scrambling to come up with strategies to fund their liabilities as low interest rates continued to drag on. More recently, the funding status of pension plans has improved.
“This improvement dovetails nicely with feedback we are getting from clients who have implemented a glide path strategy,” Barry said. “They are reaping the rewards of this rapid improvement.”
The funded status of the 100 largest corporate defined benefit pension plans improved by $95 billion during the month of May compared with the same period last year, as a sell-off in bonds caused a rise in the interest rates on corporate bonds used to value pension liabilities, according to the Pension Funding Index published by the actuarial and benefits consultancy Milliman.
The funded percentage of the 100 largest corporate defined benefits plans also rose to 86 percent in May from 81.2 percent in the year-ago period, the Milliman index also found.
Funded ratios for the 100 largest plans would climb to 95 percent by the end of 2013 and to 114 percent by the end of 2014 under an “optimistic” forecast model, Milliman also said. A pessimistic model pegs a funded ratio at 83 percent in 2013 and 77 percent in 2014.
Funded ratios depend on investment performance of the assets in the plans and on interest rates. A funded ratio of less than 100 percent means the value of a pension plan’s obligations outweighs its assets. A ratio of more than 100 percent means the value of the plan’s assets outweighs its obligations.
Cyril Tuohy is a writer based in Pennsylvania. He has covered the financial services industry for more than 15 years. He can be reached at [email protected].
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