More Pension Plan Sponsors Adopt De-Risking Strategies

Ford, General Motors and Verizon are among a growing number of U.S. companies taking measures to reduce the risk in their pension plans and, according to Ari Jacobs of Aon Hewitt, increase the liquidity of their assets.

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This month Ford Motor Co. expects to complete a program offering 90,000 former U.S. salaried employees a lump-sum payment in place of a pension annuity. Bob Shanks, Ford’s chief financial officer, said in a statement when Ford adopted the de-risking strategy for its defined benefit plans in April 2012 that it was being undertaken to “reduce our pension obligations and balance sheet volatility.” Offers began to go out in August 2012 to retired salaried workers, as well as to former employees who are not yet retired but whose pension contributions are vested.

Employees have taken up the offer in sufficient numbers to settle $3.4 billion in pension obligations at a cost of $689 million as of September 30. The payouts were made from plan assets to former employees who accepted the offer. While Ford’s U.S. pension plans were underfunded by $9.7 billion at the end of 2012, the shortfall has been reduced this year by higher interest rates, higher returns on assets and an additional $2.7 billion in plan contributions during 2013, plus the lump-sum program. Ford declines to say by how much, but Shanks told Reuters in July that the funding gap for the company’s U.S. plans should be closed by the end of 2015.

Ford’s strategy reflects a powerful trend toward de-risking that is expected to get even stronger in the coming years among corporate plan sponsors. This is among the findings of a survey published in November and conducted by professional services firm Towers Watson, in cooperation with Institutional Investor Forums, on the risk management practices at 180 of the largest U.S. pension plans. (Read more: The 2013 Pension 40)

Of the sponsors surveyed, 50 percent reported they had adopted a so-called journey plan to take a number of steps to de-risk their pension schemes, with 8 percent of those adopting such a framework in 2013. An additional 25 percent reported that they are planning on adopting a de-risking strategy in 2014 or are considering doing so in 2015.

There are three broad de-risking strategies. The first involves changing the design of the plan, usually by freezing the pension plan and closing it to new entrants. Second, plans can also step up contributions to close the funding gap and adopt liability-driven asset strategies to reduce risk. The third approach involves risk transfer and settlement programs that include offering lump sums to participants, purchasing annuities or ultimately terminating the plan.

According to Towers Watson’s findings, 70 percent of corporate defined benefit pensions, including frozen plans, are no longer open to new participants. That includes 27 percent of plans that continue accruals for present workers. While the number of frozen plans is slightly higher than in the past, this trend may have leveled off, says Michael Archer, a Philadelphia-based senior consultant for Towers Watson.

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Towers Watson estimates that 60 percent of defined benefit corporate plans are open or closed but not frozen. “I’m hearing much less buzz around plans freezing and closing right now,” Archer says.

Rising funding ratios have buoyed plans this year. The aggregate funding ratio status for 300 large companies rose from 76.7 percent at year-end 2012 to 91.1 percent by September 30, according to Archer. This trend has made lump-sum settlements more attractive for many plans as it becomes more feasible to execute this strategy. The Towers Watson survey found that 58 percent of corporations have offered or expect to offer lump sums.

Improvements in aggregate pension funding ratios are owed nearly equally to higher interest rates, which have lowered the cost of the funding liability, and to a surge in the market value of equities held in pension plans. “If I looked at a 60-40 [equity-bond allocation] plan, investments would have produced a return of about 11 percent through September 30,” Archer says. “At the same time, the liability has dropped by about 8 percent.”

There was mixed news in the survey for the future of defined benefit plans. One third of sponsors of frozen plans expect to terminate their plans within five years. Conversely, 30 percent of those plans that remain open to new hires expect their plans will still be open in five years. Archer contends that this latter trend shows that sponsors have grown more comfortable with managing the risks of an ongoing plan.

The increase in funding ratio status also moves frozen plans closer to termination because the sponsors would be more likely to have the financial resources to transfer away all the liabilities. “You see the sponsors of the smaller plans wanting to get out of it,” says Archer.

Reallocating investment dollars has been a key focus of pension plans seeking to reduce risk. Out of the sponsors surveyed, 78 percent said that during the next two years they expect their focus will be more on reducing risk than on seeking higher investment returns. Sponsors told Towers Watson they favored a strategy of aligning changes in asset allocations with shifts in pension liabilities. One common approach is to move the plan’s allocations out of equities and into long-term bonds. “If you generate excess assets in U.S. defined benefit plans, it’s very difficult to use those excess assets,” says Archer.

Companies have also shifted their allocations into more liquid assets to be ready and able to pay out benefits when they come due, says Ari Jacobs, a senior partner at Aon Hewitt in Norwalk, Connecticut. Companies are driven by concerns over asset-liability mismatch risk that has been a source of volatility for corporate balance sheets, he adds. Organizations are taking advantage of higher funding levels to shift more assets into longer-term, fixed-income assets that reduce the asset-liability mismatch.

Another general strategy is to diversify into alternative investments that can produce more stable, if lower, returns over time; they remained relatively resilient following the 2008 financial crisis. This trend is particularly strong among open plans. Possible asset classes for pension plan sponsors to explore include alternatives.

During the past two years, there have been notable moves to de-risk pension plans in the corporate sector. “You’ve seen a ton of lump-sum windows in 2012 and 2013, with companies offering sums to their deferred vested participants,” Jacobs says. Typically, sponsors find that roughly half of participants offered lump sums accept them, he observes. Ford has not yet reported the number of former employees who accepted its lump-sum offer. The automaker has promised to make the information public in January when it reports fourth-quarter 2013 earnings.

As head of the global retirement solutions group at Aon Hewitt, Jacobs has been involved in the two biggest pension risk transfer deals in the U.S. In 2012 he advised General Motors Co. on its purchase of a group annuity from Prudential Insurance Co. of America to settle $26 billion in pension obligations to retired salaried workers. The plan offered 42,000 retirees the opportunity to accept a lump-sum buyout. For those who rejected the offer, the responsibility for paying the monthly income benefit was shifted to Prudential under the group annuity purchased by GM. That same year Jacobs worked with Verizon Communications, which bought a group annuity from Prudential to replace $7.5 billion in pension obligations to 41,000 retired salaried workers, after making an additional $2.6 billion contribution to its plan.

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