A Trend Worth Following For Public Pension Plans

There has been a movement to more fixed income and LDI use among corporate pension plans since the Great Financial Crisis, says CEM Benchmarking in a recently published report. According to the analysis, corporate plan sponsors are using the plan’s funded status to drive de-risking approaches. We, at KCS, couldn’t agree more with this strategy. Despite strong equity gains since 2008, declining U.S. interest rates have slowed down gains in funded ratios for most plan sponsors.

“For the 69 U.S. corporate sponsors that participated in the CEM database in 2007 and 2008, the average decline in funded status over 2008 was 30%,” the analysis points out. “A quarter of the plans saw declines in excess of 37%, and fewer than 10% of plans remained fully funded on a U.S. GAAP basis at the end of 2008. Despite the relatively positive returns for many asset classes in recent years, the decline in interest rates has proven to be a large impediment to restoring the funded status of pension plans to pre-crisis levels.”

According to CEM’s study, the predominant investment theme among U.S. corporate plan sponsors has been to risk reduction, “both on an asset-only basis and also more importantly, with reference to their liabilities.”

One investment concept that has gained prominence is the de-risking glide path, a process by which a plan’s strategic asset allocation is gradually reduced, as either funded status improves, interest rates increase, or both. “Thirty percent of U.S. corporate sponsors in CEM’s database stated that they had a formal de-risking glide path in place at the end of 2016.”

Another point being stressed in the study is the fact that “a fixed-income allocation is not a perfect proxy for LDI investing, as it does not capture the duration of the fixed income investments in relation to liabilities.” We, at KCS and Ryan ALM, couldn’t agree more, which is why we recommend adopting a defeasement strategy that cash-matches retired lives from nearest to as far out as possible.

Taking risk off the table, as the plan’s funded status improves is a most prudent tool. Why continue to subject the plan to unreasonable risk of a potential 2007-2009 repeat when the average plans funded status declined by >30%? By reducing the chance that the public plan’s funded status will plummet, contribution expenses should be more consistent and less impactful on the greater social safety net provided by states and municipalities.

Plan sponsors have made a promise to their participants. Not knowing what that promise looks like on a regular basis is inappropriate, as it is this insight that should drive asset allocation and investment structure decisions.