De-Risking Isn’t Necessarily An End Game

Mercer’s study on pension de-risking that was done in conjunction with the PBGC and a plan sponsor advocacy group highlighted the following. “This de-risking trend, backed by pension industry data collected in the first phase of this study, highlighted that de-risking is not viewed solely as a means to exit the defined benefit pension system in the short-term; rather it is a practice embraced by plan sponsors across the board, including those heartily committed to maintaining ongoing pension plans.”

One respondent even took this a step further to suggest that it was the entities’ responsibility to evaluate these de-risking tactics to make the most appropriate economic decisions for their organizations.

“I think it’s our job to always continue to look for ways to transfer risk and to minimize the risk to make the best economic decisions both for the company and for our retirees.”

As we’ve discussed many times in this blog, a DB pension plan shouldn’t be focused exclusively on generating the highest return. The primary objective should be about SECURING the promised benefit at the lowest cost. DB pension systems should consistently seek opportunities to reduce risk in their plans, but they need more tools to accomplish this objective.

I mentioned at the Opal Public Fund Forum in January (Phoenix, AZ) that a generic asset allocation had outperformed generic plan liabilities by 11.7% for the 9 months ending September 30, 2018.  An incredible achievement as both assets rose, while US interest rates did, too. However, because plan sponsors rarely see how their plan’s liabilities are performing outside of receiving their annual actuarial report they didn’t appreciate this significant advantage.

Regrettably, the fourth quarter’s weak asset returns and subsequent rally in U.S. rates (U.S. Treasury 10-year bond yield peaked at 3.24% on 11/8) saw the 11.7% advantage disappear, and become a -1.7% relationship by year-end. This is a perfect example of a wasted opportunity to reduce risk while stabilizing both contribution expense and the funded status of the plan.

Many plan sponsors and their consultants believe that de-risking any portion of their plan impairs their ability to achieve the ROA, especially in this low-interest rate environment. I would counter that claim by suggesting that the significant ups and downs created by a traditional asset allocation places the plan in greater jeopardy than one that de-risks when given the opportunity, which will produce a more stable funded status and contribution expense. De-risking is going to be different for every plan, as plan liabilities are like snowflakes. There is no one-size-fits-all approach.

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