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Following the economic crisis, the financial risk implications of defined benefit (DB) plan sponsorship have become the primary pension concern for companies with large U.S. DB plans, according to a joint survey of financial executives conducted by global professional services company
The majority (56%) said that the impact of DB plans on cash flow tops their pension-related concerns reflecting the competition between funding DB plans and capital needs highlighted by the financial crisis. This is followed by concerns about DB plan impact on company income statements (47%) and balance sheets (41%). Forty percent also indicated that the crisis has increased employees’ appreciation of the retirement security inherent in DB plans.
Further, nearly two-thirds of U.S. companies said that they will focus their efforts more on reducing investment risk — rather than seeking higher returns for their DB plans — while only 14% asserted that they will place a greater concentration on increased returns. Twenty-three percent said they planned no changes.
“Clearly, the financial crisis has once again highlighted the importance of managing the risk in the pension plan,” said
To address investment risk over the next five years, a better alignment of plan assets and liabilities (e.g., liability driven investment) is the most favored strategy, chosen by 66% of respondents. Respondents are divided on the likelihood of using alternative risk strategies. Some plan sponsors will likely perform a liability redesign (e.g., changes in plan type or benefit formula), pursue long-term investment opportunities, governance structure improvement or liability transfer (e.g., pension buyouts).
“The strong, increasing interest in LDI, confirms to us that companies are stating a clear preference for a better balance between risk management and return generation,” said
“Additionally, pension funds are continuing to improve their governance structures, enabling them to implement more sophisticated investment strategies and have an increasingly dynamic approach to investment,” said Hess.
Turning to plan design, more than half of the pension plans in the survey are open (accruing additional benefits for both current participants and new participants); 32% are closed to new hires, and 14% are frozen to all employees. Over the next five years, the majority of respondents expect their open plans to stay that way — for about half of them, sponsors expect no change in benefit provisions; 29% will modify the benefit formula to reduce cost or risk, and only 15% are looking to close or freeze.
Survey findings also indicated that 71% of the closed DB plans are expected to continue benefit accruals over the next five years, and only one-fifth of frozen plans are actively seeking to terminate altogether. This indicates that risk management opportunities will be around for a significant period of time even if the plan is frozen or closed.