Companies Looking to Reduce Risk in Defined Benefit Plans, According to Towers Watson-Forbes Insights Survey

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 Towers Watson (NYSE, NASDAQ: TW) and Forbes Insights. To address these issues, many companies are considering changes to settlement options, as well as changes to investment strategy and plan design, both for today and in the future.

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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 Matt Herrmann , leader of Towers Watson’s Retirement Risk Management group. “While the current funded status of many plans limits the actions sponsors can take today, there is a desire to establish a plan for action as their funded status improves. For active and frozen plans alike, having a mechanism to reduce risk as the plan gets better funded will be key, whether that be through settlement, investment strategy changes or some other means.”

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 Carl Hess , Towers Watson’s global head of investment. “There is already a high awareness of the level of risk companies are running through their pension plans. Some are using swaps, options and other derivatives to improve risk management, and the research shows that this is likely to increase.

“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.