Amid Global Market Storms, it’s Critical to Stay Ahead of the Pension Risk Curve

The Mercer/CFO Research 2015 Risk Survey shows that plan sponsors are being spurred to action by a number of pressures on their defined benefit (DB) plans. These include updated mortality assumptions from the Society of Actuaries, reflecting an increase in longevity: 89% of plan sponsors have either updated their mortality assumption or are planning to do so, leading to an increase in liabilities and pressure on funding ratios.

In addition, the total funding deficit in 2014 rose and aggregate funding levels sank to 79%, a decline of 9 points from the previous year, according to our tracking of the S&P 500. Although funding levels rebounded to an aggregate level of 84% by the end of Q2 2015, market volatility can never be ignored, as the events of recent weeks show. Meanwhile, 55% of surveyed plan sponsors reported that rising Pension Benefit Guaranty Corp. premiums could affect changes in their funding policies.

Perhaps more importantly, though, the Mercer/CFO Research study showed a high level of satisfaction among plan sponsors—in the 80% to 90% range—with the various pension risk management actions they have taken, including lump sum cashouts to vested DB plan participants, and annuity buyouts for retirees. Nearly two-thirds of surveyed sponsors have already offered some type of one-time lump sum payout, and 49% of them say their firms are likely to employ such payouts in the next two years. Meanwhile about one-third of survey respondents say they are likely to purchase an annuity this year or next, which would signal a dramatic increase in the volume of buyout activity.

“Nearly two-thirds of surveyed sponsors have already offered some type of one-time lump sum payout, and 49% of them say their firms are likely to employ such payouts in the next two years.”

Again, economic policy is a crucial factor. An increase in interest rates, whenever it comes, could result in a significant increase in demand for annuity buyouts as prices become more attractive, and plan sponsors and CFOs should position themselves now to move quickly in response to more changes in market conditions. That means properly estimating the cost of a buyout—yet over 90% of respondents to the Mercer/CFO survey tended to overestimate the cost of annuitization. Organizations should be able to move confidently rather than making incorrect assumptions about cost.

Fortunately for plan sponsors considering such pension risk transfer strategies, the market has evolved. It now provides innovative new tools for transferring pension risk, with solutions that offer more transparent pricing, greater standardization, and a more competitive marketplace. For those choosing to retain more pension risk rather than go the cashout/buyout route, there are still ways to strategically navigate the challenges of today’s ever-changing, volatile equity markets, and the uncertain interest rate environment.

Is your CFO managing a multi-pronged approach to pension risk? This can include dividing plan participants into segments to address their financial profiles and pension risk management options, and creating “glide paths” to achieve desired plan management goals. Such dynamic de-risking strategies—by which pension plans create a framework to define their target endgame, along with a roadmap to get there—have gone from cutting-edge to mainstream in recent years.  The Mercer/CFO survey notes that 81% of respondents have either adopted or were considering such a strategy to reduce risk as their funded status improves.

Of course, each organization must come to its own conclusion about how to manage pension risk in our global era of market volatility and uncertainty. But the key to ensuring successful tomorrows for businesses—and retirement adequacy for pension plan members—lies in long-term strategies built from in-depth executive discussion and informed decisions. The time is now to take advantage of the best information and innovations on the market, no matter how stormy the economic seas.

Julio Portalatin
Julio Portalatin is the President and Chief Executive Officer of Mercer, a global consultancy providing employers solutions for the health, wealth and careers of their people. Mercer is a wholly owned subsidiary of Marsh & McLennan Companies.