Advertising Supplement PENSION RISK
MANAGEMENT STRATEGIES Understanding All the Derisking Possibilities
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SPONSORS Fidelity Institutional Asset Management 900 Salem Street Smitheld, RI 02917 Daniel Tremblay Senior Vice President and Director of Institutional Fixed Income Solutions 603.791.6599 [email protected] www.institutional.delity.com
MetLife 200 Park Avenue New York, NY 10166 Asif Mohamed Director, U.S. Pensions 212.578.8624 amohamed@metlife.com www.metlife.com/pensions
NISA Investment Advisors, LLC 101 South Hanley Road, Suite 1700 St. Louis, MO 63105 Gregory J. Yess Managing Director, Client Services 314.721.1900 [email protected] www.nisa.com
Prudential Retirement 280 Trumbull Street Hartford, CT 06103 Scott Gaul, FSA Senior Vice President and Head of Distribution, Pension Risk Transfer 860.534.4263 [email protected] www.pensionrisk.prudential.com
Schroders 7 Bryant Park New York, NY 10018-3706 Jennifer Horne, CFA Head of U.S. Institutional Clients 212.641.3800 [email protected] www.schroders.com/us
This special advertising supplement is not created, written or produced by the editors of Pensions & Investments and does not represent the views or opinions of the publication or its parent company, Crain Communications Inc.
2 Pension Risk Management Strategies
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CONTENTS
4 Taking a Journey Along the Derisking Spectrum Corporate plan sponsors wishing to mitigate pension risk have a myriad of possible strategies at their disposal 12 Underfunded? Taking the LDI Path to Full Funding Most plan sponsors looking to dial down funded status volatility turn to liability-driven investing. But what’s the best approach among the many varieties available? 16 When Pension Risk Transfer Is the Right Option Annuity transaction volumes are increasing steadily, but still represent just 1% of overall DB assets. There’s plenty of potential capacity in the transfer market
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Advertising Supplement TAKING A JOURNEY Along the Derisking Spectrum
Corporate plan sponsors wishing to mitigate pension risk have a myriad of possible strategies at their disposal
op of the agenda for corporate plan business risks. The one most familiar to plan pays o if you hold it long enough. The sponsors: identifying, managing sponsors is investment risk: asset allocation, other important risk is the uctuation of dis- Tand mitigating risk. This is not a new mitigating defaults or downgrades, meeting count rates, driven by the rate environment. observation, but nevertheless it is one that return goals, as well as interest rate and A far distant third is longevity risk.” continues to ring true. Many corporate plans equity risk, while business risks include plan Managers have spent years educating remain underfunded, even though market governance, accounting impacts and the plan sponsors and investment committees movements have bumped up funded status duciary risk of litigation, among others. on the need to focus on the volatility of a bit for some. The volatility in this statistic “Liability risks include asset-liability funded status. “If a client isn’t focused on crystallizes the risk picture for pension plans mismatch, underfunding, mortality and funded status as the lens for their reporting, today. early retirement,” said Wayne Daniel, senior there’s potential for a misunderstanding of Being underfunded and therefore owing vice president and head of U.S. pensions at strategy and poor attribution,” said David money to the pension plan is an uncomfort- MetLife. “Most employers are not adequate- Eichhorn, managing director of investment able position. By denition, pension debt is ly equipped to manage all of these risks. strategies at NISA Investment Advisors. more volatile than corporate debt, because particularly liability related risks, because It’s also necessary for plan sponsors to its value is inuenced by the assets held in it really isn’t their business.” They are not understand which risk levers to pull when. the plan and the sponsor’s attitude on fund- in the business of pooling and managing “Once you’ve set the stage for reporting con- ing. The payback terms are dierent — and longevity risk, for example. sistently to the committee on funded status, change frequently as funding relief rules are then you can drill down into the strategies extended. Pension debt carries a signicant Risk levers that you are using to reduce funded status tax in the form of rising Pension Benet One metric now stands out, though, as the volatility,” said Cheryl Hanson, director, client Guaranty Corp. (PBGC) premiums. key to quantifying pension risk. “Funded ra- services at NISA Investment Advisors. Changing this picture by reducing tio volatility is the focus of most pension risk In order to prioritize a plan’s risks, plan pension debt and getting a grip on funded management frameworks, as it has been for sponsors should determine what they are status volatility requires moving many risk years,” said Francois Pellerin, LDI strategist trying to accomplish with their plan. First, levers. Pension funds run a wide range of at Fidelity Institutional Asset Management. where does the plan t with the company’s inherent risks, though they fall into three “That is mostly impacted by equity risk, other qualied plans? Then, said MetLife’s broad categories: investment, liability and which is generally a compensated risk that Daniel, “they need to consider how the plan
4 Pension Risk Management Strategies
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can help achieve the rm’s business and tal- sits in the capital structure, the cost of owner- to consider the real economic costs and ent retention goals in a way that meets the ship — all these things make it look and feel forecast the cash ows needed to maintain organization’s strategic focus and meets the like a real operating business on the balance the pension fund.” needs of the plan participants.” sheet,” he said. Understanding the dierence between It’s not surprising then to nd that pen- the accounting value of the pension plan sion risk is not just an HR issue, but also top Cash critical and the economic obligation is another of mind for nance executives, not least Just like any other operating business, pen- fundamental issue when considering derisk- because one of the pressures companies sion plans vie with other company units for ing. “It’s the only place on your balance sheet face is the need to make cash contributions cash. Today, as more companies come to the that you can hold accounts payable at a 7% to the plan. “The low funded status that conclusion that their underfunded pension discount to its economic value,” O’Brien said. plans face is the biggest challenge today,” plans won’t be rescued by market upturns, “I spend a lot of my time educating execu- said Daniel Morris, head of U.S. portfolio more are opting to issue company debt at tives about the need to think about pensions solutions at Schroders. “This is exacerbated today’s low rates to fund pension shortfalls on an economic basis, because once you by the wealth transfer that many plan are through voluntary contributions. “There’s a understand the economic value, only then experiencing. Even as contributions are corporate nance reason to issue bonds to can you think about the decision to retain the made today, many are just helping make fund the pension plan,” said Andrew Chorl- obligation or secure it through a settlement.” benet payments rather than improving the ton, head of U.S. multi-sector xed income “Plan sponsors are looking to minimize funding level over time. This also exacer- at Schroders. “And we are seeing companies cash contributions to the plan, so they are bates the risks that plans experience from doing this because of rising PBGC premi- looking holistically at the risks the plan is equity and xed-income investments. The ums, falling corporate bond yields and the facing,” said Schroders’ Morris. “That means impact of risk is amplied when plans are current tax status of corporate debt.” weighing the assets, liabilities and sponsor net payers of benets.” “The U.S. had lived through a three- covenant.” And that can sometimes mean Glenn O’Brien, managing director of decade-long bull market,” Prudential’s that a voluntary cash contribution is neces- U.S. distribution in Prudential’s pension risk O’Brien said. “At the conclusion of the bull sary. transfer business, identied pension plans as market, what looked like a free benet has When a pension fund has a signicant a signicant corporate nance issue today. now become an annuity company that is underfunded liability, the risk prole of the “The size and scale of the obligation, how it costly to own and maintain. Sponsors need continued on page 6
Pension Risk Management Strategies 5
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company is increased. “But the risk pro le lump-sum exercise, or aim for hibernation, have some smoothing ability in terms of of the participants is signi cantly higher as keeping hold of those liabilities. As most funding shortfalls,” said Karl Dasher, CEO of well,” Prudential’s O’Brien said. “So when pension risk transfers involve retirees, what North America and co-head of xed income derisking for the company, the sponsor is are the implications of the decision to o- at Schroders. “That doesn’t mean that you really derisking for the participant as well.” load or hold onto retiree obligations? Mar- are not cognizant of the funding volatil- ket participants provide diering answers. ity risks. It just means you have a bit more Dampening volatility The approach to settle retirees will ability to take risk. We work with clients to The spectrum of derisking options starts leave the active and possibly some of the understand their particular risk sensitivities. with the recognition that gaining control of deferred participants on the balance sheet. We see varying degrees of concern about funded status volatility will be bene cial for Prudential’s O’Brien said, “It’s important how closely assets are matching liabilities.” both the sponsor and participants. Those to remember that the risk associated with plan sponsors looking to derisk start with those populations are not new. It’s always Defray payments the design of the plan itself. The rst part been on the balance sheet, but the invest- The impact of LDI is apparent in the chang- of this progression can involve modifying ment issues will be more acute given the ing landscape of pension asset allocation. the bene t formula and closing the plan to longer duration of the liablities.” “We are seeing a dramatic shift out of equity new entrants. “Those are eorts to modify into xed income,” said MetLife’s Daniel. the growth of the liability,” O’Brien said. Binary choice “Over the last decade, among the pension “The next step is to address the challenges There is an analysis to be done on the cost plans of the S&P 500, equities have dropped of asset risk. Companies should carefully of keeping or settling liabilities. Keeping from about two-thirds of assets to less consider when certain assets in the pension the liabilities will require a for-pro t asset than one-third, while xed-income assets fund can underperform and how correlated manager to manage assets. Sponsors need have risen from less than 30% to 42%, and those events are to their core business. to compare the cost of keeping the assets continue to increase.” This change, he ex- Creating a de cit in the pension fund at the to the cost of moving the liability o the plained, is because xed-income securities same time the core business is underper- balance sheet, “We see a huge emphasis on are the assets that are required to defray the forming has led to dicult trade-os for risk, the real economic cost of owning liabili- expected bene t payments from the plan. many sponsors. Even for xed income inves- ties and the impact on enterprise value,” The phrase LDI covers a multitude of tors, it’s important to remember that bonds said Prudential’s O’Brien. strategies. These range from the creation can and do decrease in value, but liabilities “Often times we talk about whether of a rudimentary hedge portfolio that is in the pension fund do not.” a plan should annuitize or hibernate as a matched by a signi cant chunk of return- By focusing on these risks and the binary choice,” Fidelity’s Pellerin said. “But seeking assets designed to impact the overall capital structure of the company, a hybrid approach is possible. You can take plan’s funded status positively, to a fully the sponsor may consider moving part of some segments of the population, typically immunized hibernation portfolio that will the liability o the balance sheet through a retirees, and transfer those to an insurance bring funded status volatility down close pension settlement,” he said. company. You then retain the rest. It doesn’t to zero. The dierence here is almost night Liability driven investing (LDI) has long have to be all or nothing.” and day. been the blanket phrase for a wide and wid- A further example of this approach is an Many refer to the journey from one ening range of investment strategies. Today, activity that probably is coming to an end. end of the LDI spectrum to the other as a most plan sponsors have embraced some “The low-hanging fruit of derisking is lump glidepath. Many U.S. de ned bene t plans form of liability aware investing, if only by sums for terminated vested participants,” remain at the beginning of the glidepath. lengthening bond duration on a por tion of Pellerin said. “And it’s cheaper for sponsors “When a plan is 85% funded, with a hefty their assets. But as LDI has become wide- if lump sums are paid before 2018. At the allocation to return-seeking assets, it isn’t spread, plan sponsors have been thinking moment mortality assumptions favor the necessary to be too precise in your hedg- about what further steps are necessary as employer and allow the derisking to be less ing program because it won’t have a huge they consider ways to limit the risks that the costly. However, this usually only impacts a impact on funded status volatility,” said pension plan poses to the company. small portion of the overall liability.” NISA’s Hanson. “As the plan moves down “We like to emphasize that pension de- “The end of the lump-sum window era the glidepath, precision becomes more risking is not a once-and-done experience,” is coming into view,” said Ari Jacobs, senior important.” said MetLife’s Daniel. “There is a spectrum partner and global retirement solutions Many plans are on a glidepath but have of choice in terms of approaches and it is a leader at Aon Hewitt. “The mortality table stalled, because the triggers to move along, journey over time.” He emphasizes the need changes are nearly complete and most derisk and become more fully funded rested for plan sponsors to break the journey down companies that are looking to open lump on the prospect of rising interest rates. into a series of steps, from embracing LDI to sum windows will have done so by the end Nevertheless, those lucky ones that have pension buyouts. of 2017.” made progress, possibly through voluntary A dilemma that all plan sponsors poten- Sponsors should remember, though, contributions, become more and more keen tially face as they seek to derisk is whether that they have been the bene ciaries of to maintain the forward momentum. to o-load a portion of the liabilities, either certain funding relief measures in recent This has given rise to a new type of man- through a pension risk transfer solution or a years. “In the U.S. market, pension plans continued on page 8
6 Pension Risk Management Strategies
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Actuarial Risk
Interest Rate Risk
Crack the de-risking code At NISA, we understand the complexities of pension risk management. Our tools and experience help us design LDI strategies that work. That’s why we manage portfolios for some of the largest institutional investors in the world.
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The selected risks are not exhaustive and their relative proportions are illustrative. 1 NISA managed $142 billion in fi xed income and equity and over $80 billion in derivatives notional as of 3/31/17.
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date. “We’ve always managed completion of the dierences in both the regulation of they are equally eective at immunizing portfolios, but they weren’t called that until pensions and valuation methodology, the the sponsor from the pension plan. Clearly four or ve years ago,” NISA’s Eichhorn said. availability of suitable bonds and the ap- when you do an annuity buyout, that slice is “We would see searches for very rened LDI petite to utilize derivatives.” wholly removed; however, we’ve yet to see mandates that were functionally comple- And way down the spectrum may not a sizable deal done where the entire liability tion engagements. Now consultants are mean the very end. “It’s dicult to derisk has been o-loaded.” dening these strategies as completion completely,” said NISA’s Eichhorn. “We Whether a plan is in the early stages of mandates.” would argue that whether a plan pursues a tackling underfunding, well on its way to a Working alongside other managers, hibernation strategy or an annuity buyout, continued on page 18 “as a completion manager, we would be responsible for maintaining the interest- rate exposure hedge at a given target,” said PUTTING THE PENSION PLAN TO SLEEP NISA’s Hanson. “But we’re also responsible for looking at the yield curve prole of those other xed-income assets vs. the liability, With all the talk of pension settlements, it can sometimes seem that many plan and trying to eliminate some of the risk gen- sponsors want to move liabilities o the balance sheet. Not so. A viable alternative erated from an undesired yield cur ve mis- is hibernation, a strategy that can bring funded status volatility below 3% per year. match. We can also be asked to monitor the Plan sponsors really do need to target an overfunded status if they want to pursue hiberna- spread component of the hedging strategy tion. “There will always be uctuations in the liability,” said Cheryl Hanson, director, client services by pulling in the return-seeking assets. That at NISA Investment Advisors. “Participants don’t always behave exactly as expected, or as was can mean monitoring what is the eective modelled in the original liability cash ow pro le. They may take lump sums or the actuarial tables spread duration of those assets as well.” may change.” Without a bu er of some sort, no plan will be able to withstand future unknowns. When a plan is overfunded to the tune of 105% to 110%, it will have a material amount of cor- Optionality baked in porate bonds, Treasuries and likely some residual risk assets, representing about 10% to 15% of the As sponsors become better funded, they plan, said David Eichhorn, managing director, investment strategies at NISA Investment Advisors. may begin to consider what the endgame A hibernation strategy involves a hedge ratio above 70% and an allocation to equities of just is for a pension plan that is no longer open 20% or lower. It is a stage beyond a fairly re ned LDI or completion portfolio. “Completion involves to new entrants. “We have many clients that a step towards re nement relative to generic LDI,” Eichhorn said. “It involves getting the liability initially wanted to temporarily hibernate in hedged to the precise amount that the client wants. After completion comes hibernation. Hiberna- order to terminate,” Fidelity’s Pellerin said. tion is really just a completion engagement in which the plan has gotten rid of the vast majority of “But when they saw how well the hiberna- its risk assets and has materially moved down its glidepath.” tion was going, they decided to stick with “In hibernation,” he continued, “there are only little swings in the plan’s funded status, so the hibernating. Furthermore, sponsors can plan has limited impact on the sponsoring company.” work with their asset managers to have “Hibernation can be a pretty ecient way to manage pension risk, short of sending it o the a portfolio that has optionality baked in, balance sheet,” said Francois Pellerin, LDI strategist at Fidelity Institutional Asset Management. allowing for eective termination when the “We have many clients with customized hedging plans and their funded ratio has been protected time is right.” for years, despite all the volatility we have seen.” Some managers suggest caution here. It is important to understand the end goal of the sponsor. The choice of hibernation is going to be “Words like immunization and hedging can materially inuenced by whether the plan is open, closed or frozen. “That inuences the shape of your give clients a false sense of security,” said glidepath and the asset allocation at di erent trigger levels. If you have e ectively derisked the plan, Schroders’ Chorlton. “Plan sponsors need then you can’t a ord any downdraft or leakage to the liability,” said Daniel Tremblay, director of xed to understand how much true hedging income solutions and LDI strategist at Fidelity Institutional Asset Management. they can really achieve. We constrain risk in Even within hibernation, there may be a mini-glidepath. “If funded status improves because certain areas — interest rates and the yield equities do well or longevity risk shifted, either for good or bad, the plan might want to derisk curve — where risk can be well-identied further,” NISA’s Eichhorn said. “That could involve stepping away from even the modest risk in and well-managed. Investors are well- corporate bonds to locking in funded status using more Treasuries.” compensated for an active credit allocation “We believe that hibernation, well-executed, can be cheaper than paying a third party to where there is visibility about the risks undertake the risk,” Fidelity’s Pellerin said. “There will be some tracking error that wouldn’t being taken.” otherwise exist, but that can be managed.” To illustrate the point about precision NISA has seen a rising number of plans opting for hibernation, but many simply don’t have the or a lack thereof, Schroders’ Morris drew funding level to adopt the solution. With the average plan in the mid-80% f unded range, many are a comparison between hedging pension still relying on equity market returns to improve funded status. Some have used debt issuance to top liabilities in the U.K. and the U.S. “In the U.K., up their funding and then opted for hibernation to protec t the investment that they have made. we can hedge plan liabilities with a solution “The expressed goal across many sponsors is to get to hibernation,” NISA’s Eichhorn said. “It that has a low tracking error of around 0.2%, could be a stepping stone to an annuity buyout, partial or otherwise, or it could be the end game while in the U.S. the closest we can get is a solution.” 4% tracking error,” he said. That’s because
8 Pension Risk Management Strategies
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FOR INSTITUTIONAL USE ONLY. Past performance is no guarantee of future results. Data as of March 31, 2017. Data refl ects the combined resources of Fidelity Institutional Asset Management® and Fidelity Investments. 759865.4.0
PS009_PI_20170612.pdf RunDate: 06/12/17 pi Pension Risk Strategies supp 8 x 10.875 Color: 4?C A resurgent Pension Risk Transfer economy IT’S PRIME TIME FOR PRT Strong equity What are you waiting for? markets Together, we can help you reduce risk and manage rising plan costs so your business is better positioned for the future.
Improving funded Learn more at prudential.com/primetime. status Build your strong defense now. Call Glenn O’Brien, Managing Director, Investment & Pension Solutions at 860-534-2440.
Insurance products are issued by Prudential Retirement Insurance and Annuity Company (PRIAC), Hartford, CT, or The Prudential Insurance Company of America (PICA), Newark, NJ. Both are Prudential Financial companies. Each company is solely responsible for its nancial condition and contractual obligations. © 2017 Prudential Financial, Inc. and its related entities. Prudential, the Prudential logo, the Rock symbol and Bring Your Challenges are service marks of Prudential Financial, Inc. and its related entities, registered in many jurisdictions worldwide. 0305553-00001-00 PRTADRE9 05/2017
PS010_PI_20170612.pdf RunDate: 06/12/17 pi Pension Risk Strategies supp 8 x 10.875 Color: 4/C PS011_PI_20170612.pdf RunDate: 06/12/17 pi Pension Risk Strategies supp 8 x 10.875 Color: 4/C A resurgent Pension Risk Transfer economy IT’S PRIME TIME FOR PRT Strong equity What are you waiting for? markets Together, we can help you reduce risk and manage rising plan costs so your business is better positioned for the future.
Improving funded Learn more at prudential.com/primetime. status Build your strong defense now. Call Glenn O’Brien, Managing Director, Investment & Pension Solutions at 860-534-2440.
Insurance products are issued by Prudential Retirement Insurance and Annuity Company (PRIAC), Hartford, CT, or The Prudential Insurance Company of America (PICA), Newark, NJ. Both are Prudential Financial companies. Each company is solely responsible for its nancial condition and contractual obligations. © 2017 Prudential Financial, Inc. and its related entities. Prudential, the Prudential logo, the Rock symbol and Bring Your Challenges are service marks of Prudential Financial, Inc. and its related entities, registered in many jurisdictions worldwide. 0305553-00001-00 PRTADRE9 05/2017
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Underfunded?
TAKING THE LDI
anaging assets against liabilities is LDI. But if a sponsor thinks that LDI will solve something of a mantra for pension all their funded status problems, they will be Mplan sponsors. But what does li- disappointed at some point, given the wide PATH TO ability driven investing really mean? “LDI is a range of strategies being described as LDI.” catchall phrase for ‘how do I reduce the risk That said, if plan sponsors take the time of the pension plan,’” said Glenn O’Brien, to consider the many facets of LDI, it can managing director of U.S. distribution for prove benecial. “We’ve seen an evolution Prudential’s pension risk transfer business. of LDI in recent years,” said Wayne Daniel, “It might be as simple as I don’t want to be senior vice president and head of U.S. pen- FULL 60% equity.” sions at MetLife. “There’s an acceptance The lack of a commonly understood that a plan’s liabilities should provide the FUNDING denition for LDI is a diculty and one that parameters within which asset deployment can lead to some mistaken conclusions. “LDI actions are taken rather than one par ticular Most plan sponsors looking to certainly is an ill-dened concept,” said Da- investment strategy or asset allocation.” dial down funded status volatility vid Eichhorn, managing director, investment “LDI remains an important component strategies at NISA Investment Advisors. of pension risk management,” said Daniel turn to liability driven investing. “The pension community has gotten better Tremblay, director of xed-income solutions But what’s the best approach in about dening the dierent segments of and LDI strategist at Fidelity Institutional As- the many varieties available?
12 Pension Risk Management Strategies
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set Management. “The tools, solutions and not just large plans but also those with $50 plans adding multipurpose equity products guidance are better than ever before. A lot million or $100 million in assets.” such as low-volatility strategies,” he con- of thinking has moved from the academic to As pension plans move down a derisking tinued. “Low vol can give you some juice to the real world and implementation can b e glidepath, generally they will seek to limit close the funding gap, but it can also help done more eectively today.” their asset mismatch by building a xed- hedge your liabilities.” For those plan sponsors that embrace income portfolio that better matches assets. the ideas that underpin LDI, the question But that doesn’t necessarily mean with- Good tools becomes how best to implement the frame- drawing completely from seeking return. More favorable markets recently mean work for their plan. “If going forward I am “The biggest risk you have when you go sponsors have been making some adjust- going to dedicate more corporate resource for growth is equity risk,” Schroders’ Morris ments to portfolios. “We do see some to the pension fund, what’s the right kind of said. “How can you keep that equity return clients taking advantage of the rising rate LDI?” asked Prudential’s O’Brien. “Is it full- (and risk), experience a smooth funding environment,” said Cheryl Hanson, director, duration matching? We’ve never seen a lot path and ensure against loss of drawdown? client services at NISA Investment Advisors. of that in the U.S. market.” To address that we create capital-ecient “More often than not these adjustments to portfolios that provide both risk and man - the hedge prole are done using derivative Immunization aged equity exposure, and are liability instruments because they are very quick, Full immunization is more of a pipe dream cognizant.” easy and ecient to use.” Some plans do for many plan sponsors. Many plans are Plan sponsors are looking to make all use physical instruments, she said, pointing signicantly underfunded. “At that point, their assets play their part. “We see the to U.S. Treasury STRIPS as a powerful tool to managers need to help sponsors tackle the thirst for yield reected in an expansion of extend duration without having to increase big risks,” said Daniel Morris, head of U.S. the xed-income universe in LDI portfolios,” the overall xed-income allocation. portfolio solutions at Schroders. “These Fidelity’s Pellerin said. “That can include It is important to remember that no plans want to go for growth to minimize the triple-B bonds, mortgages and high yield, investment strategy can solve for all under- funding gaps and associated costs, but with for example — therefore allowing assets to funding issues. “We are very clear that if a growth comes risk. So we work to spread work a bit harder to close funding gaps.” plan is 80% funded, market movements can- and limit risk.” “In the risk-seeking portfolio, we see continued on page 14 To manage risk as the funding level increases, Morris continued, “sponsors may want to move to a greater proportion of xed-income assets, but that can mean TOPOGRAPHY OF RISK giving up on return potential and impact discount rates. We think that all those assets need to work as hard as possible, so we look for strategies that both reduce risk but
also give the opportunity to generate more LC , L return.” Most plans demonstrate this approach dvisors
through the adoption of an LDI glidepath. t A “The use of glidepaths is pervasive in DB
plans,” NISA’s Eichhorn said. “But until estmen recently, sponsors haven’t made much nv
progress towards hitting the next trigger ISA I because of the markets. There was a bump f N y o
at the end of last year and the beginning of tes
this one. It is however a case of when, not i f.” ur Tailored solutions are now becoming Co available to plans of all sizes. “As plans become better funded, we see an increased Just like any topographical map, the lines represent equal ‘altitudes’ – in this context, equal funded status demand for customization,” said Francois volatilities. The southern half represents the asset-focused region, where interest-rate sensitivity is higher; Pellerin, LDI strategist at Fidelity Institu- the northern half is the land of LDI solutions. The northwest corner represents hibernated plans. tional Asset Management. “Because of the evolution of LDI solutions, we now believe Source: NISA calculations based on data from Bloomberg Index Services Ltd., customization can be brought to all clients, Citigroup and JP Morgan, as of 7/31/16
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not bail you out,” Pellerin said. “The company TAKING THE STING OUT OF PBGC PREMIUMS will need to make contributions and then LDI becomes a very important way to protect the newly improved funded ratio.” One cost of running a pension plan is not going down. In fact, it is rising. That’s partly thanks to One solution that is gaining traction is the premiums that underfunded plans have to pay the Pension Benet Guaranty Corp. to maintain pooled vehicles that oer the diversica- the pension safety net system. By 2020, the premium will rise to 4.5% of a plan’s decit, from 0.9% tion and cost eciency that used to be in 2012. But the real sting is the rise in per capita, at-rate fees paid by all plans, up from $35 per available only to larger plans. “The pools we participant in 2012 to $82 in 2020. oer are on a mix-and-match basis, so each Almost all plans are carrying participants with small balances, perhaps those who have left the plan can devise a LDI portfolio allocation company after vesting. An $82 charge on a participant with a $1,500 balance is onerous. or glidepath that best suits their particular All plan sponsors acknowledge the need for solvency in the PBGC system and that there needs situation,” Pellerin said. to be a support system for pension plans. But at the same time the fees are signicant and grow- This is an important development ing. “Plan sponsors are used to writing checks and having that improve the funded status of their because of the increased focus on the plans,” said Glenn O’Brien, managing director of U.S. distribution for Prudential’s pension risk endgame. “We recognize that some plans transfer business. “Paying PBGC premiums isn’t improving the funded status of the plan. It is just are moving to long-duration bonds as part a pure tax.” of a derisking journey to ultimately transfer “We are seeing a new genre of annuity buyouts,” said David Eichhorn, managing director, the liability,” said Andrew Chorlton, head of investment strategies at NISA Investment Advisors. “Call it PBGC cost management annuitization. U.S. multi-sector xed income at Schroders. We do see the merits of taking 5% or 10% of your liability that consists of participants with low bal- “It is important to dene where the sponsor ances.” Given the very high per-head PBGC premiums, he continued, “I can see the strong economic wants to take active risk. That shouldn’t be argument to o-load. It’s not motivated by risk considerations, but cost.” in the long end because it is quite hard work “We do see plan sponsors are acting a bit dierently around their low-balance members,” said to make money there. There’s a higher prob- Andrew Chorlton, head of U.S. multi-sector xed income at Schroders. “It does make sense to get ability of success using an active credit allo- those people o the books because of the per-head PBGC premiums rising.” cation. There are certain freedoms we would Plan sponsors are not just concerned about the per-head charge rising; the overall cost of constrain in a liability cognizant mandate vs. carrying a decit can be troubling alongside other plan expenses. “Even if a plan is frozen, you’ve a fully unconstrained core-plus mandate.” got ongoing plan expenses,” said Wayne Daniel, senior vice president and head of U.S. pensions at Schroders prefers the term “liability MetLife. “These include investment management fees, administration expense, actuarial, legal cognizant” to LDI. “Often the term ‘liability and trustee services — and of course, PBGC premiums.” A typical plan is paying between 1% and driven investing’ suggests a false precision 3% of its plan assets in PBGC premiums. “We nd that this cost is often cited as one of the reasons that simply isn’t possible,” Schroders’ Morris for contributing to pension risk transfer activity, as plan sponsors seek to mitigate this particular said. “You can impose a highly precise term expense,” he said. structure on your assets to match your liabil- The rise in PBGC premiums is yet another reason to think carefully about closing the under- ities, and two years later the actuarial tables funding gap. “It’s probably a second-order risk, but sponsors are concerned about PBGC premiums,” change and you are o by 5%.” said Daniel Tremblay, director of xed-income solutions and LDI strategist at Fidelit y Institutional So Morris suggests that sponsors need Asset Management. “A combination of lower-than-expected rates and rising PBGC premiums are to be cognizant of the liabilities, “both in the making this tax more of a focus, leading some sponsors to make voluntary contributions to way you manage the xed-income portfolio reduce or eliminate the variable premiums.” or in creating some cost-eective hedges to help mitigate the downside risk of the growth portfolio. But don’t give up on active management within xed income or growth assets.” “LDI is a well-established trend within the U.S. pension industry today,” MetLife’s Daniel said. “While it can be a useful way for plan sponsors to reduce or mitigate the risks associated with their pension plan, it’s not a panacea for all pension plan risks.” “Pension executives can sometimes focus single-mindedly on their LDI programs as a way to address their DB plan risks,” he contin- ued. “It can’t fully account for the inevitable deviations from expectations around both assets and liabilities. Then there are early retirement and mortality risks that change. These remain within the plan.”
14 Pension Risk Management Strategies
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Annuity transaction volumes are increasing steadily, but still represent just 1% of overall DB assets. There’s plenty of potential capacity in the transfer market WHEN PENSION RISK TRANSFER IS THE Right Option
ension risk transfer, or the process of Dasher, CEO of North America and co-head growth in slightly larger plans terminat- settling liabilities with an insurance of xed income at Schroders. “The frame- ing — those that are $600 million or $700 Pcompany through annuitization, has work is highly punitive when pension plans million in assets, because over a ve- or been a topic much discussed in corporate are in de cit, but pushes them to transfer 10-year period, sponsors will have taken as pension circles. The banner year of 2012, when they have a surplus. It’s logical that much action as they can by oering lump when huge portions of the GM and Verizon pension risk transfer is increasing because sums and modifying their investment strat- pension funds were settled, brought the of this asymmetry.” egy toward xed income,” O’Brien said. “So idea to the fore. Although the number Termination may be an end goal for we expect that we might see terminations of transactions completed has steadily some plan sponsors. “I see plan sponsors creep up in size.” Nevertheless, he does not increased each year since then — up to 493 wanting to settle their entire pension liabil- expect plans of larger size to start terminat- in 2017 — the dollar volume has never come ity,” said Glenn O’Brien, managing director ing in totality. close to the $35.3 billion settled in 2012. of U.S. distribution for Prudential’s pension Yet many plan sponsors still have partial The attractiveness of the solution has as risk transfer business. “The economics just pension risk transfer in their sights. While it much to do with the regulatory environ- lean into that narrative — settling the li- can be a termination for a smaller plan, for ment as it does with speci c company ability rather than bifurcating it and holding larger ones, pension buyouts are likely part circumstances. “It’s fair to say that the U.S. onto dierent pieces of it.” of a mosaic solution that will play out over a regulations make a plan biased to transfer- To date, only smaller plans — those number of years. ring liabilities because they cannot bene t under $500 million — have completed a An annuity settlement for the retiree from any pension surpluses,” said Karl full plan termination. “But I expect to see population in a plan shrinks the plan and
16 Pension Risk Management Strategies
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eliminates the costs of administering the because the pricing is perceived to be high.” Hewitt. “The biggest shift we’ve seen in the benets, said Wayne Daniel, senior vice Slicing o these assets and liabilities can market is companies looking to settle these president and head of U.S. pensions at signicantly reduce the funding level of the participants.” MetLife, “and it also preserves the income remaining plan, 90% funding, rather than benet for the plan participants. By isolating the 105% funded level before the transfer. Multiple annuity contracts and then transferring a portion of the pen- “So as you keep paring o liabilities to Some plan sponsors have a plan to ap- sion risk, you can take a step toward reduc- buyouts, you push your plan to a new place proach the insurance market for transfer ev- ing the overall plan volatility and improving and you need to change your investment ery three to ve years with new retirees and the funded status.” strategy accordingly,” he said. at the same time, review the remaining risks This can mean an entire rethink of the in the plan and ensure they are adequately Mitigating longevity company’s approach to the pension plan. secured, MetLife’s Daniel said. Importantly, pension buyouts solve one in- In the rst instance, the company may need “We’ve written a number of multiple tractable problem for corporate plan spon- to make a cash contribution to eect the group annuity contracts for the same spon- sors. “One risk that you remove when you transfer. “It goes back to the idea of whether sor,” he said. “Of course, we’ve also seen transfer a liability to an insurer is longevity,” this is a low return-on-earnings transaction tranches placed with dierent insurers. The said Daniel Morris, head of U.S. portfolio or a higher one,” Prudential’s O’Brien said. merits of each transaction can be dierent solutions at Schroders. “And that is one risk “It often depends on whether the pension depending on the economics at the time.” you can’t manage directly with traditional is an important part of the company’s DNA. Although few of Schroders’ clients are asset management solutions.” If it isn’t, then there can be some benet in close to being able to transfer any assets to Observers expect that market volume not being in the pension business and also an insurance company, Andrew Chorlton, growth will remain steady, not necessarily being able to secure the liabilities in a way head of U.S. multi-sector xed income at increasing dramatically. Prudential’s O’Brien they haven’t been secured before.” Schroders, said, “We know that plans will points out that the insurance market needs A cash contribution may be needed want to reduce costs when transferring to transact at least $15 billion in pension risk to pay the premium to eect the pension and that means delivering a portfolio that transfer deals a year, roughly the amount it buyout for say, the retiree segment of the is best suited to the needs of the insurance is currently doing. “Insurers take on liabilities participant population, but a voluntary con- company — and that might mean one with- and they are constantly rolling o,” he said. tribution may also be needed to address the out much liquidity and only higher quality, “So while there is a deep insurance market change in funded status in the remaining very diversied credit risk.” He explained for these transactions out there, we are only portion of plan. This can also be a moment that this portfolio might look quite dierent replacing, not growing the volumes.” to reconsider the investment strategy for than one used when a plan is signicantly “With supply-demand dynamics at the what is likely to be a more volatile portion, underfunded. long end of the yield curve today, it would as actives are more risky. “This has traditionally been a fourth- be much more challenging to match the quarter business as companies seek to strike jumbo transaction volume of the fourth Company DNA settlement accounting and get transactions quarter of 2012,” said Daniel Tremblay, Often, this is the moment when plans start done before year-end,” Prudential’s O’Brien director of xed-income solutions and LDI considering a move through a rened liabil- said. “Consultants have recognized that the strategist at Fidelity Institutional Asset ity driven investing glidepath toward hiber- capacity issue is around how many transac- Management. nation. (See box, page 8.) With some or all of tions can get done with the size of the Segmentation is a huge part of the the retirees secured through annuitization, teams out there and the complexity of some conversation with plan sponsors, said a cash contribution can secure the funded of these deals. So plan sponsors might want Prudential’s O’Brien “Retirees are normally status for the active and terminated vested to hedge their bets and look to completing a large part of the pension fund in general. participants who remain in the plan. The risk in the third quarter.” The company plan will be more ecient is that if this funded status isn’t protected, Operational issues are immensely im- with terminated, vested participants and the volatile nature of that plan demographic portant in pension settlements. Companies actives.” can reintroduce risk. need to be sure that the insurance company Insurance companies are less ecient One new wrinkle in the pension buyout partner is able to handle the complexity of “The sponsor is going to be more ecient at market is a focus on those participants the transaction and that participants will be providing risk-adjusted returns for an active with small balances. They may be retirees well-treated as they retire. “If the economics population than an insurer because the or terminated vested employees, but for work and there is value in the transaction, company-sponsored plan is able to own a an underfunded plan the cost of the PBGC then whether the counterparty is up to the wider range of assets, including equit y and per-capita premiums for retaining these task becomes really important,” O’Brien said. alternatives,” he continued. individuals is very high. (See box, page 14.) “Defeasing liabilities to an insurance “Plan sponsors tend to transfer the least “The participants with the smallest ben- company under the construct of the Depart- risky part of their plan membership,” said et amounts are carrying a very heavy load ment of Labor guidance can be a safe and Schroders’ Morris. “That means they are re- in terms of PBGC premiums and operating clean way to take liabilities o the balance taining the riskiest part of the membership. costs,” said Ari Jacobs, senior partner and sheet,” said Francois Pellerin, LDI strategist They tend not to transfer the risky portion global retirement solutions leader at Aon continued on page 18
Pension Risk Management Strategies 17
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TAKING THE JOURNEY, continued from page 8
at Fidelity Institutional Asset Management. tant part of the overall eort to settle the pension risk transfer or focused on hiberna- “But it is much easier said than done. Most benets under a plan. There are two dier- tion, many sponsors are looking for more plans are underfunded, therefore large pre- ent perspectives that need to be considered transformative solutions. The answers here miums are needed to purchase annuities. since the plan sponsor has both a settlor range from an increased use of third-party There could also be accounting settlement and a duciary role. The rst is the settlor risk management platforms to more reli- charges, not to mention that pension data is perspective, which involves the plan spon- ance on outside duciaries. often not ready for such transactions.” sor making a decision as to the manage- Just getting to the position of being able ment of the plan — taking the decision to Fiduciary responsibility to execute a risk transfer is complex. “Plan close the plan and seek annuitization. The Plan sponsors are increasingly looking to sponsors need to consider the cost, depen- other consideration is the duciary role on get a holistic view of their plan and the asso- dent on their funded status and where rate behalf of the plan participants. Decid- ciated risks. Today this can mean going be- levels are,” said Fidelity’s Tremblay. “The li- ing which insurance carrier to retain and yond the more traditional services provided ability data needs to be clean. They need to whether or not to accept or decline an an- by advisers like consultants and actuaries. think about whether to deliver the assets in nuity quote is a duciary responsibility. “We see a growth in the outsourced chief kind [AIK] or in cash, though plans under $1 investment ocer (OCIO) business for DB billion have more options to deliver in cash.” Settlor and duciary plans, which gives sponsors a partner in Of course, he said, the philosophical issue of The Department of Labor has produced terms of duciary responsibility and in some whether to retain the pension plan is always guidance, Interpretative Bulletin 95-1, com- cases, full outsourcing of all investment important as well. monly referred to as 95-1, which provides decision-making,” Fidelity’s Pellerin said. “As a pension plan moves toward specic criteria and guidelines for a duciary Added Daniel Tremblay, director of termination, LDI immunization, which to consider in terms of which insurer to xed-income solutions and LDI strategist typically involves long duration-matched select and the proper due diligence process at Fidelity Institutional Asset Management, xed-income assets, can make it easier for making this decision. Depending largely “Pension risk assessment is a dynamic pro- to eectuate an AIK transaction to fund a on the size of the plan, a plan sponsor may cess. You can’t operate in a silo — you need go outside to procure an independent du- all the help you can get as a plan sponsor.” ONE RISK THAT YOU ciary to ensure impartiality for this part of “There’s a growing trend toward delega- REMOVE WHEN YOU TRANSFER the decision-making process. In either case, tion,” said Aon Hewitt’s Jacobs. “While plans A LIABILITY TO AN INSURER IS it is imperative to follow a proper process have had advisers for many years — consul- LONGEVITY and document it completely. tants, actuaries — now they want to further “One of our biggest challenges — and delegate authority, to outsource because pension risk transfer,” MetLife’s Daniel said. one that we spend a lot of time talking their sta isn’t equipped, isn’t nimble enough “This is an alternative to paying the single about — is the important balance between or large enough to manage their new asset premium up front in cash. It’s a very cost- the duciary and the settlor,” Aon Hewitt’s allocation and investment decisions.” eective transaction structure.” Though AIK Jacobs said. “The two sets of roles need to “We are seeing a more formal descrip- transactions have been common in the U.K. be very crisply dened so that everyone tion of holistic risk management frame- for many years, the U.S. market has been knows their responsibilities.” works for pension plans,” MetLife’s Daniel largely a cash business. Daniel said that this While the insurance market doesn’t face said. “Advisers are pushing plan sponsors is beginning to change as intermediaries capital issues with pension risk transfer and their duciaries to articulate and have gained a greater understanding of the transactions and indeed could accommo- document who is responsible for the risk pension risk transfer process. date more, the industry does sometimes assessment, who is responsible for docu- Accurate information about participants face human capital constraints. “The menting the process, who is monitoring can have a meaningful impact on the cost of limiting factor is resource capacity within and managing risks.” With this more formal an annuity buyout. “Insurers are looking for insurance companies,” Jacobs said. “Many codication, he said, plans are enabling 100% comprehensive and accurate informa- of the transactions being done today are more eective decision-making. tion so they can administer the annuities,” smaller. Most insurance companies only Looking to the future of holistic pension Daniel said. “If we don’t have complete and do 10 to 20 deals a year; if that increased to risk management, Fidelity’s Tremblay identi- accurate data, then the insurer will make 20 to 30, that becomes complicated. An $8 ed the need for additional infrastructure more conservative assumption and the billion transactions is more dicult than a to provide transparent, daily measurements quote will be higher.” $400 million one, but not 20 times harder. of liabilities both for plan sponsors and their “You may nd some insurers not You need 20 times more capital, but not 20 investment managers. “It’s not yet fully in- prepared to quote if the information is insuf- times more resources.” tegrated into client reporting,” he said. “But cient,” he added. “But if they do quote, Fidelity’s Tremblay said he is seeing new we know that there is a need to be able to they would look at plan-specic mortality insurance companies entering the market, quantify and systematically measure the risk experience and the benet calculation to which is making bidding more competi- on a daily basis relative to the total pension understand the complexity of the benet tive for smaller transactions. The large and plan. This will allow sponsors to measure structure.” jumbo market is still served by just a few success and risk in the right context — vs. The duciary decision is a very impor- insurers. liabilities.”
18 Pension Risk Management Strategies
PS018_PI_20170612.pdf RunDate: 06/12/17 pi Pension Risk Strategies supp 8 x 10.875 Color: 4/C 7KHLQYHVWPHQWPDQDJHUWKDWŮV IRFXVHGRQZKDWPDWWHUVWR\RX :HDUHKHUHZLWKRQHVLQJOHPLQGHGSXUSRVH7RJHQHUDWHLQYHVWPHQWUHWXUQVIRU RXUFOLHQWV$QGHYHU\WKLQJZHGRLVIRFXVHGRQWKDWDLPZLWKORQJWHUPGULYH HQHUJ\DQGLQGHSHQGHQWWKLQNLQJ:HFRQVWDQWO\VKDUHLGHDVDQGLQVLJKWVWRSXVK RXUVHOYHVLQWKHVHDUFKIRUWUXHLQYHVWPHQWSRWHQWLDODQGGHVLUHWREHWKHEHVW $OOEHFDXVHZKDWPDWWHUVWRRXUFOLHQWVPDWWHUVPRVWWRXV
$OOLQYHVWPHQWVLQYROYHULVNVLQFOXGLQJWKHULVNRISRVVLEOHORVVRISULQFLSDOk6FKURGHU,QYHVWPHQW0DQDJHPHQW1RUWK $PHULFD,QF%U\DQW3DUN1HZ PS019_PI_20170612.pdf RunDate: 06/12/17 pi Pension Risk Strategies supp 8 x 10.875 Color: 4?C CONFERENCES San Francisco: Sept 12 | Dallas: Sept 14 | Chicago: Sept 26 | New York: Sept 28 The Pension Risk Strategies Summit will survey the various pension plan risk management strategies, along with guidelines to assist in the decision-making process. Going beyond theory, the experienced plan sponsors and experts gathered to speak at the Summit will share practical knowledge for implementing the strategies discussed. The conference agenda features the following sessions: PRESENTATIONS • Exploring the End-State • Is it Prime Time for a Pension Risk Transfer? The Drivers of Pension Derisking and Innovation PANEL DISCUSSIONS • The Changing Political, Regulatory and Economic Landscape and the Impact to Funding Status • Holistic Pension Risk Management • Investment Implications of a Pension Risk Transfer • Wider Considerations Regarding a Pension Risk Transfer • Enhancing Funding Status with Return-Seeking Assets CONFERENCE CHAIR Ari Jacobs Global Retirement Solutions Leader, Senior Partner Aon Hewitt Complimentary registration at www.pionline.com/RISK2017* lead sponsors: co-sponsors: Questions? For more details please contact Elayne Glick at (212) 210-0247 or [email protected] *Registration is only open to pension plan sponsors and a limited number of investment consultants. All registration requests are subject to verification. P&I reserves the right to refuse any registrations not meeting our qualifications. The agenda for the Pension Risk Strategies Summit is not created, written or produced by the editors of Pensions & Investments, and does not represent the views or opinions of the publication or its parent company, Crain Communications, Inc. PS020_PI_20170612.pdf RunDate: 06/12/17 pi Pension Risk Strategies supp 8 x 10.875 Color: 4?C