Research Looks at Trends in Private-Sector DB Plan Underfunding
A recent analysis goes a step beyond simple measurements and data and examines trends concerning pension plan underfunding.
In “The Pension Plan Underfunding Dilemma: Analyzing the Trends,” Owais Rana. head of investment services for the global investment management firm Conning, and Scott Hawkins, a pension research specialist at that firm, offer their take on underfunding trends. Their analysis appears in the September 2017 edition of Conning’s Investment Solutions Insights.
The State of Things
Rana and Hawkins write that Conning has looked at the last five years of data on U.S. private-sector defined benefit plans, and has found that while there are some variations based on plan size and industrial sector, in general their DB plans “are currently in a holding pattern” and report that:
- While plan assets are growing as capital markets improve, so are liabilities, which they attribute to low longer-term interest rates.
- Unfunded pension liabilities remain a concern — in fact, they grew in 2016 — and are becoming a greater potential drain on corporate finances.
Rana and Hawkins caution that plans are under some pressure to “maintain a certain level of funded status” and must manage “a delicate balance” because:
- approximately half of the plans they examined were less than 80% funded;
- the Pension Benefit Guaranty Corporation is raising the premiums it charges; and
- the demand to better match plan assets to liabilities will continue to grow.
They say that to improve their funding levels and better match plan assets to liabilities, it appears that more plans are beginning to look at methods such as liability driven investment (LDI) strategies. Plans overall “seem to be taking smaller, but nonetheless noticeable, steps toward reducing equity exposures and increasing fixed income allocations,” they add.Pressure
“Corporate officers have been increasingly interested in the funding status of their DB pension plans because unexpected contributions required by the plan have had an impact on their companies’ bottom line,” Rana and Hawkins observe. They also report that plans are reducing equity exposure and trying to better match their assets to liabilities, which they take as evidence that de-risking is becoming more widespread. This, they posit, heightens financial stress on the employer, because it could result in higher demand for longer-term bonds to meet longer-term liabilities, which, in turn, could raise bond prices.
If there is even a “minor slip” in funding, Rana and Hawkins argue, an employer could have to devote revenue to additional pension plan contributions, to the detriment of other priorities. They suggest that employers may need to refine their investment strategies if the seek “meaningful improvements” in plan funding status.Crystal Ball
Rana and Hawkins suggest that plans may “need to take more significant steps to improve their
funding levels and better match plan assets to liabilities or offload them to an insurer at a premium.” Among them are initially pursuing more aggressive growth strategies and then later refining asset allocations to better match assets and liabilities.
“Overall, having a well-designed de-risking glidepath is critical to the success of capturing improvement in funded status,” argue Rana and Hawkins.