Pensions: A Changing Focus on Risk

Sponsors of defined-benefit plans have shifted their attention over the past few years from a focus on returns to more of a focus on making asset decisions in the context of liabilities -- or a more individualized rate-of-return model, according to one survey. Another found that more than four of five sponsors were concerned with interest-related risks and general market uncertainty.

By Andrew R. McIlvaine

Marking a development that, experts say, bodes well for the long-term survival of traditional pension plans, two recent reports find that sponsors of defined-benefit plans are more aware of the potential risks facing their plans and are more focused on mitigating those risks than they've been in the recent past.

The 2011 U.S. Pension Risk Behavior Index from New York-based MetLife finds that plan sponsors are focusing on a smaller number of risks and paying greater attention to them than in 2010, when MetLife's survey found plan sponsors placing nearly equal importance on all the risks facing their plans.

In MetLife's 2009 survey, plan sponsors were focused mostly on asset-related plan risks.

"We've found that plan sponsors have moved from having an asset-centric outlook to looking at assets in terms of each plan's specific pension-plan liabilities, and that's great, because the old rate-of-return model was one-size-fits-all," says Cynthia Mallett, a vice president in MetLife's corporate benefit funding group who oversaw the study.

"What we see now is an emerging recognition that not all plans are the same and that plan sponsors are looking at making asset decisions in the context of liabilities," she says.

The new focus on individual plan risks is especially welcome because plans can vary considerably from company to company, says Mallett. "You can have differences in the distribution of ages and years of service, differences in benefit-plan formulas, differences in the form of payments.

"Typically, these factors weren't even thought about -- plan sponsors focused on the single present value of future obligations that was prepared for accounting purposes and for use in financial reports," she says.

This year's MetLife study surveyed 149 plan sponsors from among the 1,000 largest U.S. defined-benefit plan sponsors.

Mid-sized DB plan sponsors have also gotten more focused on risk control than in the recent past, according to a new survey from Vanguard, the Valley Forge, Pa.-based investment-management company.

Vanguard's Survey of Defined Benefit Plan Sponsors 2010 queried plan sponsors with $100 million to $1 billion in assets.

Eighty-five percent of them rated pension risk as "very" or "extremely" important, with the importance of risk increasing with a plan's asset size relative to company size. The two risk concerns most-cited by sponsors were interest-rate risk (cited by 85 percent of respondents) and uncertainty in the equity markets (80 percent). Eighty-nine percent said their plans are underfunded.

"The focus on risk over returns is interesting because it's a departure from what we've seen over the years," says Kimberly Stockton, an investment analyst for Vanguard and author of the study.

A majority of respondents to the Vanguard survey said they intended to "de-risk" their plan by implementing so-called liability-driven investment strategies, increasing their portfolio's fixed-income allocation and duration, and decreasing their equity allocation.

It also found that respondents who rated their plan as more risky were more likely to make changes to their investment strategies -- including liability-driven investment strategies -- and to freeze or terminate their plan or make benefit changes.

These strategies are not without potential drawbacks, says Stockton.

"If you're moving to an asset that's expected to have a lower rate of return, you could end up with lower funding ratios and higher costs overall," she says. "Nevertheless, you'd still have less volatility, so you're not going to have these 'contribution surprises,' where the company has to come up with this huge contribution to make up for an unexpected loss."

Mallett also says she expects to see more plan sponsors changing their strategies, moving toward partial risk transfers and special investment strategies.

"It's important to note that the results of these actions will take some time to show up," she says. "There are market forces beyond the plan sponsors' control that may obscure the effectiveness of these changes during the first couple of years."

The effects of these changes may have been reflected in the rates-of-return performance of DB plans versus defined-contribution plans in 2009, according to a just-released Towers Watson analysis.

Although DB plans outperformed DC plans in 2008 by the widest margin since the beginning of the decade, DC plans had the edge in 2009, slightly outpacing DB plans for the first time since the bull market of 1995-2000.

"Larger allocations to equities in DC plans may have led to better investment performance in 2009," says Chris DeMeo, head of investment for North America at Towers Watson. "Meanwhile, many DB sponsors had already shifted toward investment strategies that were more closely linked to the underlying liabilities, which mitigated their 2009 losses but also may have hindered their overall performance in 2009."