“Defined Benefit (DB) pension plans in the United States are emerging from the COVID-19 pandemic into one of the most favorable policy and market environments they have seen in years, according to a new Mercer/CFO Research Risk Survey.
However, DB sponsors remain cautious from years of secular headwinds.
According to the 6th edition of “Next Steps in Pension Risk Management,” the pandemic offered a unique stress test for plan sponsors, as well as new opportunities to solidify and strengthen their deliberate, multi-year strategies.
The survey makes clear that CFOs are seeking strong, strategic counsel – both in-house and outsourced – to help navigate what could be the most favorable landscape for defined benefit pension plans in many years.
“2020 proved to be a true stress test for defined benefit plans, as COVID-19 created disruptions in financial markets and corporate balance sheets,” Matt McDaniel, Partner, U.S. Financial Strategy Group at Mercer, said in a statement. “However, it also created opportunities for sponsors with a strategy to improve their financial position, and many took advantage.”
Among the survey’s key findings:
Companies and CFOs are ready to take advantage of policy
The survey of over 200 executives showed companies are primed to make changes to their DB plans and they’re planning to leverage the American Rescue Plan Act funding relief legislation. Under the American Rescue Plan Act, companies have more flexibility on funding options for their DB pension plans.
About one-third of survey respondents cited their motivation to fund to a threshold was to avoid benefit restrictions or participant notices. However, as a slight departure from prior survey’s results, only 15% say they are geared to fully fund the plan over a shorter time period than the regulations stipulate. This is down from 29% in 2019 and points to higher needs for cash in other parts of the business.
Transferring risk
Plan sponsors continue to reduce their contribution and funded status volatility risk by transferring liability to an insurer or another party.
Survey results indicate that the vast majority (90%) of the surveyed executives said they had offered lump-sum features to DB plan participants to transfer risk within the decade, and with 77% of the respondents likely to offer additional lump sum options within the next two years. Annuitization is trending; while 70% of respondents have already transferred benefits to insurers via an annuity purchase, 77% expect to do this in 2021 or 2022.
Making smart investment choices
Governance of a pension plan is complex, and 65% of survey respondents said they struggle to find the time and expertise to oversee their pension investment strategy.
Further, 67% said they struggle to execute changes required by their investment strategy in a timely fashion. Given the dynamic and more favorable environment, this is leading many plan sponsors to seek strategic counsel to improve their plan’s approach to allocation and risk management. Over 70% of respondents have implemented either a full or partial outsourced chief investment officer (OCIO) model to support their investment strategy and execution.
CFOs are changing their portfolios
The most-cited investment change in 2020 was adding alternative investments – such as private equity, private debt, hedge funds and real assets – a shift cited by half the respondents.
Historically, plan sponsors have shied away from alternative investments as the liquidity restrictions and fiduciary risk were too high, but new solutions within the alternative space have the potential to provide attractive returns with more favorable liquidity. In the most recent findings, plan sponsors are ready to use these tools to seek to achieve their DB pension goals. Half of survey respondents use private assets selectively and 40% have them as a core part of their asset mix.
This reinforces the idea that plan sponsors are paying closer attention to their plans and looking for innovative solutions to address their risks and aim to improve investment outcomes.
With more than 20 years serving financial markets, John Sullivan is the former editor-in-chief of Investment Advisor magazine and retirement editor of ThinkAdvisor.com. Sullivan is also the former editor of Boomer Market Advisor and Bank Advisor magazines, and has a background in the insurance and investment industries in addition to his journalism roots.
