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Closing the Gap in DB Plans

In the sixth annual survey that CFO Research has conducted with Prudential Financial, Inc., finance executives from companies with defined benefit (DB) plans reveal a continuing concern with funding DB plans. Accordingly, many companies are increasing contributions to close their funding gaps, moving them closer to full funding. The survey shows that, while some companies still need to improve just to reach the minimum funded level required by law, others are working towards higher funded ratios. Sixty-four percent (64%) of respondents report either that their companies have already increased contributions (15%) or that they are likely to do so within two years (49%). (See Figure 1.)

A fully funded plan reduces future financial risk to the company and enables the consideration of different investment strategies available to maintain full funding. It can also lay the groundwork for the next stages of DB risk management, such as transferring pension obligations to a third party insurer.

The issue of funding pension plans has risen to the attention of companies’ leadership. When asked if their board of directors and senior management are focused on the financial risk of their DB plans, four times as many respondents agree (48%) as disagree (12%). (The remainder neither agree nor disagree.)

However, uncertainties about the timing of interest rate increases, continued volatility in equity markets, and increasing life expectancies make it more difficult to calculate liabilities and returns over the long term. Accordingly, half of the firms in the survey (49%) report that they have modeled future DB contributions based on assumptions of extreme market volatility, while 62% have modeled for increasing longevity. (See Figure 2.)

One way to manage volatility is through the use of liability-driven investing (LDI). Far more respondents agree that LDI has significantly reduced their DB risk than disagree. (See Figure 3.) Seven out of ten respondents (71%) report that their companies already invest some portion of their DB plan assets in LDI strategies.

For some companies, the benefits of an LDI strategy can extend beyond reducing volatility and uncertainty in pension plans as they are currently structured. Thirty-five percent (35%) of this year’s respondents view LDI as an initial step towards full DB liability transfer. (See Figure 3.)

In addition to volatility, longevity risk continues to garner increased attention. The Society of Actuaries has published new mortality tables based on longer life expectancies, with the result that projected liabilities may increase for some companies. (Note that the survey was conducted prior to the announcement of the latest mortality improvement scale in late 2015.)

The survey shows that most companies are preparing to account for the increase in life expectancies in their calculations. About six in ten respondents (61%) say either that they have reviewed participant mortality experience within the past 12 months (46%) or are planning on doing so within the next 12 months (15%). As one respondent writes in the survey, “You have to wonder how long you can maintain payouts [from pension plans] should the employees live much longer than currently anticipated.”

One option for managing the risk involved with mortality assumptions is longevity insurance. In the United Kingdom, some large pension plan sponsors have entered into transactions in order to protect themselves in the event that mortality assumptions prove inaccurate. About a quarter of respondents (23%) believe that these types of transactions could be relevant for their own companies.

However, the largest proportion of respondents (35%) say that they do not yet know enough about the longevity insurance transactions to have an opinion, and an additional 9% are not aware of the transactions at all. As finance executives work towards stabilizing funding and reducing financial risk in DB plans, they may wish to consider all of the options now available to them.

 

Research Sponsor's Perspective

“Employers are seeing how funded status volatility is coming from more than just investment markets and can include improvements in the longevity of their plan participants as well. To reduce volatility, many plan sponsors need to get their plan closer to a fully funded status. The survey results indicate an increased desire on the part of many companies to close their funding gaps. We know from our conversations with plan sponsors that a big reason is to get to the point where de-risking strategies, such as liability-driven investing, can be deployed to reduce the funding risk that may come from interest rate movements.”

Harsh Parikh
Vice President, PGIM Institutional Advisory & Solutions

About the Survey 

This year marks the sixth annual survey that CFO Research has conducted with Prudential Financial, Inc. The surveys provide insights into finance executives’ current thinking on their companies’ retirement and benefits programs. This year’s results are based on survey responses of 180 finance executives, most of whom (78%) work at large U.S. companies with more than $1 billion in annual revenues. All of the companies in the survey also have defined benefit (DB) plans with more than $250 million in assets; 31% have between $1 billion and $5 billion in assets, and an additional 31% have more than $5 billion in assets.

 

 

 

 

 

 

 

 

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