The Markets February 11, 2014

Corporations Look to Secure Pension Gains

The recent decrease in the funded status of defined benefit pension plans highlights the need for plan sponsors to possess a strategy for locking in a favorable funded status.
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A new analysis from Russell Investments, featured in its January “LDI Update” report, finds while 2013 saw an increase in the funded status of pension plans, this year has begun on a less favorable note. The analysis points out there are ways plan sponsors can attempt to lock in pension funding gains.

Marty Jaugietis, managing director, LDI Solutions, Russell Investments tells PLANSPONSOR, “There should be some modeling done of the impact of a reduction in funded status volatility.” He says plan sponsors pursing such a strategy will also tend to invest more in an LDI-type portfolio, investing, for example, in something such as a fixed-income vehicle that possesses a duration similar to that of the plan’s liabilities.

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The New York-based Jaugietis, who is one of the authors of the analysis, explains that de-risking and Liability-Responsive Asset Allocation (LRAA) schedules can be used as tools in the locking-in process: “The process to de-risk a plan is usually incremental. It’s not one step and you’re done. It’s also more cost-effective to de-risk over time. The LRAA schedules act as more of an investment policy strategy. As the funded status of a plan improves, a schedule can act as a glide path for funding all current and future plan liabilities.”

The report discusses plan sponsors using piping and de-risking triggers to foster a quicker response to funded status volatility. “I would define piping as the infrastructure and data feeds necessary to monitor plan liabilities and funded status on a daily basis. Piping can help plan sponsors measure when they hit certain triggers,” says Jaugietis. He explains that a plan sponsor can sit down with a provider and map out a set of responses for different levels of funded status (e.g., If trigger A happens, go with response B).

When a scenario unfolds in the marketplace and triggers are hit, the sponsor’s pre-planned response can then be carried out by the provider, who Jaugietis terms as the “LDI quarterback.” While the plan sponsor is still responsible for establishing and overseeing the content of the responses, this “quarterback” is responsible for actually carrying them out.

The “Russell LDI Update” for January can be downloaded here.

Data & Research February 11, 2014

DC Plans Important to Retirement Security

Defined contribution (DC) plans are a critical part of the U.S. retirement system, says a research report.
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“Building Retirement Security Through Defined Contribution Plans,” authored by Professors Jeffrey R. Brown and Scott J. Weisbenner from the University of Illinois at Urbana at Champaign, was written in cooperation with the American Council of Life Insurers. The report indicates that positive strides have been taken by DC plan sponsors in recent years, especially in the areas of increasing participation, providing more diversified portfolios and providing immediate eligibility to employees that are more likely to switch employers at various times throughout their career.

As the DC system has grown, say the authors of the report, it has evolved to better meet the needs of employers and participants. “Median employer plus employee contribution rates are now approximately 10% of income,” they say. “Additionally, the widespread use of life cycle and target-date funds as default investment options, as well as the decline in allocations to employer stock, has greatly improved the asset allocation of typical participants. As a result of these and other improvements, today’s defined contribution system is preparing millions of participants for a secure retirement.”

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The report addresses critics of the DC system who claim that defined benefit (DB) plans are a better retirement vehicle. “The good old days of the DB plan were not actually so good,” say the report’s authors, pointing out that prior to the protections offered by the Employee Retirement Income Security Act (ERISA), employee retirement benefits were “exposed to substantial funding risk and short-tenure workers often received no benefits at all.”

In addition, the report finds as a result of ERISA protections, many employers have found that providing a DB plan no longer passes “the cost-benefit test in light of a changing economic environment.”

As for improvements to the DC system, the authors recommend, “Policymakers and the employer community should work together to continue to build on the substantial progress already made regarding coverage, participation and contributions, as well as in the promotion of guaranteed retirement income and other retirement risk management practices.”

Other recommendations include improving incentives for employers to offer plans and making part-time and recently hired workers eligible to participate, as well as increasing employee contribution rates through automatic enrollment and automatic escalation plan features.

In terms of changes on a broader level, the report suggests that the aim of DC plans be refocused from simply accumulating wealth to “treating DC plans as a path to guaranteed retirement income.”

The full text of the report can be downloaded here.

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