More Reasons for De-Risking DB Plans

Employers are finding more reasons to de-risk their defined benefit (DB) retirement plans, says a new analysis from Buck Consultants.

The analysis, “Employers Finding More Reasons to De-Risk Retirement Plans,” observes how improvements in the funding status of DB plans are prompting DB plan sponsors and fiduciaries to take steps that will reduce future volatility in plan costs. To achieve this reduction, liabilities are being moved out of the plan and sponsors are aligning investment allocations more closely with plan liabilities.

“For nearly six years, defined benefit plan sponsors have been nervously watching their funding ratios in the wake of the financial crisis. Now that they are closing back in on being fully funded again, many want to take steps so this never happens to them again,” say Jerry Levy and Marjorie Martin, authors of the analysis.

The reasons most often cited as the underlying rationale for de-risking efforts include:

  • Funded status improvements. These may have triggered an increase in fixed-income allocation or the development of a hedging portfolio based on glide path strategies. When it comes to investment strategies, experts recommend that plan committees review the thinking behind why a glide path was set up, since significant downturn events are still not entirely out of the realm of possibility.
  • Current certainty versus the unknown. Even if the plan is in a position to pay lump sums or purchase annuities, it may be tempting to wait for interest rates to go higher and push those costs down. However, for plans that have moved heavily into fixed income, there may be no advantage to waiting. In terms of investment strategies, the analysis suggests adding a dual trigger to the glide path based on interest rate levels to ease into a hedging portfolio over time.
  • Premiums for the Pension Benefit Guaranty Corporation (PBGC) increasing. DB plan sponsors with underfunded plans pay additional risk premiums, which have increased since 2013. The analysis points out that a dynamic asset allocation approach will not reduce the premium cost immediately, but that an increase in funded status will reduce the PBGC premium costs over time.
  • Avoiding one-time accounting charges. Lump-sum cashouts may trigger one-time settlement charges sooner rather than later, so if a plan pursues a cashout strategy, this needs to be kept in mind.

The analysis also mentions guidance offered by the Department of Labor, derived from testimony and recommendations from its 2013 ERISA Advisory Council, which could have applications for de-risking strategies. A summary of this guidance can be found here.

Levy and Martin conclude that DB plan sponsors need to carefully weigh the options they have to de-risk their plans. A copy of the Buck Consultants analysis can be downloaded here.