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Employers assess pension risk to reduce exposures

Traditional pension plans remain an important benefits offering for many employers

Employers assess pension risk to reduce exposures

Although there’s been a steady decline of traditional defined benefit pension plans during the past 15 years, a sizable percentage of employers remains committed to offering the benefit to their employees.

Rather than freezing or closing their plans to new hires, many employers are exploring innovative strategies for reducing their pension programs’ exposure to the inherent volatility that have chased the majority of companies out of the business of providing defined benefit retirement plans.

About 17% of more than 400 large and midsize employers that responded to a survey in late 2013 by Chicago-based benefits consultant Aon Hewitt indicated they still offer traditional defined benefit retirement plans to all employees, including new hires.

A separate survey, conducted in February by the Alexandria, Virginia-based Society for Human Resource Management, found that the percentage of employers offering traditional defined benefit retirement plans actually increased by five percentage points to 24% in 2014 from 19% in 2013.

Experts say there are several demographic and economic factors that may inform an employer’s decision to retain a traditional defined benefit plan.

For example, experts say employers in relatively stable, high-profit-margin industries such as energy production, privately owned utilities, financial services and certain types of manufacturing are more likely to offer defined benefit plans than employers in industries where profit margins are generally lower and more susceptible to market volatility, such as construction, retail and hospitality.

“A lot of it is a matter of size,” said Kevin Wagner, an Atlanta-based strategic benefits consultant at Towers Watson & Co., noting that employers that still offer traditional defined benefit pensions tend to be larger regional or national companies.

In a November 2013 survey conducted jointly by Towers Watson and Institutional Investor Forums, 43% of employers with defined benefit pension plans with assets totaling $1 billion or more indicated their plans remained open to new hires, compared with 22% or less of employers with plan assets of less than $1 billion.

“A lot of these companies have what might seem like very big pension plans,” Mr. Wagner said. “But within the context of their overall business, the risk that those kinds of pension plans present to the balance sheet is relatively miniscule.”

Generally speaking, experts say employers that choose to continue offering defined benefit pensions to current and former employees do so as a means to attract and retain top talent, particularly in the energy production and pharmaceutical manufacturing industries, where skilled labor is in short supply.

“You’ll always have companies that will offer traditional DB plans in order to differentiate themselves and send a strong message that they value career-long employment,” Mr. Wagner said. “Employees clearly like the security of a defined benefit program, and for employers that want a great retirement program, to the extent that the volatility doesn’t impact their business, traditional defined benefit plans are a great way to go.”

Studies suggest that employers that have maintained defined benefit pension plans for new hires intend to continue doing so, at least in the near term.

Out of the 30% of employers polled in the Towers Watson/Investor Forums survey that offer traditional defined benefit retirement plans to new hires, more than 70% indicated they expected to still be doing so in five years’ time.

“One of the things that traditional DB plans do quite well is send a clear message to an organization’s workforce about the age at which they should be thinking about retiring,” said Arthur Noonan, a Pittsburgh-based senior partner and benefits consultant at Mercer L.L.C. “From a workforce management perspective, having people stay on until they’re at an appropriate retirement age versus dealing with a lot of turnover will be important for a lot of companies.”

In order to make their traditional defined benefit pension plans more sustainable, many employers have implemented one or more de-risking strategies during the past several years.

One increasingly popular method of pension de-risking is the concept of offering lump-sum buyouts — as opposed to annuity payments — to vested former employees who have not yet retired, or to current employees at the time they retire or leave the company.

Thirty-nine percent of employers polled by Towers Watson and Institutional Investor Forums indicated they had already offered lump-sum benefit payments to former employees, and another 28% said they were planning to do so in 2014 or considering it for 2015.

“That’s one way to retrospectively mitigate the risk of a traditional DB plan,” said Stewart Lawrence, New York-based senior vice president and national retirement practice leader at The Segal Group Inc. “But there is a risk with lump-sum payouts. There could be a situation where the people in poorer health take the lump-sum payment, which would ultimately raise your pension costs rather than lowering them.”

Other formal de-risking measures that have gained popularity in recent years include annuity purchases, liability-driven investment strategies and adjusting investment allocations toward fixed-income instruments and alternative return-seeking assets, such as hedge funds, private equity and real estate.

“Really, it comes down to risk appetite,” said Zorast Wadia, a New York-based principal and consulting actuary at Milliman Inc. “If your company has absolutely no appetite for pension risk or your balance sheet has no room for volatility, then you should probably get out of the defined benefit business.”

However, he said, “if you do have some level of risk tolerance, then there are ways — with the tools that are out there today — to bring your pension risk down to within whatever those specified tolerance levels are.”

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