Plan Sponsor Alert: Revisiting De-Risking Options

May 2022

Thanks to better returns and an uptick in discount rates used to value plan liabilities, defined benefit plans’ funding statuses have improved to some of their highest levels since the Great Recession. Many plan sponsors are eager to preserve these gains and want to take risk off their balance sheet by implementing de-risking strategies. Because of the recent changes in funding levels and the various de-risking methods at their disposal, plan sponsors should use this opportunity to reexamine their current approach to best fit their goals for their plans and participants.
 

Determining the right de-risking strategy

We have written about de-risking in previous articles, but the environment and appetite for de-risking has changed significantly over the past few years. De-risking activity saw a brief slowdown before the COVID-19 pandemic, but nearly all plan sponsors responding to MetLife’s 2021 Pension Transfer Risk poll said they plan to completely divest of their companies’ pension liabilities in the future.

When considering a de-risking strategy, plan sponsors should first review the plan’s goals and study what drives the need to de-risk. It is important to consult with advisors to determine how assets and liabilities can be controlled—and at what price. Next, plan sponsors should look at the various available options. Out-of-plan approaches include lump-sum payouts, annuity buy-outs, and full plan terminations. In-plan methods include liability driven investments (LDI), in-plan annuities, and freezing plan benefits or freezing the plan to new participants.

Buy-outs: Buy-out products, like annuities, transfer some or all pension liabilities to an insurer and reduce the overall risk to the plan sponsor. U.S. corporate pension plan buy-outs soared to $34.2 billion in 2021, up 37 percent from 2020 and their highest level since 2012, according to a LIMRA Secure Retirement Institute study released in March 2022. LIMRA Found that 47 percent of plan sponsors are very interested in a buy-out deal in the future, a 41 percent increase from 2018.  A complete termination of a pension plan usually involves a combination of paying participants lump sums and purchasing annuity products.

Buy-ins: Buy-in products are also usually annuity products. But instead of completely transferring liabilities to an insurer, the pension invests in annuity products which offer more stable returns and lower the risk of investment downturns.

Liability-driven investing (LDI): Buy-outs can be an expensive solution for many plan sponsors, so a more attractive approach may be liability-driven investing—investment strategies to make the underfunding in a pension more predictable. These strategies are intended to reduce the effects of market downturns, but at the same time they can also dampen the benefits of market gains. Many plan sponsors already have some kind of LDI strategy in place, but recent changes in the market and rising interest rates may require plans to take a second look at how these factors have altered their course.

A strong LDI approach should create a customized asset allocation that matches the current and future liabilities of a pension plan. But some factors are beyond a plan sponsor’s control. The war in Ukraine, rising gas and commodity prices, and lower expected returns on investments are examples of new variables to consider in just the first few months of this year. Plan sponsors may need to reach outside their existing LDI toolkit for other ways to stabilize the balance between assets and liabilities. Plan sponsors should look for a customized approach that fits the needs of their unique situation.
 

COVID-19’s impacts on mortality tables

A recent Milliman study found that between March and December 2020, total deaths were 21 percent higher than expected, and 80 percent of the increase may be attributed directly to the pandemic. It is still too early to tell whether the pandemic will impact the future of mortality tables used to determine liabilities, but plan sponsors whose workforces have been significantly affected should consult with their actuary to determine whether accommodations need to be made.  
 

Find the best approach to fit your plan and its participants

A defined benefit plan’s unfunded liability may be the biggest risk on an organization’s balance sheet. When it comes to de-risking strategies, every situation is unique and there is no one-size-fits all strategy. Making these decisions take careful consideration. Your BDO representative can help sift through the available options to help you determine which de-risking approach suits your specific situation.