Risk management trumps return on investment for pension managers

Market volatility and stringent regulatory issues are reshaping how North America's pension portfolios are being managed. More than 75 per cent of senior finance executives across Canada and the United States said they plan to focus on reducing risk in their defined benefit (DB) pension portfolios, rather than seek greater return on assets, according to the second CFO Research Services study conducted in conjunction with professional services firm Towers Perrin.

"After the highs and lows of the past several years, we're in an economic environment where being ready for storm conditions is the new normal," said Monica McIntosh, national leader of Towers Perrin's Asset Consulting practice in Canada. "The study shows that in this new world, finance executives are reviewing their pension investment strategy from a broader enterprise risk perspective to avoid undesirable and unacceptable consequences in terms of funded positions and company costs."

Increased market risk in a low return environment has forced pension managers to increase their emphasis on managing risk versus seeking greater return on assets. More than ever, companies need to use increasingly sophisticated tools and approaches to protect their investments and ensure that pension funds deliver the benefits promised to plan participants.

"The Canadian market is already challenged with another 'perfect storm.'  In our view, this is adding to the pressure on government for a complete overhaul to implement a pension system that works for all stakeholders and ensures Canadians have adequate retirement income," said McIntosh.
 
DB pension plan popularity has waned, but plans unlikely to disappear soon
Since 2000, the majority of company executives surveyed have made incremental changes to alter their DB plan designs. Thirty-six per cent of respondents have closed existing DB plans to new employees while continuing benefit accruals for current employees, while more than a quarter (28 per cent) replaced DB plans with defined contribution plans, shifting investment decisions and risk from the employer to the employee. In addition, while survey respondents noted there will likely be more incremental changes to come for DB plans, two-thirds (67 per cent) of companies are not likely to terminate them outright, at least for the next 24 months.

Executives Rethinking Plan Design
When it comes to plan design, nearly half of all respondents (45 per cent) said that performance of the economy or financial markets was the biggest external contributor influencing the decision-making process in DB plan design since 2000. Additional factors include competitors' pension offerings (40 per cent), changes in retirement program regulations (37 per cent), increased investor demand for profits and financial strength (18 per cent) and increased scrutiny of risk management practices.

Looking forward over the next 24 months, 62 per cent cite changes in regulation, legislation or accounting standards as the primary reasons to rethink their pension strategies. Additional catalysts include recent financial market events (41 per cent) and changes in company performance (33 per cent) - both of which have placed tremendous pressure on finance teams and pension portfolios.

"There will continue to be many forces at work that affect the relationship between a company and its employees," continues Monica McIntosh. "For many companies, pension plan management will include making simple changes to policies and portfolios, while for others, the process of evaluating the trade-offs involved with offering these plans will have broader implications for companies' financial health and their relationships with both current and former employees."

Additional Key Survey Findings:
  • Only 21 per cent indicated pension risk management is closely coordinated with a broader risk management framework.
  • Twenty-seven per cent noted that liability-based asset management prevails as the most common risk reduction strategy.
  • Companies have managed their asset portfolio risk by altering their equity portfolios, investing in alternative assets and optimizing their fixed-income portfolios.
  • Nearly half (47 per cent) said that regulatory or accounting requirements would be the chief obstacles impeding their ability to make timely decisions or desired changes in DB plans over the next two years.
  • Forty-eight per cent indicated that recent trends in the capital markets and macroeconomic outlook have made their company seriously consider changing its asset allocation strategies, while 29 per cent said it made their firm consider altering its DB plan design.

"In our analysis, we found that when pension plans hold significant assets (when compared to total corporate assets), represent an especially large or mature commitment to benefits, or have a substantial impact on cash flow or earnings, companies are consistently more committed to increased funding of their pension plans in the years ahead," said Sam Knox, vice president and director of research, CFO Research Services. "But they appear to be more reluctant to make dramatic changes in the actual design of their DB plans in the years ahead - or to off-load risk onto third parties. Instead, they are most likely to address the risk from pensions through asset portfolio management methods like duration matching in its various forms." 

The study, “Defined Benefit Plans Amid Market Volatility,” was conducted with CFO Research Services, the sponsored research unit of CFO Publishing, which produces CFO magazine. In March 2008, CFO collected the opinions of 214 senior finance executives across the United States and Canada with DB pension plans, and whose annual revenues range from $100 million to more than $20 billion.The full study is available through CFO's website at www.cfo-research.com, and through Towers Perrin's website at www.towersperrin.com.