Posted on 21 Aug 11
Current stock market instability and falling bond yields underscore the risk defined benefit pension plan sponsors are assuming if they don’t have measures in place to minimize that risk, according to Aon Hewitt, the global human resources consulting and outsourcing solutions business of Aon Corporation. The “perfect storm” of declining equity markets combined with diminishing bond yields increases plans’ funding deficits, which may well require additional sponsor contributions to these plans.
This time last year (August 11, 2010), the aggregated funded ratio of Canadian defined benefit plans was 87 per cent on an accounting basis. That figure steadily improved and on July 25, 2011, it sat at 97 percent. However, between July 25 and August 12, pension plans truly have been on a rollercoaster. At one point (August 8, 2011), pension plans sat as low as 85 percent, wiping out the gains – and more – from last year.
The volatility seen in accounting position has been huge, with daily swings of more than two per cent happening on every business day in August so far except four.
“Assuming some risk is common in building retirement funds,” said Tom Ault, a vice president with Aon Hewitt in Vancouver. “Plans can experience losses, but we all assume we will be able to make up those losses over time and accept that risk. However, when it comes to defined benefit plans, the risk for plan sponsors can often be very one-sided. They are exposed to the additional contribution requirements that can be caused by a market downturn, but often benefit little from plan surpluses. Given the economic ups and downs of the last few years, some sponsors are opting to minimize risk by implementing either a de-risking strategy or a dynamic investment policy. These plans will find that their funded status is less affected by market volatility.”
Measures that plan sponsors are adopting to reduce risk include making plan design modifications, as well as changing investment policy – increasing diversification out of Canadian equities and intermediate bonds and shifting to global equities, long bonds and alternatives. In addition, organizations may revamp their funding policy and contribution strategy.
Dynamic investment policies, in particular dynamic de-risking policies, which reduce risk as a plan’s funded ratio improves, are perceived to be a prudent approach to reducing risk and long-term costs, while taking the emotional element out of asset mix decisions. Fundamental to the dynamic investment policy approach is identifying the right balance between two asset categories—return-seeking assets and hedging assets—and managing that balance over time.
“The current rollercoaster ride may have convinced more plan sponsors of defined benefit plans that it’s time to adopt a more conservative approach to risk,” stated Ault.