Pension plan “de-risking” has recently become a hot discussion topic for pension plan sponsors. De-risking involves employing strategies to make the plan less sensitive to factors that affect required pension funding levels, such as market swings and life expectancy improvements, and therefore lessening the risk of future volatility in required contributions. In very general terms, there are three different approaches to de-risking:
- Allow lump sum payments from the pension plan when individuals terminate employment
This strategy removes risk of future mortality improvements and interest rate fluctuation with regard to the benefits that are paid as a lump sum. There are varying degrees of offering lump sums: to all terminated employees, at retirement age only, or as a “window” opportunity for terminated employees. This approach has the additional benefit of reducing per participant PBGC premiums.
- Use a Liability Driven Investment (LDI) asset management approach
This strategy involves investing pension assets in vehicles that match the future pension plan cash flow needs. As a plan matures and has greater cash outflows, a larger portion of investments under this approach will be directed to fixed income options which preserve asset returns and reduce the impact of market swings.
- Transfer longevity risk via use of insurance company products
Purchasing annuities for retirees in pay status is the obvious strategy here, but there are other creative options as well.
Each approach requires careful consideration of the benefits and trade-offs such as cost, philosophical positions, administration, time horizon, etc. with regard to the particular pension plan and its company sponsor. These options should be discussed with your actuarial consultants, investment advisors, and/or insurance providers to determine if any of these de-risking options are desirable for your company and the pension plan(s) you sponsor.
Blog authored by Cheryl Gabriel, CPC.