Administration May 19, 2016

DB Plan Sponsors Focusing Attention on Funding

The issue of funding pension plans has risen to the attention of companies’ leadership, a survey shows.
Reported by

A fully funded defined benefit (DB) plan reduces future financial risk to the company sponsoring the plan and enables the consideration of different investment strategies available to maintain full funding, notes a survey report from Prudential.

It can also lay the groundwork for the next stages of DB risk management, such as transferring pension obligations to a third-party insurer.

Never miss a story — sign up for PLANSPONSOR newsletters to keep up on the latest retirement plan benefits news.

The survey shows that, while some companies still need to improve just to reach the minimum funded level required by law, others are working towards higher funded ratios. Sixty-four percent of respondents report either that their companies have already increased contributions (15%) or that they are likely to do so within two years (49%).

The issue of funding pension plans has risen to the attention of companies’ leadership. When asked if their board of directors and senior management are focused on the financial risk of their DB plans, four times as many respondents agree (48%) as disagree (12%). The remainder neither agree nor disagree.

However, uncertainties about the timing of interest rate increases, continued volatility in equity markets, and increasing life expectancies make it more difficult to calculate liabilities and returns over the long term. Accordingly, half of the firms in the survey (49%) report that they have modeled future DB contributions based on assumptions of extreme market volatility, while 62% have modeled for increasing longevity.

One way to manage volatility is through the use of liability-driven investing (LDI). Seven out of 10 respondents (71%) report that their companies already invest some portion of their DB plan assets in LDI strategies. Thirty-five percent (35%) of this year’s respondents view LDI as an initial step towards full DB liability transfer, and 32% say their adoption of LDI has significantly reduced DB risk.

NEXT: Preparing for longevity risk

In addition to volatility, longevity risk continues to garner increased attention. The Society of Actuaries has published new mortality tables based on longer life expectancies, with the result that projected liabilities may increase for some companies.

The survey shows that most companies are preparing to account for the increase in life expectancies in their calculations. About six in 10 respondents (61%) say either that they have reviewed participant mortality experience within the past 12 months (46%) or are planning on doing so within the next 12 months (15%).

One option for managing the risk involved with mortality assumptions is longevity insurance. Nearly one-quarter of respondents (23%) believe that these types of transactions could be relevant for their own companies.

However, the largest proportion of respondents (35%) say that they do not yet know enough about the longevity insurance transactions to have an opinion, and an additional 9% are not aware of the transactions at all.

In a recent conversation with PLANSPONSOR, Rohit Mathur, head of Global Product & Market Solutions, Pension & Structured Solutions at Prudential Retirement in Newark, New Jersey, said borrowing to fund is a viable funding strategy for nearly all DB plan sponsors.

Results of the sixth annual survey CFO Research has conducted with Prudential Financial, are based on survey responses of 180 finance executives, most of whom (78%) work at large U.S. companies with more than $1 billion in annual revenues. All of the companies in the survey also have DB plans with more than $250 million in assets; 31% have between $1 billion and $5 billion in assets, and an additional 31% have more than $5 billion in assets.

Administration May 19, 2016

Borrowing to Fund Is a De-Risking Strategy for DB Plans

The combination of increasing annual PBGC premiums and the low rate environment make borrowing to fund a very attractive potential opportunity for plan sponsors.
Reported by

The enduring low interest rate environment offers a unique opportunity for plan sponsors to fund their pension plans, according to an article from Prudential.

Sponsors of underfunded defined benefit (DB) plans can borrow at attractive rates and contribute the proceeds to their pension plan, thereby reducing—or even eliminating—their pension deficit.

Get more!  Sign up for PLANSPONSOR newsletters.

Rohit Mathur, head of Global Product & Market Solutions, Pension & Structured Solutions at Prudential Retirement in Newark, New Jersey, explains to PLANSPONSOR that borrowing to fund means the DB plan sponsor issues a contractual debt in the marketplace. The interest rate is based on creditworthiness.

“Borrowing to fund pension deficits provides plan sponsors with a way to replace variable and potentially volatile debt obligation—the underfunded pension—with a known, certain amount of debt at a fixed funding cost,” says Mathur. “A range of plan sponsors—with small, large, frozen or ongoing plans—could benefit from a ‘borrow-to-fund’ strategy.”

The strategy benefits plan sponsors by reducing variable premiums to the Pension Benefit Guaranty Corporation (PBGC)—premiums that are expected to rise to 4.1% of unfunded liability in 2019. In addition, the economic benefit of this approach is also driven by lower after-tax debt service compared to annual plan contributions, and acceleration of tax deduction on pension contributions.

NEXT: Borrowing to fund is right for nearly all DB plans

Comparing two scenarios—making regular annual required contributions and borrowing to fund—shows a hypothetical plan could be fully funded in 10 years under the first scenario or fully funded in one year in the second scenario. A Prudential article notes that borrowing to fund yields a net present value (NPV) economic benefit of $150 million, compared to the pay-over-time strategy. This is based on a model BBB-rated company sponsoring a $7 billion pension plan that is 85% funded. The plan’s population is assumed to be split evenly among retirees and non-retirees; the average age of plan participants is 65; and plan participants receive an average annual benefit of approximately $8,200.

According to Mathur, part of the analysis in deciding whether to borrow to fund is determining if the interest on the debt is cheaper than PBGC premiums. DB plan sponsors should also look at the overall funding deficit and contribution requirement and compare that to the benefit of contributing to the plan more quickly.

Mathur also says DB plan sponsors should look at their creditworthiness. A Prudential analysis found borrowing to fund may be optimal for companies across the credit ratings spectrum based on current debt market conditions. “We believe such a strategy is optimal for most plan sponsors, except in situations where a restrictive leverage covenant in credit facilities could become adversely impacted by the issuance of contractual debt,” the Prudential article says.

"We believe borrowing to fund is an important first step to consider in the context of an overall risk-reduction strategy, and should be utilized based on a plan sponsor’s end goal for pension de-risking,” Mathur says. He tells PLANSPONSOR borrowing to fund can be an important part of any strategy, including liability-driven investing (LDI), offering a lump-sum payment window or completing a pension risk transfer.

«