Administration February 11, 2019

DB Plan Funded Status Rebounds in January

Stronger equity markets pushed pension funding up 2% to 3%, according to firms that monitor defined benefit plan funded status, but plan sponsors should continue to watch market volatility.

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After December wiped out all funded status gains for defined benefit (DB) plans last year, firms that track funded status estimate 2% to 3% improvement for the first month of 2019.

The estimated aggregate funding level of pension plans sponsored by Standard & Poor’s (S&P) 1500 companies increased by 3% last month to 88%, as a result of an increase in U.S. equity markets, according to Mercer. As of January 31, the estimated aggregate deficit of $262 billion decreased by $50 billion as compared with $312 billion measured at the end of December.

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The S&P 500 index increased 7.87%, and the MSCI EAFE index increased 6.47% in January. Typical discount rates for pension plans as measured by the Mercer Yield Curve decreased by 15 basis points (bps) to 4.04%.

“Even though January was a solid improvement in equities, there is still much uncertainty in the market as evidenced by persisting volatility. We expect plan sponsors will continue to keep a close eye on markets and look for opportunities to lock in gains as opportunities arise,” says Matt McDaniel, a partner in Mercer’s U.S. wealth business.

According to Wilshire Associates, the aggregate funded ratio for U.S. corporate pension plans increased by 2.8 percentage points to end January at 87.3%. The monthly change in funding resulted from a 5.5% increase in asset values partially offset by a 2.2% increase in liability values. The aggregate funded ratio was down 1.6 percentage points over the trailing 12 months. The aggregate figures represent an estimate of the combined assets and liabilities of corporate pension plans sponsored by S&P 500 companies with a duration in line with the FTSE Pension Liability Index – Intermediate.

“January’s bounce back in funded ratios was propelled by the best monthly percentage increase for the Wilshire 5000 in more than seven years,” says Ned McGuire, managing director and a member of the pension risk solutions group of Wilshire Consulting. “January’s 2.8 percentage point increase in funding was the largest monthly increase over the past 12 months and follows December’s 6 percentage point decline.”

The aggregate funded ratio for U.S. pension plans in the S&P 500 improved from 84.9% to 86.5% last month, according to the Aon Pension Risk Tracker. The funded status deficit decreased by $27 billion, which was driven by an asset increase of $66 billion, offset by liability increases of $39 billion year-to-date.

Pension asset returns experienced steady growth during January, ending the month with a 4.3% return.

According to Aon, the month-end 10-year Treasury rate decreased by 6 bps relative to the December month-end rate, and credit spreads narrowed by 11 bps. This combination resulted in a decrease, from 3.96% to 3.79%, in the interest rates used to value pension liabilities. Given that a majority of the plans in the U.S. are still exposed to interest rate risk, the increase in pension liability caused by decreasing interest rates slightly counteracted the positive effects from asset returns on the funded status of these plans.

Northern Trust Asset Management (NTAM) also found that corporate pension plans’ average funded ratio improved, from 83.8% to 85.9%, last month. The increase was primarily driven by a sharp rise in assets that was partially offset by a decrease in discount rates. Global equity markets were up approximately 8% during the month. The average discount rate decreased from 3.91% to 3.75%. 

Legal & General Investment Management America (LGIMA) estimates the average defined benefit plan’s funding ratio increased 2.1% to 86.5% in January. Speaking of the improved market returns, a representative for LGIMA says, “A change in the Fed’s tone has certainly contributed to the recovery—the comments on flexibility regarding rate and balance-sheet-size decisions have contributed to a general sense that, despite its claims to the contrary, the Fed is increasingly dovish and attuned to risk markets. But beyond this, it is hard to pinpoint any other specific catalysts for the rebound.”

Both model plans that October Three tracks improved last month: Plan A gained almost 3%, while Plan B gained about 1%. Plan A is a traditional plan (duration 12 at 5.5%) with a 60/40 asset allocation, while Plan B is a largely retired plan (duration 9 at 5.5%) with a 20/80 allocation, the emphasis being greater on corporate and long-duration bonds.

According to October Three, January was a very good month for stocks, and bonds gained ground as well, driven by lower interest rates. Overall, the firm’s traditional 60/40 gained 5% to 6%, while the conservative 20/80 portfolio grew about 3%. Corporate bond yields fell 0.15%, pushing pension liabilities up 2% to 3%.

Looking ahead, Brian Donohue, a partner at October Three, says, “Pension funding relief has reduced required plan funding since 2012, but relief is expected to gradually sunset over the next three to four years, increasing funding requirements for pension sponsors that have made only required contributions. Discount rates moved down last month. We expect most pension sponsors will use effective discount rates in the 3.9% to 4.3% range to measure pension liabilities right now.”

Opinions February 11, 2019

How to Run the Perfect 401(k) Plan RFP

Andrew S. Zito, with LAMCO Advisory Services, offers tips for organizing and implementing the best retirement plan provider request for proposals (RFP) process.
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The selection process a plan sponsor uses to hire a 401(k) recordkeeper can dramatically affect the long-term success of the plan and, in some cases, can mean the difference between compliance and noncompliance. Unfortunately, we often see well-intentioned sponsors make common mistakes during the process.

 

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We recognize that it isn’t easy to navigate this competitive marketplace. There are a wide variety of providers offering an array of services that may or may not all be relevant to every organization. This is typically where an adviser or other financial intermediary comes in.

 

The single largest mistake we see sponsors make, however, is the selection of an adviser and a recordkeeper at the same time. The scenario happens frequently: The sponsor calls in two or three advisers, each one picks a recordkeeper he or she feels will be best and does a presentation for both the adviser’s services and the recordkeeper’s services, and one “team” wins. As we will discuss below, this is a flawed approach.

 

No two plans are the same

Let’s start with the premise that no two organizations are the same and no two plans are the same. Even if the assets and employee count are similar, the unique needs of each organization can be very different.  A plan for a manufacturing company will have very different needs than that of a plan for a law firm.

 

On the provider side, it is also important to recognize that each 401(k) provider has its own strengths and weaknesses. Not all providers service all plan sizes. They may say they do, but they don’t—at least not well. Some providers are set up internally to handle thousands of employees by way of automation and strong online features. Others are geared for more hands-on consulting but don’t offer automatic distribution of notices, for example. The goal of the request for proposals (RFP) process is to find the provider whose strengths best line up with the plan’s needs.

 

When you keep that in mind, it becomes clear why, when both adviser and recordkeeper are being evaluated in an RFP, the decision making process is automatically complicated. What if, for example, the recordkeeper that Adviser A brought in is the best fit, but Adviser B seems like the best fit on the adviser side? Does the committee select from two different teams?

 

Additionally, understanding the unique needs of an organization and its plan takes time. I always tell sponsors to be leery of any adviser who brings in a provider without spending considerable time understanding their organization and workforce. There is simply no way an adviser can blindly pick the right recordkeeper for a plan without knowing more about the organization.

 

The best practice is to pick your adviser first and then let the adviser help you select a recordkeeper. When selecting an adviser, among other things, it is important to select one who is completely independent of any specific providers.  This means that the recordkeeper and the adviser do not have any financial conflicts – i.e., the recordkeeper does not pay any special referral compensation, marketing costs, etc. Partnering with an adviser who works with all of the major recordkeepers is helpful, as it increases the adviser’s visibility into the entire provider landscape. The list of options can quickly be trimmed down to those few that most likely fit your plan’s needs. An experienced adviser can also highlight the unique nuances, strengths and weaknesses of each provider candidate. These are benefits you simply will not get if you are in a situation where each adviser has to select one recordkeeper.

 

What if you already have an adviser?

If you already have an adviser and you are comfortable with his (or her) ability to guide you through this process, then you are ahead of the game. Let your adviser manage the RFP for you.

 

If you are unsure of your adviser’s independence or understanding of the market, then it may be time to look for a new adviser as well. Again, select your new adviser first. It may seem like an extra step, but, in the end, it will lead to a significantly better outcome.

 

Other tips for running the perfect RFP

 

  • Select the right decisionmakers. A recordkeeper selection should not be made in a vacuum. It’s important to ensure that both the financial and human resources (HR) decisionmakers are part of the process, as this will help ensure their interests are represented when evaluating candidates.

 

  • Make a list of criteria. The committee should agree on a set of written goals that the organization expects the provider to able to facilitate. For example, is the sponsor seeking a provider that will satisfy regulatory obligations and generally limit overall plan expenses, or does it intend to use the plan as an employee-recruitment tool with high-touch features for participants?

 

  • Limit your candidates. Consider a limited approach to RFP issuance. Either you or your qualified adviser should expend the effort upfront to shorten the list to five pre-qualified providers; this will result in a higher-quality pool of candidates and limit the amount of RFP scoring required by the committee.

 

  • Interviews are important. The ideal short list should contain two candidates, or three if they’ve scored closely. These recordkeepers need to be invited to give a finalist presentation to the committee. They have already been deemed qualified, and now is when the plan sponsor needs to be convinced of which finalist is the right fit for the organization. Sponsors should insist that the presentation team include someone who will be involved at a high level in the ongoing work for the plan, not a business development person.

 

  • Don’t get distracted by “sliders.” As a professional plan adviser, I’ve sat in hundreds of finalist presentations. I’ve listened to scores of providers go on and on about how their website has a “slider” that allows a participant to see what a gradual increase in his deferral rate will look like. Is this important? One hundred percent. Is it what we should focus on in a finalist presentation? No. This time should be used to focus on how the provider will solve the specific challenges faced by your plan. The bells and whistles should be demonstrated in a separate website presentation.

 

  • Don’t forget conversion. How does the process of converting your plan to the new recordkeeping platform happen? Who is in charge of overseeing that process? (Hint: Your plan adviser should be heavily involved).

 

A typical RFP process should take between one and three months, depending on the availability of the committee and the depth of the RFP itself. We have found that RFPs that go longer than this tend to result in the company deciding to retain the status quo.

 

There is little question that the RFP/provider selection process can be time-consuming. It is, however, an important and necessary part of fulfilling your fiduciary responsibility.

 

Andrew Zito, AIF, is executive vice president, retirement plan services, at LAMCO Advisory Services, an independent retirement plan consulting and advisory firm.

 

This feature is to provide general information only, does not constitute legal or tax advice, and cannot be used or substituted for legal or tax advice. Any opinions of the author do not necessarily reflect the stance of Strategic Insight or its affiliates.

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