Investment Strategies are Among the PRT Alternatives

Plan sponsors can consider plan conversions, similar to what IBM has done, hibernation or different investment strategies to reduce risk without transferring it.

Current conditions, including improved plan funding status, support pension risk transfers. However, sponsors that still offer defined benefit  pensions can consider options besides PRTs to reduce their plan’s risk exposures. One option, funding a cash balance plan with a DB plan’s overfunded surplus, drew headlines last November. IBM announced plans to replace its 5% matching contributions and 1% automatic contribution to employees’ 401(k) plan accounts with a 5% contribution to a cash balance “retirement benefit account.”

“The ingenuity of that shift in retirement benefits vehicles was that this generated a tremendous cash savings because to make the 401(k) matching contribution that was a 6% of pay cash cost,” says Zorast Wadia, principal and consulting actuary with Milliman. “If you’re providing that similar level of benefit accruals in the defined benefit plan, [and] if your plan is already at a surplus level, it’s not going to take a cash action. So, they went from a massive cash contribution to zero, potentially saving several billions of dollars, presumably, over the next several years to the extent that they can maintain the defined benefit plan surplus.”

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Copycats Expected?

IBM has a history of making significant changes to its retirement plans, including using hard and soft freezes and completing one of the largest U.S. PRTs. Given IBM’s role as a plan innovator, will other sponsors follow the company’s most recent move? Perhaps, but it’s likely to be a select few.

The Center for Retirement Research at Boston College identified seven other companies whose plans’ financial metrics were similar to IBM’s and conducive to a similar move. Milliman examined the 100 largest U.S. DB plan sponsors and found 34 companies that could adopt IBM’s change. Wadia said he would not be surprised to see some companies following IBM’s lead soon. “When a trendsetter like IBM basically goes first, that opens the door for other employers to consider the same thing,” he says. “I think that several are in serious discussions as we speak, and we could learn of several more by the end of this year. It also has to do with competitors, industry standards, and recruitment and benefits strategy. But I wouldn’t be surprised if we see more companies follow that pattern.”

Seeking Alternatives

Improvements in a DB plan’s funded status also enhance alternatives for de-risking the plan without a PRT. For example, Wadia cites the hibernation option. “This is when you naturally let the plan wind down its balance sheet footprint as a result of participant terminations and eventual deaths,” he explains. “And then, at some point, if it becomes small enough, you pursue annuitization.”

Glide path management and liability-driven investing strategies also can be alternatives to PRTs. With glide paths, Wadia notes that higher interest rates are prompting DB sponsors to reduce their equity exposures and increase fixed-income allocations. The 2023 year-end average fixed income allocation in the Milliman 2024 Corporate Pension Funding Study was 53.5%, versus the 51.1% level at year-end 2022.

Russ Kamp, managing director with Ryan ALM Inc., believes sponsors should consider bifurcating their plan’s assets into liquidity and growth or alpha buckets. The liquidity bucket holds a defeased bond portfolio using investment-grade bonds, creating a sinking fund for the plan’s liabilities. These assets ensure the plan can pay benefits and expenses while allowing the alpha assets to grow long-term.

“Now you’ve bought time, which is a critical variable,” says Kamp. “When you give somebody 10 years and get away from these quarter-to-quarter cycles, you’re going to dramatically enhance the probability of success. That’s what we need to do—we need to give the alpha assets time to grow and what they produce will meet future liability growth.”

Duration matching and cash-flow matching are two frequently used LDI strategies. Kamp explains that numerous plans have used duration-matching strategies, either buying long-duration bonds to match portfolio duration or using derivatives to establish an interest rate hedge.

Because duration-matching strategies typically use average duration or key rates along the Treasury yield curve, Kamp advocates for cash-flow matching. “With cash-flow matching, you are matching durations every month of that mandate,” he says. “So, if you have a 10-year assignment, that’s 120 bespoke duration matches.”

Kamp adds that cash-flow matching is a viable alternative for smaller and mid-sized pension plans. Bonds are available in small lots, allowing these plans to match their unique liabilities. “You have to make sure that it’s done in a separate account because each entity’s liabilities are going to be unique,” says Kamp. “But you can build a cash-flow matching assignment for small and mid-size pension plans and it’s easily done.”

MFS: Sponsors Expect to Reevaluate Investment Lineups

The investment reviews will happen as plan sponsors are even less confident than are participants about employees’ ability to retire when they want to, MFS’ DC Plan Sponsor Survey reveals.   

Plan sponsors are concerned about retirement readiness, regulatory and administrative burdens and are putting major focus on re-evaluating their investment lineups, finds MFS Investment Management research.

 

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Almost half of plan sponsors surveyed (45%) have either made or are considering making changes to their fixed income offerings and more than a third (35%) have made or are considering adjusting their inflation-protected investment offerings in the next 12 to 18 months, found the MFS 2023 DC Plan Sponsor Survey, “Building Better Outcomes.”

 

The survey, “asked a number of questions around the investment lineup and because of our participant survey—and finding that participants are thinking differently about retirement because of inflation—[participants] are more likely to think about their investments and change them to become more conservative,” explains Jeri Savage, retirement lead strategist for investment solutions at MFS.

 

The MFS research revealed retirement plan sponsors are increasingly concerned by volatility and inflation as more than half (56%) of all plans say they expect to evaluate their investment lineup in the coming year.

 

The newest findings aim to complement  MFS’ 2023 Global Retirement Survey, which compiled more than 4,000 retirement plan participant’s responses in four countries, was published in October 2023 and MFS’ Retirement Outlook 2024, published in January

 

Three-quarters of participants said they expected to need to save more for retirement than they originally thought because of inflation, the Global Retirement Survey found; and 61% said they expected to become more conservative in their investments as a result of inflation, according to MFS’ 2024 Outlook.

 

Against the backdrop of their participants’ financial concerns, sponsors are more likely to add fixed income and inflation-protection options to their investment offerings than equity options, MFS found in the new report.

 

“[Almost an] equal number [of sponsors] are contemplating changes to the fixed income and equity portions of their menu, but the changes that are contemplating are a little bit different,” adds Savage. “In the fixed income space, they say they’re more likely to be adding to the menu and in the equity space, they’re more likely to be either removing options or changing their managers.”

 

In addition to concerns about investment offerings, the survey found that 55% of plan sponsors cited the “changing regulatory and legislative landscape” as “keeping them up at night.” Litigation risk, administrative burdens and “figuring out retirement income solution(s) for the plan” ranked next, and all were considered more worrisome than overall participation rates, fee pressures and having the right number and types of investment options.

 

Regarding the plan features that sponsors can add because of the passage of the SECURE 2.0 Act of 2022, the survey found emergency savings was most popular, with 45% of respondents selecting it overall.

 

When asked what changes they would make if costs were not a factor, “the answers change considerably, with 57% indicating they would match student loan payments, and 76% indicating they would create a vehicle for, or provide access to, 401(k) assets for emergency savings,” stated the MFS report.

 

“This demonstrates that sponsors recognize their participants could benefit from these features.”

 

Regarding changes they have made or plan to make to their investment offerings, nearly one-fifth of sponsors (18%) are considering investment lineup changes to their fixed-income investments in the next 12 to 18 months, 18% have added options, 7% replaced managers and 7% reduced or removed options.

 

For equity investment adjustment, 16% of sponsors are considering changes in the next 12 to 18 months, 9% have added options, 12% replaced managers, and 7% reduced or removed options.

 

Sponsors considering changes to their inflation-protection investments in the next 12 to 18 months measured 11% of responses, 17% have added options, 4% replaced managers and 3% reduced or removed options.

 

“Participant behavior is driving some of this,” adds Savage. “[Sponsors are] seeing participants become more conservative in their investments and they want to make sure they have the right array of options to do so.”

 

While sponsors are considering investment menu changes, nibbling at the margins could be the result, MFS data suggests.

 

Sponsors are more likely to replace equity managers than fixed income managers, and qualified default investment alternatives, “tend to see fewer changes than core menu options,” write the report’s authors Savage and Jonathan Barry, managing director of investment solutions.

 

For sponsors plotting QDIA lineup changes, 10% are considering changes, 11% have added options, 2% replaced managers and 1% reduced or removed options.

 

The 2023 MFS DC Plan Sponsor Survey was conducted from September to November 2023 with 141 plan sponsors of varying asset sizes. Plan sponsors were based in the U.S. and sourced through the DCIIA Plan Sponsor Institute.

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