While they’re increasingly interested in managing risk, DB plan sponsors in Canada still aren’t far along the de-risking continuum, experts explained in a recent Association of Canadian Pension Management webinar.

According to Ian Edelist, a principal with Eckler Ltd., DB plan sponsors can use different levers to manage risk: benefits strategy (i.e., plan design, such as target benefit plans); funding strategy (e.g., letters of credit or prepaid plan contributions); investment strategy (such as asset allocation or liability-driven investing, [LDI]); and risk transfer (such as annuitization, lump sum payments or longevity hedging).

From an investment standpoint, asset/liability mismatch is often an issue. “Many plan sponsors still look at their assets in an asset-only environment,” Edelist noted. A common first step to manage this risk has been to lengthen the duration of the bond portfolio, added Daniella Vega, a senior pension consultant with Eckler Ltd., followed by increasing the bond allocation.

Moving further along the risk spectrum, some DB plan sponsors are implementing LDI. However, “these strategies are generally more complex and may require the use of derivatives,” said Vega, so they also require greater understanding.

DB plan sponsors seeking to further de-risk can go the annuitization route (annuity buy-ins or buyouts) or pay out lump sums to members. As Vega noted, plan windup is the only way to completely eliminate the risk.

Dynamic de-risking
But when is the best time to de-risk your plan? Concerned about getting the timing right, some plan sponsors are moving toward a more dynamic approach to asset allocation, de-risking when the cost to do so becomes more favourable, said Vega.

Dynamic de-risking involves making investment strategy changes based on predefined triggers, such as funding levels, bond yields or particular dates, she explained. However, this approach isn’t a quick fix.

“It’s important for plan sponsors to understand that it can be some time before specific trigger points are reached,” said Vega, noting that plans that introduced a de-risking strategy several years ago based on bond yields may still be waiting to have their first asset shift. Using specific time points as triggers can help to ensure that de-risking actually occurs, she suggested.

In terms of risk transfer strategies, lump sum payout is currently most popular option among Canadian plan sponsors, Vega explained. However, “more and more, plan sponsors are considering group annuities for ongoing pension plans,” she added—particularly annuity buy-ins, since they don’t require sponsors to inject additional cash into the plan.

Longevity hedging, in the form of longevity insurance or longevity swaps, is another emerging risk transfer strategy. “The market for longevity hedging has been building in the U.K. but is in its infancy in Canada,” said Vega, adding that during 2008/09—a favourable environment for annuity pricing—many U.K. plans capitalized on this environment. In general, she noted, Canadian risk management practices are about five to 10 years behind the U.K.

Whatever de-risking strategy a plan sponsor chooses, the most critical aspect is to clearly identify the plan’s objectives and risk tolerance, Edelist explained. Because if plans fail to do so, “sometimes, the results are that the tactics they use don’t work as well as they should.”

Copyright © 2020 Transcontinental Media G.P. Originally published on benefitscanada.com

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