Pension column: Risk management for pension plans

Canadian pension plans can take a page from the U.S. when it comes to risk management

A number of American companies with DB plans are likely to take more deliberate actions to manage the risks in their pension obligations. That’s according to an Aon Hewitt U.S. study released earlier this year. The study surveyed 400 plan sponsors representing nearly 10 million participants on current and future retirement trends. In general, the survey found that companies are taking a more thorough approach to monitoring and managing pension risk. These organizations are focusing on four crucial areas.

1. Understanding potential risk – According to the Aon Hewitt survey, nearly one-quarter (24%) of pension plan sponsors in the U.S. have recently conducted an asset/liability study in order to obtain a better picture of their plan’s performance under varying economic conditions. That’s double the number of companies that did so in 2012. Of the companies that have not yet conducted a study, 45% are somewhat or very likely to do so in the next 12 months.

2. Monitoring funded status – Employers used to evaluate their plan’s funded status only once a year, when they were required to report on the plan’s financial health. Now they understand that it’s critical to have a real-time view of how market and economic conditions are affecting the plan so they can adjust and execute their risk management strategies at a moment’s notice. Some employers have already established a method to monitor the daily funded status of their plans, which measures portfolio performance, changes in pension liabilities, sponsor contributions and so on. And many that do not have this monitoring in place are looking to implement it this year.

3. Reducing balance sheet liabilities – Pension plan sponsors continue to adopt strategies to limit their balance sheet liabilities. Lump sum settlements through cash-out opportunities are becoming more popular. In the survey, 12% of plan sponsors said they recently introduced or expanded the availability of lump sum windows for retirees or terminated vested participants. Also, 43% said they are somewhat or very likely to complete a lump sum window for inactive participants in 2014. Additionally, 26% are somewhat or very likely to complete an annuity purchase in the next two years—a real jump from just 3% a year ago.

4. Adjusting assets – One out of every six companies with a DB plan has adjusted plan investments to better match liabilities, according to the survey. By the end of this year, as funding levels improve, the percentage of plan sponsors that have high equity exposure will be nearly equal to the percentage that are constructing portfolios with higher fixed income exposure and more risk-hedging options.

These strategies have varying appeal and applicability in Canada, but it’s safe to say that risk management is becoming a key initiative for many pension plans on both sides of the border. For the first time in years, the news is positive for Canadian pension funds. But while every Canadian plan sponsor faces different challenges and opportunities, they all need to remember that the good times of 2013 won’t last forever.

The message is clear: consider the current and new pension risk management options, develop a plan to take advantage of opportunities as they arise and structure your governance process so that you can seize the day with confidence.

4 Steps to managing risk
  1. Understand potential risk by conducting an asset/ liability study.
  2. Monitor funded status frequently.
  3. Reduce balance sheet liabilities.
  4. Increase exposure to fixed income.

William da Silva is a senior partner in Aon Hewitt’s retirement practice.

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