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Thanks to better yields and a slight increase in the discount rates used to value plan liabilities, the funded statuses of defined benefit plans have improved to some of their highest levels since the Great Recession. Many plan sponsors are keen to preserve these gains and want to remove risk from their balance sheet by implementing “risk reduction strategies”. Due to recent changes in funding levels and the various risk reduction methods available to them, plan sponsors should take this opportunity to re-examine their current approach to better meet the objectives of their plan(s). ) and their participants.
Determine the right risk reduction strategy
Although you may have read about risk reduction in the past, the current environment and appetite for risk reduction has changed significantly over the past few years. Harm reduction activity experienced a brief downturn prior to the COVID-19 pandemic, but nearly all plan sponsors responded to MetLife 2021 Pension Transfer Risk Surveysaid they intended to completely divest of their companies’ pension liabilities in the future.
When considering a risk reduction strategy, plan sponsors should first examine the plan’s objectives and consider what drives the need to reduce risk. It is important to consult advisers to determine how assets and liabilities can be controlled – and at what cost. Next, plan sponsors should consider the various options available. Out-of-plan approaches include lump sum payments, annuity buyouts, and full plan terminations. In-plan methods include liability-driven investing (LDI), in-plan annuities, and plan benefit freezes or plan freezes for new entrants.
Redemptions: Buy-out products, such as annuities, transfer some or all of the pension liabilities to an insurer and reduce the overall risk to the plan sponsor. U.S. company pension buyouts soared to $34.2 billion in 2021, up 37% from 2020, and their highest level since 2012, according to a LIMRA Secure Retirement Institute Studyreleased March 2022. LIMRA found that 47% of plan sponsors are very interested in a future buyout transaction. Full termination of a pension plan typically involves a combination of lump sum payments to participants and the purchase of annuity products.
Purchases : Buy-in products are also generally annuity products. But instead of transferring pension liabilities entirely to an insurer, the plan invests in annuity products that provide more stable returns and reduce the downside risk of investments.
Liability Driven Investing (LDI): Buy-ins can be a costly solution for many plan sponsors, so a more appealing approach may be liability-driven investing – investment strategies to make underfunding a pension more predictable. These strategies aim to reduce the effects of market declines; however, they can also mitigate the benefits of market gains. Many plan sponsors already have some sort of LTD strategy in place, but recent market changes and rising interest rates may require plans to re-examine how these factors have changed course.
A solid LDI approach should create a personalized asset allocation that matches a pension plan’s current and future liabilities. But some factors are beyond the plan sponsor’s control. The war in Ukraine, rising gas and commodity prices and falling expected investment returns are examples of new variables to consider in the first few months of this year alone. Plan sponsors may need to step out of their existing LDI toolkit to find other ways to stabilize the balance between assets and liabilities. Plan sponsors should look for a personalized approach that meets their plan’s needs.
Impacts of COVID-19 on mortality tables
A recent milliman study found that between March and December 2020, the total number of deaths was 21% higher than expected, and 80% of the increase can be attributed directly to the pandemic. It is still too early to tell whether the pandemic will impact the future of mortality tables used to determine liabilities, but plan sponsors whose workforces have been significantly impacted should consult with their actuary to determine if any adjustments need to be made. facts.
Find the best approach to fit your plan and its members
The unfunded liability of a defined benefit plan can represent the biggest risk on a company’s balance sheet. When it comes to risk reduction strategies, every situation is unique and there is no one-size-fits-all strategy. Making these decisions requires careful thought. Your plan’s actuary can help you sift through the options available to help you determine which risk reduction approach is best suited to your plan’s particular situation.
The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought regarding your particular situation.
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