Survey of Defined Benefit Plan Sponsors, 2010

Transcription

1 Survey of Defined Benefit Plan Sponsors, 2010 Vanguard research February 2011 Executive summary. In September 2010, Vanguard conducted the first of a planned series of surveys of corporate defined benefit (DB) plan sponsors. The broad objective of this initial assessment titled Survey of Defined Benefit Plan Sponsors, 2010 was to judge how sponsors are managing their plans in the current economic, market, and regulatory environments. We focused on mid-sized plans (representing 99 of the 155 survey responses received) with assets of $100 million to $1 billion. Author Kimberly A. Stockton Findings of the Survey of DB Plan Sponsors indicated that, overall, sponsor-respondents are continuing to revise their investment strategies and plan design in response to the difficult environment of the past decade. In the process, many have reassessed the risks associated with their pension plans and have established new priorities. In short, sponsors often now appear more concerned about risk and less intent on the return. Despite ten years of mostly unfavorable economic and financial conditions for DB plans, many sponsors are continuing to maintain plans for their employees. At the same time, a substantial number are freezing or closing Connect with Vanguard > vanguard.com > global.vanguard.com (non-u.s. investors)

2 plans in an effort to obtain some risk relief. Responses showed that mid-sized plans have been the hardest hit in many cases, but that many plan sponsors are making changes to address the current state of their plans. Survey of DB Plan Sponsors key findings Survey respondents indicated more awareness of risk, less focus on return Most plans are underfunded. Eighty-nine percent of all respondents reported that their plans are underfunded. Mid-sized plans were the most underfunded, with 4 in 10 reporting funding status below 8. Managing pension risk and plan costs are top concerns for plan sponsors. Eighty-five percent of respondents rated pension risk as very or extremely. Sponsors assessment of the importance of risk increased with the plan s asset size relative to company size. Plan sponsors cited a variety of risks, but interest rate risk was a top concern. The derisking trend appears to be continuing among pension plans through changes in investment strategies. When asked about recent and future changes, a majority of respondents said that they had increased or planned to increase liability-driven investing (LDI) strategies, as well as the portfolio s fixed income allocation and duration. Mid-sized plans have made or will make the biggest changes. Pension plans equity allocations have decreased and bond allocations increased, on average, relative to historical pension plan asset allocations. Sponsors reported current equity allocations, on average, of 47% and bond allocations, on average, of 3. Asset-management objectives are primarily cost- and risk-based, as opposed to returnbased. Only 56% of respondents agreed that they focus on meeting a return hurdle, while 81% agreed that they understand the impact of LDI on plan costs. Although the majority of plans surveyed are open and active, most plans are making changes to plan design. Only about 4 of active-plan respondents expected no changes to their plans over the next several years. Plan-sponsor respondents who continue to manage open and active plans are most likely maintaining the plan for paternalistic reasons. Most sponsors reported that they keep the plan open because employees valued the benefit; the next most-cited reason was a desire to provide a secure retirement for employees. Survey respondents are continuing to focus more on risk, and their perceptions of risk influence plan investment policy and plan design. Sponsors who rated their plans as more risky were more likely to take (or to have taken) action to lower the risk, through changes to both plan design and investment strategy. Notes on risk: All investments are subject to risk. Past performance is no guarantee of future results. Investments in bond funds are subject to interest rate, credit, and inflation risk. Because high-yield bonds are considered speculative, investors should be prepared to assume a substantially greater level of credit risk than with other types of bonds. Foreign investing involves additional risks, including currency fluctuations and political uncertainty. Prices of mid- and small-cap stocks often fluctuate more than those of largecompany stocks. Diversification does not ensure a profit or protect against a loss in a declining market. 2

3 In fall 2010, Vanguard conducted the Survey of Defined Benefit Plan Sponsors, 2010, the first of a number of planned periodic assessments of how corporate DB plan sponsors are managing their plans. The survey s overall objective was to evaluate how sponsors are faring in the current economic, market, and regulatory environments. Specific survey aims included: Assessing current DB plans and their funding status; Understanding plan sponsors general attitudes about managing plan assets, as well as their top concerns; Understanding sponsors specific planmanagement approaches in three main areas: risk management, investment strategy, and plan design. Gauging trends in and reasons for potential changes to risk management, investment strategy, and plan design. Survey background We received survey responses from 155 DB plan sponsors with decision-making authority. 1 We concentrated on mid-sized plans (representing 99 of the 155 survey responses received) with assets between $100 million to $1 billion. The accompanying box, on page 2, encapsulates the survey s main findings. A majority (63%) of respondent plans were open and active. The pension crises of the past decade left most of the plans in Vanguard s survey significantly underfunded, with reporting current funding status below 8 and only 11% fully funded. Midsized plans were the most underfunded, with 4 of plan sponsors reporting current funding status below 8 and only 8% fully funded. Eighty percent is a critical threshold, because it is generally the Figure 1. Defined benefit plan funding status Which range best characterizes your defined benefit plan s current funding status? Average 13% 23% 48% 1 $1B or more 86% 6% Under % 80 89% 90 99% 10 or more $100M <$1B 8 level below which a plan is considered at risk and subject to accelerated funding requirements. Figure 1 provides detailed findings on funding status, by plan size. Risk perception and management $20M <$100M 87% Understandably, plans that managed to survive one or both of the pension plan crises are now more focused on pension plan risk and are taking steps to manage it. In the risk category, we asked two questions. First, we asked respondents to rate how pension risk was, with risk defined as cost variability or uncertainty in the pension plan. Eighty-five percent of respondents rated pension risk as very or extremely ; respondents 8% 19% 23% 17% 28% 12% 8% 1 The material presented in Survey background is a point-in-time summary from our sample respondents. We do not intend to draw conclusions about the broad defined benefit market from these results, nor do we wish to imply that these responses are indicative of market trends. Note: For simplicity, most of the data in this paper s text and figures are rounded to the nearest whole number. Unless otherwise indicated, text references to averages are based on the total number of survey respondents. 3

4 Figure 2. Overall importance of pension risk Figure 3. Risk rating by plan/company size How an issue for your organization is pension risk, defined as cost variability or uncertainty in the pension plan? 10 How an issue for your organization is pension risk, defined as cost variability or uncertainty in the pension plan? % 35% 35% 5 56% Plan asset/company marketcapitalization average 25% 15% 1 5% 1 $1B or more 1 24% $100M <$1B 5% $20M <$100M Somewhat Very Extremely Extremely Very Somewhat Not at all/not very Risk rating assessment of the importance of risk also increased with the value of their pension plan assets, as shown in Figure 2. Risk importance also increased for sponsors with larger plans relative to their company size. For public company respondents (totaling 62), we calculated the average pension asset to company marketcapitalization ratio and sorted results by the response to this risk question. Those who ranked pension risk as extremely had an average plan asset to company market-cap ratio of 25%, compared with for those who rated risk as very, and 9% for those who rated risk as somewhat (see Figure 3). Second, we queried sponsors about the types of risks that were to them. Specifically, we asked them to rate risk types on a scale of 1 to 5, with 5 being extremely and 1 being not at all. Figure 4 shows the percentage of all respondents ranking risk types as very (4) or extremely (5). Their responses reflect the current low interest rate environment. As illustrated, plan sponsors expressed the greatest concern (nearly 85%) over interest rate risk, followed by uncertainty in the equity markets (nearly 8). Declining interest rates are a primary risk for any pension plan. Low interest rates can have a negative impact on pension metrics such as liabilities, funding ratios, and pension expense, which ultimately translates to higher required plan contributions. However, large asset allocations to equities and strongly performing equity markets can offset this impact. As a result, in the past, plan sponsors have often been more concerned about equity market volatility than the level of interest rates. Investment policy In terms of investment policy, the Survey of DB Plan Sponsors asked several questions about plans current and future investment strategies. The results support the prevalent trend of derisking through changes in investment strategies. Although risk is clearly sponsors primary focus, they still appear to be seeking higher returns, through alternative assets. 4

5 Figure 4. Importance of types of pension risk Please rate the following types of risk associated with your pension plan in terms of importance. Combined results for very and extremely Interest rates Equity markets Fiduciary risks Expected longterm costs Longevity Inflation As illustrated in Figure 5, total equity allocations reported by our survey respondents averaged 47%; bond allocations, 3; alternatives, 18%; 2 and cash, 5%. Compared with historical pension plan asset allocations, our respondents equity allocations have declined dramatically and bond allocations have increased, as plans attempt to match assets to liabilities. For example, the average equity allocation for Standard & Poor s 500 companies in 2003 was 63%, and the average bond allocation was 27% (Goldman Sachs, 2010). 3 Portfolios have clearly become less risky in terms of funding ratio volatility and other pension metrics. Figure 5. Asset allocations on average What is your pension plan s current asset allocation? 33% 3 14% 5% Domestic equity Domestic bonds International equity Cash 18% Alternatives Toward more liability-sensitive portfolios Although some of the allocation changes reported by sponsors were probably passive because of market movements, responses to other survey questions indicated that plan sponsors are actively building more liability-sensitive portfolios. When asked about recent and future changes, a majority of sponsors indicated that they planned to increase not only LDI strategies but also the portfolio s fixed income allocation and duration. Also, most respondents planned to decrease their equity allocation. Mid-sized plans, which, as stated, were the most underfunded plans, appeared to be making big changes to derisk their plans, with 47% of plans increasing portfolio duration, 37% increasing LDI strategies, 47% decreasing equity allocations, and 52% increasing their fixed income corporate allocations. Details by market segment are shown in Figure 6, on page 6. Of course, active allocation changes may not indicate derisking, but, instead, may be evidence of returnchasing or -fleeing. The Survey of DB Plan Sponsors was conducted on the heels of two consecutive tenyear periods of negative annualized returns for U.S. broad-market equities ( and ). Negative ten-year annualized returns have occurred only one other time since 1926 for the decade 2 Note that our respondents reported a somewhat higher allocation to alternative assets than has been claimed in other, broader survey samples. 3 Note that we are comparing two different samples here: S&P 500 sponsor companies (Goldman Sachs) and Vanguard s survey sample. 5

6 Figure 6. Changes to plan asset investment strategy Regarding plan asset investment strategy, which of the following are planned in the next few years or have you made in the past few years? $1B or more $100M <$1B $20M <$100M Percentage increasing Percentage Percentage increasing Fixed income corporate allocation 65% 52% 4 Bond immunization strategy 26% Duration of portfolio 74% Fixed income U.S. Treasury allocation 35% % Dynamic asset allocation 45% LDI strategy (interest rate hedging) 77% % Alternative allocation International equity allocation Investment time horizon % Domestic equity allocation 3% Decreasing No change Increasing ended December 31, A good test of whether attitudes toward pension risk have really changed might be to measure sponsor asset allocation changes in 2011, after having registered two very good years in the domestic equity markets. With respect to managing plan assets, our survey respondents indicated that although risk management is the primary objective, cost containment is also. Return-based objectives were the least common aims cited. As shown in Figure 7, most sponsors are focused on risk, with 81% of respondents agreeing that they fully understand how LDI affects pension plan costs; 81% managing assets with the objective of controlling the impact on company financials; and 72% agreeing that they change asset allocation based on funding level, a liability-driven approach to asset management. An interesting result was that even though a large majority of respondents agreed that they understand the impact of LDI, only 63% indicated that their board understands the same possibly an indication of disconnect between board and plan-sponsor objectives. With respect to returnbased objectives, only 56% of respondents indicated that they have such objectives, and only 44% of plans were reported to focus on beating a peer benchmark. We believe returns-based numbers would have been much higher in the pre-pensioncrisis years and following a bull market for example, that of The move from a focus on return to risk has, again, likely emerged from the recent tumultuous environment for pension plans. For plans with fixed income allocations, our survey asked about durations, because many plan sponsors are lowering pension (interest rate) risk by matching their fixed income durations to their liability durations. Most liability durations are in the range of years. Durations generally increased with plan size, likely indicating more sensitivity to pension metric volatility for the bigger plans. Mid-sized and large plans had the largest amount of long-term bonds, defined as those with a duration of 6 <15 years, probably due to asset-liability matching. Yet, many sponsors in all asset segments (about 35%) still had fixed income durations akin to those of the broad market, at 3.5 <6 years. (See Figure 8.) Plan status and design Although the majority of respondents to the Survey of DB Plan Sponsors reported plans that were open and active, many sponsors said they expect to make changes in the future thus signaling no decline in the ongoing trend of freezing and terminating DB 6

7 Figure 7. Attitudes toward managing plan assets Please rate how much you agree or disagree with the following statements with respect to managing plan assets. Combined results for strongly agree and agree I fully understand how a liability-driven investing (LDI) strategy impacts pension plan costs My investment board fully understands how an LDI strategy impacts pension plan costs My company wants to control the pension plan s impact on earnings and financials My company wants to minimize the long-term cost of the pension plan Changes in the level of funding in our plan will drive changes in the asset allocation My company is focused on meeting a return hurdle My company is focused on beating a peer benchmark Managing assets from a fiduciary perspective is consistent with managing corporate pension risk pension plans. Thirty-six percent of active-plan sponsors, for example, plan to freeze their plans in the next few years. With respect to all plans, 4 of respondents stated that they had frozen their plan in the past two years or expected to freeze their plan in the next several years. Thirteen percent of all respondents were planning to convert to another plan type, 2% were planning to terminate, and 5% were planning to reduce benefits. The generally underfunded mid-sized plans are making the greatest number of changes, with 67% of those respondents altering their plans design. Results, by plan size, are shown in Figures 9 and 10, on page 8. For those making plan-design changes, we then asked the reasons for the changes, as illustrated in Figure 11, on page 8. The results were not surprising: Most plans cited costs or volatility of costs as the primary reasons. Other reasons cited were the generally poorly performing equity markets, low interest rates, stricter regulatory requirements, and mark-to-market accounting, which have increased required contributions and expense amounts, as well as volatility, to unmanageable levels for many plans. Figure 8. Domestic bond allocations by term And what proportion of your domestic bonds are...? % 35% 52% 6% $1B or more 21% 34% 35% $100M <$1B Short-term (<3.5 years) Intermediate-term (3.5 <6 years) Long-term (6 <15 years) Extended duration (15 or more years) 34% 34% 26% 11% 7% $20M <$100M 7

8 Figure 9. Current plan status Figure 11. Primary reasons for changing DB plan What is your current defined benefit plan status? What were the primary reasons for this change? % 65% 67% 3 44% 39% 35% 11% 6% Cost too high Cost volatility too high Impact to the company financials too high Benefit not valued by employees 3% Management distraction and time required 2% Administrative burden 3% Other Figure % $1B or more Frozen, with no accruals Open and active Closed to new entrants $100M<$1B 26% $20M <$100M Changes to defined benefit plan status Which one of the following changes to plan design or status have you made in the last two years or will you make in the next several years? % % $1B or more 3% 31% 12% 5% 33% $100M <$1B 2% 24% 24% 48% $20M <$100M 4% None of these Termination Reducing level of benefits Convert to cash-balance/hybrid DB plan A hard freeze/close to existing members A soft freeze/close to employees hired after a specific date Finally, for those sponsors who had open and active plans, we asked why they were maintaining the plan. Employers cited paternalistic reasons, with most stating that they kept the plan because employees valued the benefit; the next most-cited reason was that employers wanted to provide a secure retirement for their employees. Also mentioned were the potential for negative employee relations as a result of plan freezes and termination, as well as the value of the plan as a recruiting and retention tool (see Figure 12). Cross-tabulation: Risk, investment strategy, and plan design In our analysis of the results, we sought also to determine whether there was any relationship among the responses to the three main categories of questions; that is, whether results for one question varied with those for another. We found that responses on risk perception, plan design, and investment strategy did appear to be related in both directions. For example, answers to questions about risk varied with answers to plan-design questions; and answers to plan-design questions varied with answers to risk questions (see Figure 13). Risk perceptions and plan design We first looked at how risk responses varied with plan status and vice versa. The results suggest that the plan-sponsor respondents are taking action to address the increased risk that they now associate with the pension plan. Not unexpectedly, we found that plan sponsors who had frozen or converted their DB plan were less sensitive to plan risk. This is not 8

9 Figure 12. Primary reason for maintaining DB plan Figure 14. Risk importance by plan status What is the primary reason for maintaining your defined benefit plan? Scale: 1 5; 5 = extremely and 4 = very 4.5 Risk assessment rating % 23% 3% 3% Employees value the benefit Employer wants to provide for secure retirement Employer values recruiting and retention impact Employee-relations impact of closing the plan Cost-efficiency due to pooling of investment, longevity risk Employer values more predictable retirement patterns Other 3.5 Open and active Closed to new entrants Frozen with no future accruals Cash-balance/ hybrid plan Note: Results are for plan sizes of $100M <$1B. Figure 15. Changes to plan status by risk assessment Figure 13. Relationships among survey topics 8 Perception of risk % 11% 2% 4 Investment strategy Plan design surprising because freezing or converting a plan commonly reduces uncertainty for the plan sponsor. At the same time, as Figure 14 shows, sponsors of open and active traditional plans were generally more sensitive to the risk of the pension plan than were sponsors of frozen or cash-balance plans. Next, we looked at the reverse relationship, which also appeared to be present. Those who assessed risk of the pension plan as only somewhat were much less likely to change their plan s design than were those who thought pension plan risk was very or extremely. Of those who rated pension risk as somewhat, % 5% Somewhat Hard freeze Soft freeze Convert to another plan type Terminate Reduce benefit Assessment of risk 29% 15% Very/extremely only about 3 planned to change plan design or had made such changes in the past few years. In contrast, of those who rated risk as very or extremely, nearly 65% planned to make or had made changes in design (see Figure 15). As 9

10 Figure 16. Risk perception and use of risk-management investment strategies Figure 17. Plan status and use of risk-management strategies 6 Frozen Open and active 5 Percentage implementing % Plan to/have implemented LDI 37% Not very Somewhat Very Extremely Risk assessment Implementing LDI Implementing dynamic asset allocation Figure 18. Plan-design changes and use of LDI 6 5% 5 13% noted, many sponsors with open, active plans are planning to freeze those plans. These results, combined with those in Figures 14 and 15, may indicate that sponsors of open plans who see the plan as more risky are lowering their perception of risk by freezing their plans. Risk perception and investment strategy With respect to risk perception and investment strategy, the survey results suggested that the plansponsor respondents are managing pension plan risk through changes in investment strategy. Use of such investment strategies, including dynamic asset allocation and LDI, increased with the plan sponsor s perception of plan risk, as shown in Figure 16. Investment strategy and plan design/status With regard to investment strategy and plan design, the survey s findings implied that plan sponsors are addressing pension risk on both fronts. Our crosstabulations indicate that sponsors of frozen plans are more likely to implement LDI than active plans; and also that those implementing LDI are more % 33% Have not/will not implement LDI 41% Have/will implement LDI Percentage freezing Percentage converting to a cash-balance or hybrid plan Percentage terminating likely to change plan design. Figure 17 shows that 54% of frozen plans have instituted or plan to institute LDI, while only 37% of active plans have or will institute such plans. Also, as shown in Figure 18, of those implementing LDI, about 6 are making some plan-design change. By contrast, only about 4 of those not implementing LDI are making plan-design changes. 10

11 Conclusion Findings of the Survey of Defined Benefit Plan Sponsors, 2010, indicated that, overall, sponsorrespondents are continuing to revise their investment strategies and plan design in response to the difficult environment of the past decade. In the process, many have reassessed the risks associated with their pension plans and have established new priorities. In short, sponsors often now appear more concerned about risk and less intent on the return. The survey s responses also indicated that despite ten years of mostly unfavorable economic and financial conditions for DB plans, many sponsors are continuing to maintain plans for their employees. At the same time, a substantial number are freezing or closing plans in an effort to offer companies some risk relief. Responses showed that sponsors of midsized plans have been the hardest hit in many cases, but that they are making changes to address the current state of their plans. Reference Goldman Sachs Group, Pension Preview: Challenges and Changes. Global Markets Institute. New York: Goldman Sachs Group. 11

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