Aon Retirement & Investment Global Pension Risk Survey 2017 U.S. Survey Findings
Table of Contents Executive Summary Demographics of Survey Participants Long-Term Objectives Managing Benefits and Liabilities Investment Strategy Considerations Hedging Risks Delegation Monitoring and Mitigating Pension Risk U.S. Pension Funding Methodology Aon 2
Executive Summary Every other year, Aon Hewitt s Global Pension Risk Survey charts the course of pension plan sponsors, mapping out where they ve been and where they re going. Since our first survey in 2009, we have seen sponsors of plans in the United States make steady progress along several fronts: Opportunistically shrinking plan size via lump-sum windows and annuity buyouts Shifting away from asset-only frameworks and toward an integrated asset-liability approach to measuring performance Shifting away from equities and toward liability-matching investments such as corporate bonds, treasuries, futures, and swaps Managing the transition to lower-risk liability-matching investments via dynamic policies linked most commonly to plan funded status Refining dynamic policies to reflect interest rate views and credit spreads, for instance via hedge paths and credit paths Concurrent with the shift to dynamic investment policies is a shift toward delegation of pension investment management to a firm with the resources to execute these policies effectively. Our 2017 survey shows this trend spreading to larger plans as well. Fueled by this trend, Aon plc s affiliated investment consulting practices reached $108 billion (USD) in worldwide assets under management for its delegated solutions clients across 10 countries as of June 30, 2017. The shift to dynamic investment policies has taken place as low interest rates and greater life expectancies exert downward pressure on funded status, slowing the pace of investment de-risking. Aon Hewitt Pension Risk Tracker (Pension Plan Funded Status for S&P500 Companies) 100% July 2012 European Debt Crisis June 2013 Taper Tantrum October 2014 Society of Actuaries (SOA) releases final RP-2014 mortality report November 2016 Presidential election 80% 60% 12/31/12 12/31/13 12/31/14 12/31/15 12/31/16 Aon 3
Executive Summary (Continued) But rather than abandon their de-risking glide paths, sponsors instead are taking matters into their own hands: Some are accelerating contributions to their plans using available cash flow, debt financing, and even non-cash ( in-kind ) vehicles Lump-sum windows continue to be an option to reduce headcount and plan costs, with some sponsors planning on a second round Annuity liftouts are on the radar for about one-third of survey respondents Finally, we estimate from company SEC filings that in the five year wave of settlement activity that started in 2012, just 6% of US corporate pension obligations have actually been settled, of which around 2.5% were settled via annuity buyouts, the remainder via lump sum windows This survey reveals that sponsors now have greater visibility and control over their pension risk than ever before. Empowered by new tools, they are taking steps to dial pension risk downward. DEMOGRAPHICS OF SURVEY PARTICIPANTS Aon 4
BACK TO EXECUTIVE SUMMARY Demographics of Survey Participants Approximately 100 plan sponsors responded to the 2017 survey, totaling nearly 4 million participants and $US 400 billion in assets. Respondents covered the full range of plan sizes, from the small (8% of respondents plans had fewer than 1,000 participants) to the very large (30% with over 25,000 participants). By Size of Employee Base in the Defined Benefit Plan By Total Assets in the Defined Benefit Plan Over 25,000 30% Under 1,000 8% $5,000 M and over 16% 1,000 to 5,000 25% Under $500 M 40% $2,000 to $5,000 M 13% 10,000 to 25,000 24% 5,000 to 10,000 13% $500 to 2,000 M 31% In terms of assets, 40% of respondents plans held less than $US 500 million, while 16% held $US 5 billion or more. Aon 5
Long-Term Objectives We first asked respondents about their long-term objectives. As with prior surveys, these objectives varied considerably. We find that they fall into four categories of approximately equal size: 25% minimize or eliminate risk (full buyout or hibernation) 24% maintain risk but at a lower level 20% minimize cash contributions or accounting expense 31% other Long-term objective No long-term objective (as yet) 8% Insure to remove all risks (e.g., full buyout) 13% No change to current levels of risk 18% Invest without equity-type risks (e.g., hibernation) 12% Other long-term strategy 5% Minimize accounting expense 4% Invest with lower (but still significant) equity-type risks 24% Minimize cash contributions 16% FURTHER ANALYSIS Aon 6
BACK TO LONG-TERM OBJECTIVES Long-Term Objectives (Continued) We also asked respondents about their expected timelines for achieving their long-term objectives. Those that specified a timeline saw themselves achieving their objective: 34% within five years (up from 31% in 2015) 48% between six and 10 years (up from 39% in 2015) 13% between 11 and 20 years (down from 17%) 4% beyond 20 years (down from 11%) Expected timing to achieve long-term objective More than 20 years 4% 11 20 years 13% 5 years or less 34% 6 10 years 48% Aon 7
BACK TO LONG-TERM OBJECTIVES Long-Term Objectives (Continued) The trend toward shorter time horizons is most pronounced with smaller plans. Of those with assets under $500 million, 59% expect to reach their target within five years. This trend is also evident in our survey results in Canada and the UK. Despite stagnating plan funded status over the past few years, the expected time to reach long-term objectives has shrunk. This stands as testament to the actions plan sponsors have taken to better manage pension plan risks and funding levels, and the more robust controls and levers that are now in place. We wanted to know what key factors influenced the anticipated length of time to reach their long-term objectives. Four themes stood out: The amount of risk they are willing to take (26%) The level of long-term interest rates or corporate bond yields (41%) A fixed timeline (13%) The employer s ability to make contributions (13%) The most notable change since 2015 is the rise in proportion of sponsors reporting a fixed timeline 13% in this survey, up from just 6% in 2015. Consistent with other results, more sponsors are moving toward their long-term objectives on their own timetable, rather than allowing markets to dictate the pace. Factors determining time to long-term objective The level of corporate bond yields 3% Resources to execute our plan 6% Fixed timeline 13% The employer s ability to make contributions 13% The level of long-term interest rates 38% Amount of risk we are willing/able to take 26% Aon 8
BACK TO LONG-TERM OBJECTIVES Long-Term Objectives (Continued) Glide paths help sponsors manage risk downward as they get closer to their funded status objective. As in prior surveys, we asked respondents to describe their glide paths as robust, basic, or aspirational. We used the following definitions in the U.S. survey: A robust glide path is one that has been documented and implemented A basic plan has documented intent, but is still in the development or implementation phase An aspirational plan is one where the long-term objective has been established but development has not yet started The largest sponsors are most likely to have a robust glide path with 41% of $US 2 billion+ plans having a robust path, compared to 35% of plans holding less than $US 500 million. Similar to the UK survey findings, our U.S. survey shows robust glide paths in place at roughly the same level as in the 2015 survey. The percentage with aspirational plans, or no plans at all, fell from 24% to 17%. Glide path robustness by plan size Robust Basic Aspirational No plan All 38% 45% 9% 8% Over $2B 41% 45% 14% $500M to $2B 40% 45% 10% 5% Under $500M 35% 43% 4% 17% 0% 20% 40% 60% 80% 100% Aon 9
Managing Benefits and Liabilities Pension plans are becoming a legacy obligation for more and more sponsors, as the chart below shows. Our 2017 Hot Topics in Retirement and Financial Wellbeing Report showed open, closed, and frozen plans in roughly equal proportions. Those who responded to our Global Pension Risk Survey reported higher proportions of frozen and closed plans. This is consistent with our observation that companies seeking to control pension risk often start with design changes closing or freezing their plans before embarking on other measures. Benefit Actions: What is your outlook on the following strategies over the next 12 24 months? Already implemented Very likely to implement Somewhat likely to implement Unlikely to implement Shifting to defined contribution 61% 6% 8% 24% Restrict level of earnings on which pension accrues 28% 7% 65% Reducing future pension benefit levels but retaining DB-style benefits 25% 5% 5% 64% Freezing/closing to future accrual for existing members 58% 5% 8% 29% Closing plan to new entrants 81% 5% 4% 11% 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% FURTHER ANALYSIS Aon 10
BACK TO MANAGING BENEFITS AND LIABILITIES Managing Benefits and Liabilities (Continued) Further Analysis on Managing Benefits and Liabilities Once design-based savings options have run their course, sponsors generally turn their focus to plan costs. Since 2012, a majority of U.S. corporate plan sponsors have run lump-sum window programs, offering former employees with vested benefits the opportunity to receive the full value in a lump sum. In most cases the goal has been to reduce plan cost and risk. Most sponsors that haven t done this yet aren t philosophically opposed to it instead, they already offer lump sums to terminating employees on an ongoing basis, so further savings from a window are limited. On the other hand, a small portion of respondents that have already opened a window are very likely to do so again in the future. For those that have exhausted the window opportunity, retiree settlements with life insurance companies is a potential next step. We have seen a surge in buyouts since 2016, usually of a select group of retirees with smaller benefits for whom the cost of administering the plan is high compared to the value of the benefits being delivered. Our survey reveals that sponsors are increasingly aware of the buyout opportunity and while just a small percentage have actually performed such a transaction, many more are at least somewhat likely to do so in the future. A few sponsors are exploring more advanced strategies, including plan mergers and spinoffs that may reduce PBGC variable rate premiums. But insured buy-ins, somewhat prevalent in the UK, remain of interest to only a handful of sponsors in the U.S. For pensions in the UK, mandatory pension benefit indexing leads to very high longevity risk. Fortunately, longevity hedging is available in the UK on a standalone basis. For U.S. corporate plans, such indexing is extremely rare, and longevity risk is therefore smaller. U.S. longevity hedging is effectively accomplished via a lump sum or insured annuity settlement by which longevity risk is eliminated along with investment, interest rate, and all other pension risks. Because these alternatives are generally available at a relatively low cost, few U.S. sponsors have even explored standalone longevity risk hedging. Liability management: What is your attitude regarding the following strategies over the next 12 24 months? Already implemented Very likely to implement Somewhat likely to implement Lump-sum offer to former employees Insured annuity buyout 8% 3% 30% 43% 17% 22% Restructure plans to reduce PBGC premiums Insured annuity buy-in 5% 2% 5% 9% 9% 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% Aon 11
Investment Strategy Considerations Our opening questions were aimed at understanding what changes sponsors had made to their asset allocations over the past 12 months. Investment changes: What changes have you made in the last 12 months to your target investment strategy? Reduced Not changed Increased Domestic equities 21% 63% 16% Foreign equities Fixed government bonds TIPS Corporate bonds 18% 66% 16% 6% 76% 18% 5% 88% 7% 13% 67% 21% Active management 15% 76% 10% Real estate 7% 83% 10% Liquid alts* 13% 73% 13% Illiquid alts** 8% 77% 15% Derivatives 3% 84% 12% Responsible/ESG*** 100% Smart beta Dynamic asset allocations 92% 8% 84% 16% 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% * Hedge funds, commodities, and other liquid alternatives ** Private equity, private real estate, infrastructure, and other illiquid alternatives *** Environment, Social, and Governance FURTHER ANALYSIS Aon 12
BACK TO INVESTMENT STRATEGY CONSIDERATIONS Investment Strategy Considerations (Continued) Continuing the trend we have seen in previous surveys, respondents generally are reducing their exposure to equities and moving toward strategies consisting of a diverse portfolio of returnseeking assets combined with a liability-matching portfolio. This is evidenced by the net increase in fixed interest Treasury bonds of 11% (percentage increased less percentage reduced) along with a net increase in corporate bonds (8%) and derivatives (9%). Reductions in equity allocations and increasing allocations to alternative assets are also consistent with this de-risking trend. Even among this relatively risk-sensitive group, however, it is surprising to note that hedge ratios are still quite low, with 41% showing interest rate hedge ratios of 20% or lower on a liability basis. Many of these plans are poised to de-risk aggressively when their funded status rises or interest rates rise. For now, interest rate risk remains significant. Interest rate hedging ratios: What is your ratio as a percentage of the value of the liabilities? 61% 80% 18% 20% or less 41% 41% 60% 14% 21% 40% 27% Aon 13
BACK TO INVESTMENT STRATEGY CONSIDERATIONS Investment Strategy Considerations (Continued) Once the investment strategy has been set, the question of how it is implemented arises. We asked respondents how they felt about delegating implementation to a third party across a wide spectrum of investment activities. Not surprisingly, the monitoring of managers is already quite heavily delegated (56%) and remains the most common area of delegation. However, even the least common area delegation of the entire investment strategy has already been carried out by one-third of respondents, up from 25% in 2013 and 29% in 2015. Once primarily a solution for small plans, delegation of investment policy implementation is increasingly embraced by larger plans, with 17% of respondents with over $2 billion in assets taking this path. Delegation: What is your attitude toward having your professional advisers implement aspects of your investment strategy? Yes, delegate Very likely to delegate Somewhat likely to delegate No, unlikely to delegate No and haven t evaluated/don t know Manager monitoring 56% 3% 36% 5% Manager selection 44% 3% 1% 45% 7% Tactical asset allocation 44% 1% 4% 43% 8% Hedging 39% 1% 4% 42% 14% Implementation entire 33% 1%1% 55% 10% Implementation sleeve 39% 1%1% 46% 13% Insured annuity purchase 12% 7% 5% 38% 38% 0% 20% 40% 60% 80% 100% Aon 14
BACK TO INVESTMENT STRATEGY CONSIDERATIONS Investment Strategy Considerations (Continued) More details on investment strategy implementation When low hedge ratios are combined with widespread adoption of glide paths, and the prospect of accelerated contributions and rising interest rates is mixed in, the path forward seems clear. Looking ahead, our respondents expect to continue their shift out of equities and into liabilitymatching instruments. This pattern is consistent with prior surveys. While capital markets have slowed glide path progress by pressuring funded status, the glide path concept is proving to be a durable one. Sponsors are sticking with their glide paths, and our survey suggests they have the patience to allow them to work. In addition to the overall de-risking trend, a smaller move away from active management is evident, with some of that shifting to smart beta strategies. Traditional alternative allocations, liquid and illiquid alike, would shrink along with public equity exposure if a shift toward higher hedge ratios became apparent. Investment changes: What changes do you expect to make in the next 12 months to your target investment strategy? Reduced Not changed Increased Domestic equities Foreign equities Fixed government bonds TIPS Corporate bonds Active managment Real estate Liquid alts* Illiquid alts** Derivatives 36% 56% 7% 29% 60% 11% 7% 63% 30% 4% 88% 8% 6% 56% 39% 17% 79% 4% 12% 82% 6% 18% 78% 4% 17% 68% 15% 8% 73% 20% Responsible/ESG*** Smart beta Dynamic asset allocations 2% 2% 4% 98% 93% 4% 72% 25% 0% 20% 40% 60% 80% 100% * Hedge funds, commodities, and other liquid alternatives ** Private equity, private real estate, infrastructure, and other illiquid alternatives ** * Environment, Social, and Governance Aon 15
Hedging Risks We asked about the general policy on hedging four different types of investment risk. Similar to prior surveys, and in contrast to results in the UK and Canada, U.S. sponsors focus on interest rate risk while choosing to incur inflation, currency, and credit risk. This is understandable: Most of U.S. respondents with qualified plans have little inflation exposure beyond that embedded in wage inflation for pay-based plans The vast majority of U.S. respondents plan investments are in U.S. dollar-denominated assets Credit is usually viewed as a risk to be incurred rather than hedged Hedging policy Inflation Rates Credit Currency 40% 38% 38% 38% 36% 36% 36% 35% 30% 28% 25% 23% 23% 20% 18% 15% 14% 13% 14% 13% 10% 10% 9% 6% 5% 0 1% 4% 2% At any price (these are unrewarded risks) At fair value Pre-determined triggers We will not hedge No policy Aon 16
Delegation The full scale of the increasing delegation trend is apparent when we compare the 2017 results with those of our two prior surveys. The chart below shows that nearly every aspect of the investment strategy has shown consistent growth in delegation over the last four years. Particularly notable is the increase in the delegation of the entire investment strategy (+8%). We believe this rise is likely due to plan sponsors becoming leaner; they are increasingly focused on their core competencies and outsource areas where they lack resources and/or expertise. And this year, for the first time, we asked respondents whether they delegated the investment of a sleeve (e.g., a single asset class) as opposed to the entire strategy. Over one-third of respondents indicated that they did so, demonstrating that this approach to implementation is most definitely a mainstream activity. Change in attitude to delegation: Percentage of sponsors reporting they had already delegated certain investment functions 2013 2015 2017 60% 52% 56% 50% 40% 30% 41% 35% 44% 44% 31% 38% 44% 24% 28% 39% 25% 29% 33% 20% 10% 0% Manager monitoring Manager selection Tactical asset allocation Hedging Implementation entire FURTHER ANALYSIS Aon 17
BACK TO DELEGATION Delegation (Continued) Is there a link between plan size and the degree of delegation? Most definitely, as shown in this chart sponsors with smaller plans are more likely to delegate investment implementation across every single category. Investment delegation is one way in which smaller plans can benefit from the advantages of scale, such as access to the best managers and lower fees than their larger counterparts can achieve directly. However, we noted above that larger sponsors are embracing full delegation in increasing numbers, suggesting that the move is as much about improving execution capabilities as it is about lowering costs. Delegation by size Large Medium Small 80% 70% 60% 50% 40% 59% 71% 55% 50% 41% 61% 39% 53% 48% 50% 30% 20% 29% 21% 21% 17% 17% 27% 26% 27% 10% 0% Manager monitoring Manager selection Tactical asset allocation Hedging Implementation entire Implementation sleeve Aon 18
Monitoring and Mitigating Pension Risk As monitoring tools become more powerful, sponsors have access to more timely data on funded status and projected costs. The result is more frequent monitoring of key pension financial variables not just asset values and funded status, but also projected accounting P&L costs and balance sheet obligations and even potential annuity purchase prices. If we can indeed only manage what we measure, then the scope of pension risk management is now greater than ever before. Frequency of monitoring Annually or less frequently Quarterly Monthly Weekly or more frequently Funded status 12% 52% 23% 13% Year-end accounting balance sheet 37% 48% 13% 2% Projected P&L cost for next year 51% 39% 9% 1% Cost of potential annuity purchase 78% 19% 3% Asset values and investment performance 3% 54% 31% 11% 0% 20% 40% 60% 80% 100% Aon 19
Frequency of Monitoring We analyzed the monitoring of pension risks by plan size, and a clear trend became visible. The larger pension plans tend to monitor asset values more frequently than their smaller counterparts. For example, 74% of smaller plans monitored asset values quarterly or less frequently, whereas 68% of respondents managing larger plans monitored assets more frequently. Frequency of monitoring assets by plan size Annually or less frequently Quarterly Monthly Weekly or more frequently Large 32% 45% 23% Medium 5% 57% 24% 14% Small 4% 70% 26% 0% 20% 40% 60% 80% 100% Aon 20
U.S. Pension Funding So far, 2017 has seen a surge in corporate pension contributions with US $12 billion in debt-financed contributions reported through August. Survey respondents tell us that this trend is driven primarily by the desire to reduce PBGC premiums. Primary reasons for making additional contributions 80% 70% 70% 60% 50% 43% 40% 33% 30% 20% 10% 19% 16% 10% 6% 0% Reduce PBGC premiums Reduce reported pension deficit Avoid benefit restrictions Accelerate tax deductions Take advantage of low cost of debt Achieve earnings differential on pension EROA vs. cash return Other The responses above hint at another theme: Contributions are increasingly being financed by debt as sponsors seek to lock in low financing costs. But cash flow and cash reserves are still the dominant financing source: Source of additional contributions to plan 80% 75% 70% 60% 50% 40% 30% 20% 10% 39% 8% 3% 3% 1% Operating cash flow Cash reserves Debt offering Bank loan Commercial paper Other Other sources, including in-kind contributions of company stock and real property, continue to be relatively uncommon. However Boeing s recent announcement of a $3.5 billion company stock contribution in the third quarter of 2017 is certain to trigger additional interest in this strategy. Aon 21
Methodology The 2017 survey was completed by approximately 100 employers across a variety of plan types, sizes and industries. It was administered in the second quarter of 2017 to gain a better understanding of employer trends related to retirement plan offerings, design, and investments. Unless otherwise indicated, all figures shared were derived from the results of the 2017 Global Pension Risk Survey. Aon 22
Contacts Rick Jones Senior Partner +1.847.442.3279 rick.jones@aonhewitt.com Alan Parikh Associate Partner +1.847.442.0235 alan.parikh@aonhewitt.com Aon 23
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