The median value at risk for the 200 largest corporate defined benefit plans in the United States is 17%, meaning that their assets could drop in value by as much as 17% in a one-in-20 worst market year, according to a new report.
"A VAR of 17 is pretty aggressive," said Eric Stubbs, managing director in the Strategic Advisory Group at Credit Suisse Asset Management, New York, which put out the report.
The range in VARs is substantial -- from 9.5% to more than 28%. The conservative end corresponds to risks of an intermediate bond portfolio, while the aggressive end has risks similar to those of an aggressive growth equity portfolio.
Overall, 120 pension plans, or three-fifths of the 200 included in the report, could become underfunded in a worst-case market year unless the sponsors made contributions, according to the report.
"That's a high number," said Mr. Stubbs. "And we're focusing on the asset side. If you focus on the liability side the number could be worse."
For plans currently funded at 100% to 110%, a one-in-20 market year could reduce the median funding level to 87%. For the best-funded plans, at 125% or more, the median funding level could drop to 118%.
"The (17% VAR) number doesn't surprise me," said William Quinn, president of AMR Investment Services Inc., Fort Worth, Texas, which manages American Airlines' $5.2 billion in defined benefit assets. "Most pension plans are overfunded and are well-positioned to absorb that amount of loss. It's only important for plans that are underfunded or companies that are teetering on bankruptcy."
"People here were skeptical as to the validity of such a report," said an official with one of the plans included in the report who did not want to be named. "You can't use assets stand alone. Depending on your liabilities, there may be differences in your asset mix."
According to the report, aggressiveness increases with plan size, with pension funds of $5 billion and up being the most aggressive, with the highest median VAR of 17.71%, and then levels off. However, the range of differences in VAR is greatest for the plans with between $1.5 billion and $2.5 billion, whose numbers range from 9.525% to 28.25%.
The smallest range in VAR is among plans with more than $10 billion in assets. This suggests that as plans grow, their asset allocations become more similar to those of their size peers.
The most aggressive companies are in the technology, health care and transportation industries, which have median VARs of, respectively, 18.7%, 18.4% and 18.22%.
Basic materials and utilities industries have the most conservative companies, with median VARs of 16.74% and 16.83%, respectively.
The report also calculates the VARs of companies in six other industries: Capital goods, with a median VAR of 17.55%; communications services, 17.31%; consumer cyclicals, 17.06%; consumer staples, 16.93%; energy, 17.36%; and financial, 17.51%.
The widest range is with companies in the financial industry, in which the minimum VAR is 9.52% and the maximum is 28.25%; the basic materials industry, with a minimum of 13.29% and a maximum of 24.75%; and the capital goods sector, with a minimum of 11.77% and a maximum of 26.78%.
The risks and rewards of taking aggressive market risk may depend on funding status. Just-underfunded plans have much to gain in terms of expenses and required contributions by crossing the hurdle to just-funded status. Therefore, one could expect them to have higher risk profiles.
Less to gain
Similarly, significantly overfunded plans have less to gain from aggressiveness and might instead adopt conservative asset-preserving risk profiles. However, the results of the report show just the opposite is true. The underfunded plans were generally the most conservative, while the most over-funded plans were the most aggressive in their risk taking and also had among the greatest variability in risk profiles.
The report says that VAR can be used by plan sponsors in several ways to improve plan operations and the competitive position of the sponsor firm.
It states that VAR is a better measure of short- and medium-term market risk exposure of the plan than is strategic asset allocation. Although strategic asset allocation is traditionally used to measure the risk exposure of a plan, the report says, actual risks over a two-year horizon can deviate from those expected in light of the asset allocation by plus or minus 25% as market volatility and correlations move.
VAR allows plans to track the dynamics of changes to their risk profiles over time and permits the attribution of those risks to asset allocation changes, market changes or manager behavior changes.
The Strategic Advisory Group used previously reported asset allocations and three years of data on asset class returns and volatility to compute the VAR for each plan. It did not adjust for differences in manager performance and risk.
However, previous work by the group shows that seven-eighths of market risk in a typical pension plan comes from volatility of the asset classes, while only one-eighth comes from active management.
Consequently, it says that the estimated VARs in the report should be within 12% of the actual risks that would be computed using manager-level data.