The drop in the capital markets might prompt pension funds to consider moving to liability-driven investing to mitigate against further losses and increased contributions.
With many U.S. corporate pension plans facing huge pension deficits because of the financial crisis, the only (plans) that are doing materially different are those that move significantly to the so-called liability-driven-investing model, said Alan Glickstein, senior retirement consultant and actuary, Watson Wyatt & Co., Dallas. These plans could even be overfunded at the end of the year.
Folks who chose to go LDI two or three years ago are looking real smart, Mr. Glickstein said.
The LDI strategy seeks to match pension investments with the duration of pension liabilities so both move close in unison with market fluctuations, minimizing changes in the pension funding level. The strategy mitigates risk in investment and in interest rates on liabilities, but also dampens return.
The success of LDI will certainly pique the interests of plans that are willing to give up (expected) higher returns in equity for more stable funding, Mr. Glickstein said.
An analysis by the Center for Retirement Research at Boston College estimates the shortfall created by this year's market collapse will need to be made up by $92 billion in annual contributions over seven years.
That analysis is based on an estimate that, as of Oct. 9, the funding level fell to 75% of assets, or $645 billion short of full funding, from 100% funded at the beginning of the year. The analysis was written by Alicia H. Munnell, director of the center and professor of management sciences at the school, and Jean-Pierre Aubry and Dan Muldoon, both research associates of the center.
Standard & Poor's, New York, estimates that by the end of 2008, the aggregate deficit for the 348 companies in the S&P 500 with defined benefit plans could be higher than the $219 billion deficit in 2002, a record.
Mr. Glickstein doesn't see a rush to LDI after the market debacle. The time to go to LDI is when plans are about 100% funded, Mr. Glickstein said. But if plans are underfunded, there will be pressure to regain what they lost and go for higher expected returns in equities. Probably the thing you don't want to do is to make a sudden change in investment direction, such as into LDI. Sponsors would be locking in investment losses.
Plan sponsors might look at 2008 and see that (market fall) as a reason to move to LDI, he said.
Mark-to-market rules, or fair valuation, of the Financial Accounting Standards Board, Norwalk, Conn., might also have an impact on a plan sponsor's consideration to use an LDI approach, because it will introduce more volatility, Mr. Glickstein said.
But I don't think you will see any short-term moves based on the market direction this year, Mr. Glickstein said. But I see this (market fall) as (the catalyst for) a debate on whether the mark-to-market has put too much volatility into a plan.
That volatility is now reflected directly on the corporate balance sheet under Financial Accounting Standard 158.
The rule might cause some companies to consider whether they want to switch investment strategy to better manage the funded status of the plan to mitigate downside volatility in the level of funding.
Despite the shape decline in funding level and expected increase in contributions, Mr. Glickstein sees little impact on the current trend in plan termination. I don't see an increase in terminations, he said.
We've seen very few plan terminations in the last few years, because plans were not fully funded on a termination basis and sponsors would have to contribute more to the plan to reach full funding to terminate, he said. So there is no saving in the short term, at least.
We have sponsors freezing plans, but the rate of freezes is going down, he added.
If you freeze a plan, it doesn't change the funded status. It doesn't change the challenges and problems of maintaining a plan.
The liability of a pension plan won't look that much different 10 years out whether you terminate or freeze the plan now, he said.