Cost and choice are two important considerations for any retirement plan, from defined benefit pension plans to defined contribution plans. However, a plan's size can significantly affect both cost and choice.
For defined benefit, or DB, plans, the issue is economic and becomes acute for plans that are derisking. On the defined contribution, or DC, side, the challenges are freedom of choice in the investment options plan sponsors can offer their participants and the plan costs buried in investment expenses or a reduced stable value return.
Securian Financial considers large plans as those with more than $500 million in assets, mid-size plans as those with $50 million to $500 million and small plans as those with $50 million in assets or less.* The size of a DB plan can determine the breadth of flexibility — or lack thereof — and options that can put the plan's assets to best use.
“While many DB plans pursue liability-driven investment strategies, their approach and how they manage it depend on the plan size,” said Craig Stapleton, Securian Asset Management's senior vice president and head of quantitative and ALM strategies. “LDI targets a reduction in funded status volatility over time, which is due to a mismatch between the assets and liabilities.”
There are target-risk profiles that derisk over time, depending upon the funded status level.
“As a plan gets closer to fully funded, 100% of assets may be in fixed income,” Stapleton said. “But if it's very underfunded, there may be 50% in equities, with the hope to grow assets and migrate toward a fully funded immunized portfolio.”
Small DB Plans: Limited Flexibility
With little or no economic clout, small DB plans often get less attention and stuck in less-than-ideal structures. For example, a $50 million plan is likely in a 50/50, 60/40 or 70/30 balanced-fund portfolio.
“It could be just exchange-traded funds, and the duration within the fixed-income portion may only be five years,” Stapleton said. “Whereas the liability may have a duration from nine to 20 years. That asset allocation is not based on a thoughtful approach to fully fund the plan and derisk over time.”
Interest rate uncertainty adds another layer of risk, especially if the plan is not matching from an asset-to-liability perspective.
“You have a lot of risk embedded in that mismatch,” Stapleton said. “If interest rates move against you, you'll have a big adverse economic impact to your funded status.”
And smaller plans don't have the capability to reduce that risk, which can be costly.
“Plan sponsors may not even be aware of the magnitude,” he noted. “Whether it be the equity risk they're holding or the interest rate mismatch. An education process is needed to show, 'Here's your economic risk and exposure, and here's how we can help mitigate it.'”
Securian Financial offers customized LDI solutions for smaller plans, and looks at statistics within a plan's pool of participants, such as retirees versus active workers.
“This allows us to create a portfolio that effectively matches and immunizes the cash flow profile,” Stapleton said. “We also offer an active-derisking glidepath mechanism that actively monitors a plan's funded status.”
When the funded status increases, or targeted interest rate levels are breached, the firm can programmatically derisk the plan's asset-liability profile.
“As an insurance company, we can provide general account stable value solutions,” he added. “If plan sponsors with small plans don't want to take any interest rate risk and want a fixed-crediting mechanism, we can provide that.”