You're a U.S. corporation, your frozen defined benefit plan is fully funded, and now it's time to get rid of it, right? One expert says perhaps not.
U.S. corporate defined benefit plans are healthier than they've been in decades, and companies should think about keeping them so they can take advantage of surplus assets, said Jared Gross, head of institutional portfolio strategy at J.P. Morgan Asset Management, in an interview on Monday.
The profile of corporate DB plans has diminished significantly over the past several decades, especially following a disastrous first decade of the 21st century that saw returns crash and funding ratios plummet following what Mr. Gross called the "tech wreck" of the early aughts. While the Pension Protection Act of 2006 was meant to remedy funding problems — especially among airline companies — the global financial crisis of 2008 brought funding levels crashing down and motivated companies to get out of the pension business.
Before companies started aggressively derisking their plans by closing and freezing them and oftentimes transferring assets and liabilities to insurance companies, Mr. Gross said pensions were seen "as a largely benign and relatively efficient mechanism."
But after 2008, pensions were seen "as a burden and a risk and a potential time bomb on the balance sheet." That potential was not just rumor and innuendo, he noted, but analysts soon punished companies for low pension funding ratios landing on their balance sheets and rating agencies started to hold microscopes to those funding ratios.
"It's occurred to us that many of the attitudes toward the DB plan were reflecting the 'scar tissue' of this period of extreme volatility," Mr. Gross said.
However, that volatility has ebbed. According to J.P. Morgan Asset Management's recent analysis, over half of the 100 largest corporate DB plans now have funding ratios of 100% or over.
"In that light, there is a very fair discussion that needs to happen around the future of defined benefit plans," he said. "They've gradually gotten back to full funding since the global financial crisis, since the lows of that era, and that's been on the basis of pretty good asset performance, as well as meaningful contributions."
One such discussion is how hibernation prevents a DB plan from improving its funding ratio.
"That narrative or that attitude pre-supposes that there is no value to the plan continuing to improve its funded status and achieving a surplus. In fact, that the next step to a plan's evolution is to terminate," Mr. Gross said. "I will just say that the path of derisk, hibernate, terminate is one possible path among many, and it is a path that ignores the massive value that a well-funded and well-managed defined benefit plan can provide to a sponsor if it is allowed to do what it was at the beginning."
"A lot of the negative attitudes are reflective of this kind of scar tissue from an era of volatility that no longer applies," Mr. Gross said, adding that there has long been the misconception that surplus assets of a pension fund are "trapped" assets that have no value and that "the money will be captured by the IRS through its excise tax."
Mr. Gross said there is tremendous value in having a pension surplus. It could provide capital to pay for retiree healthcare benefits, for establishing follow-on pension funds, and to provide capital for M&A activity, although not all possibilities apply for all companies.
"The idea that none of them apply across the board, and therefore pension surplus is without any value, I think, is preposterous," Mr. Gross said.
Re-embracing the DB plan makes sense, he said, especially in light of how defined contribution plans are trying to step into the shoes of a DB plan. Mr. Gross cited options such as target-date funds, retirement income portfolios and even some DC plans attempting to offer life annuities as an investment option in their DC plans.
Mr. Gross noted that particularly life annuities are the hardest part of a DB plan to replicate in a DC plan, which is why many sponsors haven't offered them. Meanwhile, actual defined benefit plans are now better funded and sponsors have figured out how to manage risk against liabilities, which means DB plans provide a benefit that is hard to replace and replicate, he said. "What it ultimately adds up to is a fairly strong case for sponsors to reconsider this decision to sort of end their defined benefit plans."
Mr. Gross said that embracing a pension surplus has made a lot of sense to the sponsors he has spoken to, and many are now revisiting the glidepaths of their liability-driven investing portfolios so they can continue to gain returns beyond a 100% funding level.
"There is at a minimum a very strong level of recognition that extending your plan's life into the future so you can accumulate a healthy level of surplus makes a tremendous amount of sense," Mr. Gross said.
