Creative ideas for managing pension plan risk
The past couple of years have been very interesting times for US pension plan sponsors. Obviously, the global pandemic and its effect on the economy has been the most impactful. We’ve also had new pension legislation as a result of the pandemic, The American Rescue Plan Act of 2021 (“ARP”) which has presented plan sponsors with new opportunities. At River and Mercantile, we have been partnering with many plan sponsors and their consultants to help improve their pension plan’s funded status and future outcomes, in spite of the unprecedented circumstances over the last two years.
Listed below are a number of these ideas that have benefited plan sponsors:
Paying lump sum benefits to active participants
We have worked with plan sponsors to structure a design to implement lump sum payments to active participants. This is particularly beneficial to frozen plan sponsors who may have many active participants with small benefits. The result of paying these benefits has led to reduced plan sponsor cost and risk, transfer of assets to the 401(k) plan and improvement in employee satisfaction.
Redesigning pension glide paths
Many sponsors haven’t seen an increase in their funded status as one would have hoped as a result of the recent market rally. This is typically due to low equity allocations from a glide path that has reduced equity exposure as markets have risen over the last ten years. We have developed an alternative glide path that allows plan sponsors to independently allocate the amount of equity risk and interest rate protection desired and not decrease equity exposure as funded status improves, but yet still reduce risk. Our glide path typically does not introduce any additional risk and often decreases investment fees.
Utilizing call options in glide paths
Most frozen plan sponsors utilize some form of a glide path. While we discuss an alternative glide path in the point above, a traditional glide path could be enhanced by selling an equity call option with a strike price estimated at the next trigger point in the glidepath. This is especially beneficial for plan sponsors who have high interest rate hedge ratios which make predicting the equity strike price much easier. As a reminder, the seller of a call option receives a premium and thus the plan could benefit from receiving this premium now for a transaction it will implement in the future.
Enhancing downside interest rate protection
To increase a plan’s interest rate hedge ratio, most sponsors will need to either allocate more assets to hedging assets, increase their fixed income duration or a combination of both. While this helps to mitigate the impact of any downward movement in interest rates, it also mitigates the impact of any rise in rates. Interest rate swaptions are an alternative to this that allows a plan sponsor to maintain their growth portfolio position while decreasing the downside risk associated with a fall in discount rates.
Using an independent expert to place annuities
Many plan sponsors have placed annuities over the past few years as they further de-risk their plans. However not all annuity placement providers/advisers will serve as a fiduciary in that capacity. This decision, like any other decision involving qualified plan assets, should be advised by someone taking fiduciary responsibility under ERISA. A plan sponsor can still utilize their consultant of choice but can ask to hire an independent expert to help evaluate the potential insurance carriers and provide the due diligence documentation and support that a prudent fiduciary should want. We have been assisting plan sponsors, ERISA attorneys, actuarial firms, and investment consultants with these fiduciary services.
Obtain unbiased assessment of plan termination readiness
Engaging with an outside firm to assess a pension plan’s readiness to terminate brings a fresh and unbiased perspective that often results in multiple recommendations to improve the pension plan. Applying our experience implementing lump sum offerings and annuity purchases, we provide a more refined estimate of the true cost to terminate a pension plan, which will differ from the liability for funding or accounting purposes. In many cases, this has resulted in an accelerated timeline to plan termination and peace of mind that everything will go smoothly when starting the termination process.