Pension Funds—2013 Year End Review: Marked Improvement…Time to Play Defense?February 13, 2014
Kevin D. O’Brien, CFA
Fiduciary Investment Advisors
During 2013, pension funds enjoyed some of the largest improvements in funded status in decades. Marked by strong asset returns and an increase in the discount rate, pension funds are estimated to end 2013 approaching 96% funded (source: JP Morgan Pension Pulse Fall/Winter 2013).
Sources of funded status improvement
Asset returns were very strong in 2013, with domestic equity indexes generating returns over 30% and most international indexes returning over 20%. Conversely, fixed income markets were challenged by rising interest rates, resulting in the majority of fixed income indexes producing negative returns in 2013.
The increase in the discount rate that resulted from the Federal Reserve’s announcement in May 2013 about the potential for “tapering” QE3 was beneficial to pension plans. According to the Milliman 100 Pension Funding Index (“PFI”), the monthly discount rate ended November of 2013 at 4.78%, up from 4.05% in November 2012.
The 2002 and 2008 calendar years encountered what has been popularly dubbed ”perfect storms” for pension funds, with decreasing assets and falling discount rates causing funded statuses to drop to an average of 76% and 70%, respectively (exhibit 2). With increasing asset levels and rising interest rates, 2013 has seen just the opposite. A stark improvement in the funded status of most corporate pension plans means that now may be the time for plan sponsors to ”play defense”, locking in higher funded status levels.
Have you established a formal de-risking ”glide path” policy and governance structure?
If your plan hasn’t already done so, now may be the time to establish a dedicated de-risking glide path that systematically reduces risk assets and increases fixed income allocations. As a plan becomes more fully funded, it generally makes sense to take risk assets off the table in favor of liability-matched assets. We are, of course, hopeful that risk assets continue to have strong positive performance, but if we have learned anything from the 2002 and 2008 “perfect storms”, we should know that volatility can return quickly, and negative asset returns can swiftly erase the funding level progress that has been made.
Having a glide path policy in place is critical to success, as it sets ”guideposts” for the Investment Committee or other governing body to modify the plan’s allocation (e.g., more liability-matched fixed income as funded status improves). Removing emotion from the decision-making process can help ensure that the “end game” of a de-risking strategy is met with success. We at FIA have many clients who have asked us to work with their actuaries to prepare a quarterly or monthly liability ”snapshot” as a way to actively manage the glide path. When it comes to dynamically managing a pension in the current market environment, a frequent look at the liabilities is critical.
Stronger financials and next steps…
Many plan sponsors have continued to make meaningful contributions to their plans in 2013. Year-end 2013 financial statements will likely reflect a marked improvement to the balance sheets of many corporations. As such, plan sponsors may want to consider a lump sum strategy to potentially reduce plan size, lower administrative costs, and transfer liabilities. Terminated Vested (“TV”) participants, those who have terminated employment with the company but have not yet started to receive their benefits, is a potential group to evaluate. Also, higher discount rates at the end of 2013 (compared to the end of 2012) help to reduce the size of the lump sum payment, as such payments, like liabilities, are calculated using similar higher interest rates.
2013 has seen the most meaningful improvement in pension funding status in many years. Plan sponsors should be actively monitoring the status of their pension plans and adapting to the current environment accordingly. Protecting gains in funded status with increased fixed income allocations predicated on a clearly defined de-risking glide path can be a key determinant of success.
It would be a shame to see the significant gains of 2013 eroded in a similar fashion to 2002 and 2008. Now is truly a time for plan sponsors to consider implementing a “good defense”.
FIA has helped many clients navigate through the various stages of plan management, be it a growth-seeking strategy, a liability-matched long duration approach, or complete risk transfer by off-loading liabilities to an insurance company. If you would like to discuss your pension plan and the applicability of some of these risk mitigation strategies, please contact us.
Sources: Milliman; Pension & Investments; Towers Watson; JP Morgan
Past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product made reference to directly or indirectly in this newsletter will be profitable, equal any corresponding indicated historical performance level(s), or be suitable for your portfolio. Fiduciary Investment Advisors does not provide legal or tax advice. Due to various factors, including changing market conditions, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this newsletter serves as the receipt of, or as a substitute for, personalized investment advice from Fiduciary Investment Advisors, LLC.