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Comment: US plans look to capitalise on market opportunities to de-risk

16 May 2014

A recent report suggests that nearly 30% of closed defined benefit (DB) pension plans, private open plans and plans with less than $1 billion in assets under management in the US are considering transferring risk to a third party insurer in 2014.

Accounting transparency, regulatory changes and increased scrutiny by shareholders and analysts have put pension risk at the very top of the corporate agenda in the US. Indeed, a North American, industry-wide study just released by Clear Path Analysis highlights that as many as 35% of closed plans, 31% of small plans and 27% of private open plans are considering pension risk transfer in the coming year.

The report also notes increasing US pension plan enthusiasm for Liability Driven Investment (LDI) – a key thrust of which is to hedge a portion of a plan’s exposure to changes in interest rates and inflation. Last year, leading US publication Pensions & Investments suggested that two-thirds of DB executives had LDI strategies in place, with all signs pointing to the LDI train rumbling on in 2014.

Of course, a key barrier does exist in this respect: the low rate environment. Clear Path’s report highlights that a majority of plan sponsors (93% for private plans) believe that movement in interest rates will impact their decisions to implement an LDI strategy, or to execute a bulk annuity transaction. Given the low rates, and associated low funded status and higher contributions, the consensus is that now is not the right time to “lock-in” to such a strategy.

This, to some extent, is understandable. But what is not is inactivity, however. Those pension schemes that are considering LDI (or alternative de-risking strategies) should begin to put themselves in a position where they can capitalise on changing conditions and market opportunities as soon as they become compelling. Firstly, schemes should take steps to understand their liabilities in a better manner. Here is where technology can help; allowing plans to not only more accurately assess the value of their assets and liabilities – and thus assess any mismatch between the two – but also to ask pertinent questions of their data and stress-test it to analyse how market fluctuations may impact their risk profile. Certainly, the report highlights a desire and willingness for plans to customize their hedging programs as they approach full funding – yet this requires a top-to-bottom understanding of their sensitivity to inflation, interest rate and longevity risks.

What is more, when the time does come to transact, such real-time, granular information may not only allow them to pull the trigger at the right time – it will also allow providers to structure more efficient and cost-effective hedging decisions. 

All signs point to the year ahead being a good one for de-risking. Make sure your own plan isn’t taken by surprise.

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