Towers Watson-Forbes Insights 2010 Pension Risk Survey …...Towers Watson–Forbes Insights 2010...

Towers Watson–Forbes Insights 2010 Pension Risk Survey

U.S. Executive Views

December 2010

Pension plan sponsors in the United States are seeking more eff ective management of pension risks through better investment and funding strategies and implementation, according to the Towers Watson-Forbes Insights 2010 Pension Risk Survey.

Towers Watson–Forbes Insights 2010 Pension Risk Survey — U.S. Executive Views 3

Towers Watson–Forbes Insights 2010 Pension Risk Survey

U.S. Executive Views

Table of Contents

Current and Future Plan Status 4

Figure 1. Current coverage status of pension plans 4

Figure 2a. Potential actions for open plans over next fi ve years 4

Figure 2b. Potential actions for closed plans over next fi ve years 5

Issues Facing Plan Sponsors 5

Figure 3. Top concerns of DB plan sponsors over next fi ve years 5

Figure 4. Effect of fi nancial crisis on plan sponsors 5

Investment Risk and Management 6

Figure 5. Reducing risk versus increasing returns 6

Figure 6. How likely is your company to use the following strategies to reduce risk in its DB plan over the next fi ve years? 6

Figure 7. Does your company use the following fi nancial instruments to manage risk in its DB plan? 7

Figure 8. Does your company hold the following investments in its pension fund? 7

Regulatory and Funding Risk 7

Figure 9. Current funded status of pension plans 7

Figure 10a. Which relief method will your pension plan elect? 7

Figure 10b. For which two years will your plan elect the funding relief? 8

Figure 11. Potential actions to reduce size of DB plan obligations 8

Figure 12. Potential actions as a result of IFRS 9

Figure 13. Funding policy on pension contributions 9

About the Survey 10

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There is no sign that the decline in the sponsorship of active defi ned benefi t (DB) plans has reversed. Neither is the extinction of DB plans imminent. Instead, the survey shows that most sponsors of active plans will continue to provide retirement benefi ts, although many will cut back on benefi ts, and some are indeed seeking to close or freeze. The task for pension plan sponsors, according to respondents, is to take action to manage risk and reduce liabilities.

There is a strong desire on the part of plan sponsors to reduce the risk of their pension plans. Many plans are signifi cantly underfunded in the aftermath of the fi nancial crisis, and their sponsors have experienced the resulting pressure on corporate cash fl ows. Rather than rushing to seek higher investment returns to close this funding gap, however, the majority of sponsors attach greater importance to reducing risk. The most favored strategy is to seek a better alignment of assets with liabilities — for example, through liability-driven investment programs. Executives expect to increasingly utilize swaps, options and other hedging derivatives to achieve better risk management. More plan sponsors today are setting formal funding policies in place of ad hoc decisions. Over time, lump sum payments and annuity purchases are also expected to be vehicles for settling DB obligations on a wholesale basis.

Current and Future Plan StatusMore than half of the pension plans in the survey are active; 32% are closed to new hires, and 14% are frozen to all employees (Figure 1). The majority of plan sponsors expect open plans to stay open in the next fi ve years, although about a third of them expect to modify their benefi t formula to reduce cost or risk. Fifteen percent of plan sponsors with open plans do expect to close or freeze over the same period (Figure 2a). Only 22% of plan sponsors with closed DB plans will probably freeze them in the

next fi ve years, and another 7% will terminate (Figure 2b, page 5). One-fi fth of sponsors with frozen plans are actively seeking to terminate. These results indicate the continued decline in the active accrual of benefi ts from DB plans, but the management of the plans will remain a critical issue for many years to come.

54% Open pension plan

32% Closed to new hires

14% Frozen32%

54%

14%

Figure 1. Current coverage status of pension plans

49% No significant changes are currently planned to the DB regarding existing/new employees

29% Accrual will continue in the DB plan for existing/ new employees, but the benefit formula will likely be modified to reduce cost or risk

15% Our company is actively seeking alternatives to its DB plan for existing/new employees

1% Our company is actively seeking to terminate its DB plan

6% Other

1%

29%

6%

49%

15%

Figure 2a. Potential actions for open plans over

next five years

The survey, conducted in September and October 2010,

includes responses from more than 300 executives who are

in charge of pension fi nance at large companies. The results

provide new insights about the current trends and practices of

pension plans.


Issues Facing Plan SponsorsAccording to respondents, the impact of DB plans on cash fl ow tops all other concerns listed in the survey. This presumably refl ects the competition between DB funding and business capital needs, particularly in light of the fi nancial crisis. Impacts of the DB plan on the income statement and balance sheet are ranked the second- and third-highest concerns, respectively. Following them are concerns about attraction and retention of workers, and conforming to regulatory requirements (Figure 3).

More than half of respondents said the fi nancial crisis has caused their DB plan to have a negative impact on their companies’ cash fl ows, fi nancial statements, DB plan fi nances and long-term commitment to DB plans. Four out of 10 executives also noted that the crisis has increased employees’ appreciation of their DB plans (Figure 4). This may suggest that plans in which employers assume some fi nancial risk will more likely gain recognition and support from employees. Over the next 12 months, capital improvement is ranked highest on the spending agenda of corporations, and health benefi ts are ranked ahead of DB contributions (not shown).

47% No significant changes are currently planned to the DB regarding existing/new employees

16% Accrual will continue in the DB plan for existing/ new employees, but the benefit formula will likely be modified to reduce cost or risk

22% Our company is actively seeking alternatives to its DB plan for existing/new employees

7% Our company is actively seeking to terminate its DB plan

8% Other

16%

8%

47%

7%

22%

Figure 2b. Potential actions for closed plans

over next five years 0% 10% 20% 30% 40% 50% 60%

Impact on public perception of our company

Lack of appreciation from employees

Orderly exit of older workers

Impact on our credit rating

Impact on investor perception of our company

Conforming to regulatory requirements

Impact on attraction and retention of workers

Impact on our balance sheet

Impact on our income statement

Impact on our cash flow

2626

1616

99

2525

4747

5656

1313

4141

1212

1111

Figure 3. Top concerns of DB plan sponsors over next five years

0% 20% 40% 60% 80% 100%

Your DB plan’s impact on your company’s ability to raise capital through debt or equity

Your employees’ appreciation of the DB plan

Retirement pattern of older workers (orderly exit of workforce)

Investor concerns about your DB plan

Your company’s long-term commitment to its DB plan

Your DB plan’s impact on your company’s financial statements

Your DB plan’s impact on your company’s cash flow

The financial strength of your company’s DB plan

1111

55

22

44 1313 35354141 77

1919 5858 1717 44

22 2222 6969 55 22

55 3333 5757 4411

1616

2222

6161 1616

5050 1919 66

55 22

33

1212 4242 3434 77

Strongly Slightly No effect Slightly Stronglynegative negative positive positiveeffect effect effect effect

Figure 4. Effect of financial crisis on plan sponsors

55 2828 5454 22

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Investment Risk and ManagementNearly two-thirds of respondents (63%) said they will more likely focus on reducing investment risk rather than seeking higher returns. Only 14% of plan sponsors place a greater focus on higher returns (Figure 5). To address investment risk, a better alignment of plan assets and liabilities (e.g., liability-driven investment) is the most favored strategy, chosen by 66% of respondents. Respondents are divided on the likelihood of using alternative risk strategies. Some plan sponsors will likely perform a liability redesign (e.g., changes in plan type or benefi t formula), pursue long-term investment opportunities, governance structure improvement or liability transfer (e.g., pension buyouts) (Figure 6).

63% Focus on reducing risk more likely than seeking higher returns

14% Focus on seeking higher returns more likely than reducing risk

23% No change

14%

63%

23%

Figure 5. Reducing risk versus increasing returns

0% 20% 40% 60% 80% 100%

Better alignment of assets with liabilities (e.g., buy-ins, liability-driven investment)

Greater focus on dynamism (e.g., to capture long-term investment opportunities whenextreme market pricing moves in your favor)

Governance structure redesign (e.g., more formal decision-making structures for the planto enable better decision making)

Liability redesign (e.g., changes in plan type or benefit formula)

Liability transfer (e.g., buyout through annuity purchase, lump sum)

Capital market innovations (e.g., moving benefits to captive insurance vehicles)2626 2222 2121 1717 8866

4499

441515

88 1515 30302626 771414

1717 1616 2323 2525

55 66 1919 3131 443535

2222 2020 2323 2222 331010

1616 1616 3232 2323

Very Somewhat Equally Somewhat Very Don’tunlikely unlikely likely/unlikely likely likely know

Figure 6. How likely is your company to use the following strategies to

reduce risk in its DB plan over the next five years?

“Nearly two-thirds of respondents (63%) said they will more

likely focus on reducing investment risk rather than seeking

higher returns.”


While a majority of respondents use various fi nancial instruments to manage pension risk, no single instrument is used by a majority of companies. For instance, slightly fewer than 40% of plan sponsors use interest-rate swaps and futures, and about 30% use credit derivatives (Figure 7). The use of such instruments, however, will likely increase over time. Also, more than a third of current users expect to further increase the use of interest-rate swaps, futures or option-based strategies. Some plan sponsors that are not currently using these fi nancial instruments expect to adopt them in the future (not shown).

Private equity is a prevalent part of asset portfolios for the majority of plans (62%) (Figure 8). Other types of assets, including private real estate, private infrastructure, company stock and alpha-seeking strategies utilizing short selling or derivatives, have lesser prevalence in portfolios. All of these classes will likely gain further importance because many respondents say they expect to increase their use (not shown).

Regulatory and Funding RiskAccording to the survey, four out of 10 large pension plans are signifi cantly underfunded (less than 80%) on an accounting basis. Most of the rest are in the range of 81% to 100% funded (Figure 9). Nearly a quarter of sponsors will elect the funding relief that was provided by legislation earlier this year. They will either amortize the funding shortfalls over a 15-year period (the 15-year rule) or make interest-only payments for two years, followed by seven years of amortization (the 2+7 rule). The majority of these sponsors will apply the relief to the 2010 and 2011 fi scal-year funding shortfalls (Figure 10a, and Figure 10b, page 8).

0% 10% 20% 30% 40% 50%

Option-based strategies

Credit derivatives

Currency forwards

Interest-rate swaps

Interest-rate futures

3131

2626

3939

3939

3030

Figure 7. Does your company use the following financial instruments to

manage risk in its DB plan?

0% 20% 40% 60% 80%

Private infrastructure

Company stock*

Private real estate

Alpha-seeking strategies that utilize short selling or derivatives

Private equity

3939

4343

4343

6262

2626

Figure 8. Does your company hold the following investments in its

pension fund?

* 58% of respondents with company stock mentioned they contributed company stock to theirpension in lieu of cash over the past year.

5% Less than 60%

35% 60% – 80%

53% 81% – 100%

5% 101% – 120%

2% More than 120%

35%

5%5%

53%

Figure 9. Current funded status of pension plans

2%

7% The 2+7 rule

15% The 15-year rule

24% No relief is needed because our plan is well funded

21% No relief will be taken because we will make the required contributions

4% No relief will be taken because we are concerned about the cash-flow rule

2% No relief will be taken because of other reasons

27% Don’t know

15%27%

4%

7%

21%

24%

Figure 10a. Which relief method will your pension plan elect?

2%

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Plan sponsors are taking actions to reduce the size of DB obligations. Annuity purchases are not currently prevalent for settling DB obligations on a wholesale basis. However, more respondents expect their companies to take lump sum and annuity routes over the next two to fi ve years (Figure 11).

According to the survey, global pension accounting reform will likely cause (e.g., pension-related IFRS rules) 52% of plan sponsors to reduce equity exposure, 48% to adopt liability-driven investment strategies, and 48% to reconsider their long-term commitment to pension plans (Figure 12, page 9).

2009 and 2010 2010 and 2011 2009 and 2011Other Don’t know

0%

20%

40%

60%

80%

100%

The 2+7 ruleThe 15-year rule

Figure 10b. For which two years will your plan

elect the funding relief?

1111

7777

55

77

1818

99

6464

5544

0% 20% 40% 60% 80% 100%

Purchase annuities for pension plan next year

Purchase annuities for pension plan over next two to five years

Offer lump sum to terminated vested participants next year

Offer lump sum to terminated vested participants over next two to five years

Add lump sum option for current active participants next year

Add lump sum option for current active participants over next two to five years1212 2626 20202626 101066

1515 88

88 66

3131 1414 14142828 55 88

2828 1414 2727 1717

2424 1616 2121 2525 8866

4242 1313 2222 1212 7744

1616 1313 2626 2222


Figure 11. Potential actions to reduce size of DB plan obligations

“Plan sponsors are taking actions to reduce the size of

DB obligations.”


In the wake of the fi nancial crisis, many pension sponsors are managing their plan contributions more tightly and are striving to achieve explicit funding targets. Specifi cally, fewer sponsors today (7% of plans versus 12% before the crisis) are contributing the maximum tax-deductible amount, and fewer sponsors (20% versus 26% before the crisis) aim to fully fund their plans. More plan sponsors (29% versus 21% before the crisis) choose to make the minimum required contributions. Nonetheless, a growing number of sponsors are formalizing their funding policies. Only about 8% of sponsors make ad hoc funding decisions, down from 15% before the crisis. More sponsors (36% versus 26% before the crisis) choose to set explicit funding targets and contribute just enough to achieve them (Figure 13).

0% 20% 40% 60% 80% 100%

Adopt LDI

Lower its allocation to equity investments

Adopt liability hedging

Reconsider its long-term commitment to its pension plans

Reduce size of plan through liability transfer

1212 3030 303066 11111111

1313 77

2323 1010

1111 1818 27272828 66 1010

55 88 2929 2525

1010 1313 2323 2929 661919

66 1010 2525 3939


Figure 12. Potential actions as a result of IFRS

Figure 13. Funding policy on pension contributions

Funding Policy

Before Crisis

Funding Policy

Today

Contribute the legal or negotiated minimum payment 21% 29%

Contribute the maximum tax-deductible amount 13% 7%

Contribute the amount that ensures the plan is fully funded 25% 20%

Contribute enough to achieve explicit funding targets 26% 36%

Make ad hoc decisions on pension funding without formal policy 15% 8%

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About the SurveyForbes Insights, in association with Towers Watson, conducted the 2010 Survey on Pension Risk from September 8 to October 8, 2010. The survey received 304 responses from U.S. corporate executives, including chief fi nancial offi cers, vice presidents of fi nance and controllers. Respondents represented a variety of industries. Manufacturing, with 50 respondents, had the highest representation. The vast majority (87%) of respondent companies had revenue of more than $1 billion in the recent fi scal year, and 30% of them exceeded $10 billion in revenue. Seventy-six percent of the companies had 5,000 or more employees. The survey inquired about the single-largest DB pension plan sponsored by the company. Eighty-seven percent of the plans had more than $100 million in plan assets, and 41% had over $1 billion.

Disclaimer: The information contained in this report does not constitute legal, accounting, tax, consulting or other professional advice. Before making any decision or taking any action relating to the issues addressed in this report, please engage a qualifi ed professional advisor.

About Forbes InsightsForbes Insights (www.forbes.com/forbesinsights) is the strategic research practice of Forbes Media, publisher of Forbes magazine and Forbes.com. Taking advantage of a proprietary database of senior-level executives in the Forbes community, Forbes Insights’ research covers a wide range of vital business issues, including talent management, technology, marketing, fi nancial benchmarking, small business, and more.

Towers WatsonInvestment ServicesTowers Watson Investment Services, a division of Towers Watson & Co., creates fi nancial value for institutional investors by offering independent, best-in-class investment advisory services. We are specialist investment professionals who provide coordinated investment strategy advice based on our expertise in risk assessment, strategic asset allocation and investment manager selection.

Towers Watson provides investment advisory services to some of the world’s largest pension funds and institutional investors, and has more than 500 associates in Europe, the Americas and Asia.

In the United States, investment advisory and investment consulting services are provided by Towers Watson Investment Services, Inc., a subsidiary of Towers Watson & Co. Towers Watson Investment Services, Inc., is a registered investment advisor with the Securities and Exchange Commission.

About Towers WatsonTowers Watson is a leading global professional services company that helps organizations improve performance through effective people, risk and fi nancial management. With 14,000 associates around the world, we offer solutions in the areas of employee benefi ts, talent management, rewards, and risk and capital management.

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