CFA Institute - Retirement Trends Defined Benefit …...FAS 158 –Balance sheet recognition Net funded status recognized on balance sheet Changes in funded status during the year

© 2010 Towers Watson. All rights reserved.

Retirement Trends – Defined Benefit Plans

A presentation to the CFA Society of Minnesotaby James J. Andrews, FSA, EA

March 11, 2010

towerswatson.com © 2010 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only. 1

Agenda

Key Developments Impacting Defined Benefit Plans

Pension Protection Act

Accounting Reform

Market Impact (2008)

Employer Responses

Plan changes

Funding and investment strategy

Legacy benefit strategies

Questions


Impact of Pension Protection Act

A new single Target Liability which moves with interest rates

The impact of interest rate changes (duration) is now more important

New funding rules (PPA) may find equities less attractive

Prior funding rules allowed plan sponsors to lower currentcontributions when investing more in equities than bonds due to the use of the expected rate of return

Funding reform requires equity risk premiums to materialize before reducing future contribution levels

This change may make high equity allocations less attractive

Risk taking in pension plans is now on par to risk taking in core business; evaluate trade-offs between taking risks in pension plans versus core business, considering taxes in this analysis


Pension Protection Act – Key Concepts

Minimum Contribution – Normal Cost + shortfall amortization (seven years)

Interest rate – high quality corporate bonds (24 month average or spot yield curve)

Threshold triggers

Benefit restrictions

— < 80% - limitation on lump sums

— < 60% - cessation of accruals, no lump sums

At-risk determination – accelerated contributions

PBGC variable premiums

Volatility relief

Asset smoothing

Credit balances

One-time elections for 2009 valuation


Accounting Reform

FAS 158 – Balance sheet recognition

Net funded status recognized on balance sheet

Changes in funded status during the year recognized

— P&L – FAS 87 Expense

— Other Comprehensive Income – Other plan changes and gains/losses

Phase II – Comprehensive reform (longer term)

Exposure draft due this month

May separate employment costs from financing costs

Tentative decisions

— Gains and losses recognized in OCI

— Plan changes recognized immediately

— Interest on net funded status (i.e. eliminates return on asset assumption)


DB Funding Dropped Significantly in 2008

PROJECTED BENEFIT

OBLIGATION

($ in billions)

PENSION PLAN

ASSETS

($ in billions)

PENSION

SURPLUS/DEFICIT

($ in billions)

12/31/2007 $992.0 $1,077.9 $85.9

12/31/2008 $1,016.5 $798.9 -$217.5

Amount of

Change +2% -26% -$303.4

The nation’s largest DB plan sponsors went from an $86 billion surplus at the end of 2007 to a $217 billion deficit at the end of 2008 — a total loss of $303 billion over the last calendar year.

Aggregate Funding Status for 100 Largest U.S. Pensions*2007 vs. 2008

n=100

* The analysis was based on pension disclosures for the 100 largest pension plan sponsors among publicly traded

companies with year-end 2008 fiscal dates, ranked by amount of plan liability at the end of 2007.


27%

14%13%12%11%

2%

4%

1%2%0%0%0%

14%

0%

3%

0%

3%1%

7%5%

11%12%

18%16%

15%

2%3%4%

Fewer Pension Plans Are At Least 90% Funded

n=100

+4 +3 +2 +15 +14 +17 +8 +9 -6 -7 -11 -10 -14 -24

<50% 50-54.9%

55-59.9%

60-64.9%

65-69.9%

70-74.9%

75-79.9%

Pe

rce

nta

ge o

f P

lan

s

80-84.9%

85-89.9%

90-94.9%

95-99.9%

100-104.9%

105-109.9%

110%+

At the end of 2007, 80% of plan

sponsors realized pension funding

levels of over 90%. By the end of 2008,

only 14% were more than 90% funded.

Funding Ratio

Percentage Point Difference

12/31/2007 12/31/2008

Distribution of Funding Ratios for 100 Largest U.S. Pensions2007 vs. 2008


External Pressures Are “Squeezing” the U.S. Pension System

Financial Pressures

Increasing Benefit Costs

Cost Volatility

Shareholder Pressure

Regulatory Pressures

Pension Protection Act

FASB Accounting Reform

Environmental Pressures

Economic Uncertainty

Industry Dynamics

Demographic Shifts

Employee Attitudes

Trends

• Shift from Retirement Income

to Wealth Accumulation

• Greater Emphasis on Risk

Management

• Elimination of early retirement

subsidies

• Curtailment of retiree medical

plans

• General ―downward‖ trend of

size of plan


Pension Management Framework

Objectives & Thresholds

ONGOING BENEFIT

STRATEGYEffective at managing

active liability risk profile

and long-term plan cost

ASSUMPTIONS

AND METHODSEffective only for short-

term issues and cost

recognition timing

INVESTMENT


long-term plan cost

and volatility

FUNDING


short-term plan cost

and volatility

LEGACY BENEFIT /

EXIT STRATEGYEffective at managing

size of plan and overall

risk exposure


Marketplace Trends – Plan Design

towerswatson.com 9


Flight to reduced volatility

Emphasis on risk management

(investment return, interest rate,

inflation, longevity, early retirement and

workforce management)

Shift from retirement income to wealth

accumulation

Marketplace Trends

Retirement Plan Available to New Hires Among FORTUNE® 100 Companies

Type of Plan 1985 1998 2002 2004 2006 Today

Defined Benefit Pension Plans 90 90 83 74 58 44

Traditional DB Plan 89 67 49 40 31 20

Hybrid Pension Plan 1 23 34 34 27 24

Defined Contribution Plan Only 10 10 17 26 42 56

Traditional

DB

Reduced

DB

Career

PayHybrid

Plans

All

DC


556514 500

455417

4571

113

588

169138

190

Nu

mb

er

of

Co

mp

an

ies

DB Plan Sponsorship Among the Fortune 1000

Sponsors of

active DB plans588 556 514 500 455 417

Sponsors of

frozen DB plans45 71 113 138 169 190

Total number of

DB plan

sponsors633 627 627 638 624 607

Note: The active DB plan row includes companies that maintain a DB plan that is actively accruing benefits, the frozen DB plan

row includes companies that sponsor one or more frozen DB plans, and the total row includes sponsors of both active and

frozen pension plans.

2004 2005 2006 2007 2008

Active

DB plan

Frozen

DB plan

Since 2006, the rate of pension plan freezes among

Fortune 1000 companies has remained constant.

2009


Funding and Investments

towerswatson.com 12


Asset Allocation (FY 2010)

2009 Average: 38% Median: 37%

3

7

28

73

51

25

4 41

0

10

20

30

40

50

60

70

80

Fre

qu

en

cy

0-9% 10-19% 20-29% 30-39% 40-49% 50-59% 60-69% 70-79% 80%+

Fixed Income + Cash


REITs

US Equity

International Equity

Return-Seeking

Assets

Liability-Matching

Assets & Fixed Income

Examine two possible fixed income strategies

100% Return-

Seeking

100% Liability-

Matching

Asset Strategies ExaminedReturn-Seeking Assets vs Fixed Income

Liability-Matching

Barclays Long Government / Credit Index

(10-11 Duration)

Liability-Matching

Barclays Aggregate Bond

Index

(4-5 Duration)

Fixed Income

Real Estate

TIPS

High Yield


-3%

-2%

-1%

0%

1%

2%

Return vs. Liabilities

Std Dev

Re

turn

vs

. L

iab

ilit

ies

Me

an

Defining risk in a Post-PPA World

100% LB

90% LB

80% LB

70% LB

60% LB

50% LB

40% LB

30% LB

20% LB

10% LB

100% Agg

90% Agg

80% Agg

70% Agg

60% Agg

50% Agg

40% AggCurrent

30% Agg

20% Agg

10% Agg

0% Agg

Long Bonds

Aggregate Bonds

Desirable

5% 10% 15% 20%

Risk/return

paradigm has

changed from

asset-only to

asset-liability100% LB

90% LB

80% LB

70% LB

60% LB

50% LB

40% LB

30% LB

20% LB

10% LB

100% LB

90% LB

80% LB

70% LB

60% LB

50% LB

40% LB

30% LB

20% LB

10% LB

100% LB

90% LB

80% LB

70% LB

60% LB

50% LB

40% LB

30% LB

20% LB

10% LB


Dynamic Asset Allocation

A dynamic asset allocation is ―pre-programmed‖ to change as

conditions change (internal or external)

This type of approach allows a plan sponsor to make proactive, rather

than reactive, decisions and improves the coordination and consistency

of plan management

Triggers are set to make changes to the allocation based on the

conditions that are of importance to the plan sponsor

Potential Changes

• Equity allocation

• Equity composition

• Fixed income duration

• Credit exposure

Potential Triggers

• Funded status

• Interest rate/spread levels

• Market conditions

• Corporate financial situation


Dynamic Asset Allocation Examples

Below is an example of four approaches to reducing the equity allocation as

plan funded status improves

The linear approach is the most basic

and assumes a constant risk/reward profile

The risk management approach moves

more quickly away from equities, reflecting

a strong desire to reduce risk when able

The cost management approach moves

more slowly away from equities, reflecting

a strong desire to keep expected cost

levels as low as possible for a given level

of risk

The threshold approach reflects the

increased risk around 80% funded, with a

larger risk appetite outside that corridor

(and before overfunding becomes a risk)

40%

50%

60%

70%

80%

90%

100%

60% 70% 80% 90% 100% 110% 120%

Funded Status

All

oc

ati

on

to

Fix

ed

In

co

me

Linear Approach Cost Management Approach

Risk Management Approach Threshold Approach


Interaction of Other LeversFunding Strategy

30% 30%

20%15%

10%

20%

10%

0%

Fund Minimum Target $50M/yr Target 100M/yr Contribute to

80%

Funding strategy can be used to

address several issues, including

accelerating settlement readiness or

providing contribution volatility.

To the extent current sponsor financial

conditions don’t allow for funding

flexibility, other levers can be used to

reduce short-term costs.

To assess the best use of capital,

various management options can be

compared (reduce equity exposure,

settle retirees, etc.) and measured

consistently with the alternative (non-

pension) opportunities

Probability of reaching 120%

Probability of falling below 80%


Legacy Benefit Strategies

towerswatson.com 19


Managing Trade-offs


Many Hurdles Must Be Cleared

What is the current deficit? What level of funding is feasible?

How much/what kind of risk exposure can be tolerated?

How does the financial aspects of different options compare?

Are there accounting issues to address (onetime vs. ongoing)?-

What options can should be reviewed?

Are there philosophical issues that may limit our options?

What workforce implications need to be considered?

How do we address regret risk and market timing issues?

How could the regulatory/legal environment impact the route?

Are there marketplace issues (capacity, pricing, etc.) to address?

Are there market trigger thresholds to be identified?

What operational costs/issues are important considerations?

What plan provision challenges exist?

Are there administrative and data challenges that limit our options?

Are there governance or compliance issues?

Financial

Philosophical

Operational

Marketplace




The dynamic allocation process helps determine both the path(s) to follow and the triggers for each node

Asset

Allocation

Strategies

Current

Keep all obligations

Offer Bulk Lump

Sums to TV’s

Settle/transfer

Retiree Obligations

Settle/transfer

Remaining

Obligations

Current

allocation

Reduce

interest

rate risk

Reduce

equity riskGoal

Option A

Option B

Asset

Allocation

Strategies

Current

Keep all obligations

Offer Bulk Lump

Sums to TV’s

Settle/transfer

Retiree Obligations

Settle/transfer

Remaining

Obligations

Current

allocation

Reduce

interest

rate risk

Reduce

equity riskGoal

Option A

Option B


Questions?

J:\Allusers\ANDREWS\Retirement Trends 2010_03112010.ppt

Documents

CFA Institute - Retirement Trends Defined Benefit …...FAS 158 –Balance sheet recognition Net funded status recognized on balance sheet Changes in funded status during the year