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October 7, 2010. Pension Investments in the Ice Age 2010 MAAC meeting. Matt McDaniel, FSA, EA, CFA . The trend from DB to DC continues How many Fortune 200 companies have frozen or closed their plans? . 2009. 2006.

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the trend from db to dc continues how many fortune 200 companies have frozen or closed their plans
The trend from DB to DC continuesHow many Fortune 200 companies have frozen or closed their plans?



Ongoing DB plans No DB plans Frozen, new employees Frozen, some existing employees Frozen, all existing employees

Source: Internal Mercer analysis


Sponsor financial risk

  • Market value
  • fluctuations in:
  • Plan assets
  • Plan liabilities
  • Funded status



  • What’s different today?
  • Pension Protection Act
  • FAS 158
  • Increased equity volatility
  • FAS / IAS convergence?


  • Fluctuations in:
  • Expense
  • Balance sheet/equity
  • Cash flow

Pension Financial Risk is Changing – Volatility is being Unmasked

why are sponsors moving from db to dc
Why are sponsors moving from DB to DC?

“Volatility reduction” is almost always cited by sponsors as a key reason to freeze DB plans. Yet plans have generally not experienced reduced volatility following a freeze. Why?

Source: 2006 Mercer survey

how do we define risk and reward a football analogy
How do we define risk and reward?A football analogy
  • 4th quarter, 1:08 remaining
  • Ravens have the ball
  • 1st and 10 on the Pittsburgh 18 yard line
  • Ravens call a long pass into the endzone
  • Was this a good strategy?
  • What key piece of information do you need to know to evaluate this decision?
the right strategy depends on the rules of the game and the score
The right strategy depends on: the rules of the game and the score

When is risk uncompensated?

When might it be appropriate to take more risk?

So why aren’t frozen plan sponsors taking risk off the table once fully funded?


How do we define pension risk?Pension Risk = Funded Status Volatility

Pension Frontier

Asset Only Frontier



100% Equity

100% Equity



Reward: Expected Returns

Reward: Expected Returns

Matched Bonds (least risk)


Cash is Inefficient:

Less Reward

& More Risk

Cash (least risk)








Risk: Funded Status Volatility

Risk: Return Volatility

Goal:Minimize Funded Status Volatility for a specified level of expected return

Goal: Minimize return volatility for a specified level of expected return

When liabilities are considered, the efficient mixes are not the same as those that are efficient in an asset-only framework… simply due to the change in the definition of “risk”.

the business case for derisking
The Business Case for Derisking

Funded Status (S&P1500 Companies)

Aggregate funded status improved from 73% in 2003 to well over 100% in 2007

Less than 5% of plans fully funded by early 2009

Why were these opportunities missed?

  • Not ready: no formal plan for de-risking as conditions improve
  • Not aware: infrequent monitoring of funded levels
  • Not fast enough: lack of execution capabilities to take advantage
risk management in the pension context
Risk management in the pension context


Asset Only


Liability Driven


Excess Return

Active Management

Diversified Return Generation

Excess Return

Market Exposure

Fixed Income

Fixed Income


LiabilityRisk Mitigation

Fixed Income Exposure

Unrewarded Risk Management

getting from here to there dynamic derisking

Funded status (%)

% growth portfolio allocation



Desired trajectory














Starting point

End game


Actualfunded status

Gradual de-risking from growth portfolio as funding status rises

Getting from here to thereDynamic derisking

Illustration of the “glide-path”

How does it work?

  • Strategic analysis to define glide-path, trigger points, and target state in advance
  • Regular funded status monitoring
  • As funded status improves plan is derisked by transferring assets from growth to matching portfolio
  • Regular strategy is review
how do we build a glide path
How do we build a glide path?


Specify a dynamic program to move from current to end point in discrete steps.

Translate primary characteristics in asset class allocations.


These primary characteristics can define each portfolio

Articulate “behavior” as primary characteristics for the portfolio.



Determine the desired “behavior” of the end point portfolio.

how do we build a glide path13
How do we build a glide path?

Reducing equity allocation

Increasing duration hedge

Increasing credit hedge

Increasing fixed income allocation

Calculated based on target duration hedge and credit hedge

Calculated to achieve duration hedge ratio

Calculated using portfolio return calculator

financial strategy execution determine the endgame strategy retain versus transfer liabilities
Financial strategy & executionDetermine the endgame strategy: retain versus transfer liabilities
  • Plan Termination eliminates all financial risk and ongoing administration, but at an up-front cost
  • Continued Management is often a less costly alternative but requires ongoing administration and management of the plans

Plan termination

Dedicated bond portfolio

Annuity placement for a portion of liability (retirees and/or terminated participants)

Settle portion of liabilities by offering lump sums

Increase fixed income allocation

Increasing Cost And Decreasing Risk*

Interest rate hedging strategies using derivatives; retain some equity exposure

Traditional asset management strategy



*Not to scale; information provided on directional basis for discussion purposes

what are sponsors doing
What are sponsors doing?

Status Quo

Change only with legislation driven modifications

Re-allocate assets

Risk hedging

US DB assets$1.5 TN

Transform to run like an insurance entity

Annuitization / Buy-in / Buy-out

Manage a completerisk transfer

  • Recent survey about endgame strategy:
    • 159 people responded from a variety of industries
    • Question: What is the endgame strategy for your pension plan?
      • Undecided 48%
      • Terminate in 5-7 years 24%
      • Terminate ASAP 16%
      • Maintain indefinitely 12%
what are other employers doing
What are other employers doing?

If yes, what is it?(54 responses)

Does you have a specific endgame target?(110 responses)

Wasting trust 5 (9.26%)

Other2 (3.70%)

57 (51.82%)




Plan termination

47 (87.04%)

What is the anticipated horizon to plan termination? (101 responses)

Other – please specify

6 (5.94%)


43 (42.57%)

5+ years

28 (27.72%)

2-5 years

18 (17.82%)

0-2 years

6 (5.94%)

what are other employers doing17
What are other employers doing?

What is the current asset allocation to risk assets, e.g., equities (110 responses)

More than 50%

68 (61.82%)


29 (26.36%)


13 (11.82%)

What is pre-disposition to de-risking in the future? (108 responses)

Other – please specify

14 (12.96%)


36 (33.33%)

5+ years

16 (14.81%)

2-5 years

6 (5.56%)

0-2 years

36 (33.33%)

what are other employers doing18
What are other employers doing?

Funding strategy (110 responses)

Other – please specify

43 (39.09%)

Fund minimum

67 (60.91%)

Plan for unlimited lump sum cashouts (105 responses)

Other – please specify

48 (45.71%)

Likely to offer in 2012

7 (6.67%)

Looking at feasibility of offering

26 (24.76%)

Already offered

24 (22.86%)

  • The views expressed herein are the views of the individual(s) making the presentation, and are not necessarily shared by his/her employer.
  • The information contained in this document (including any attachments) is not intended to be used, and it cannot be used, for the purpose of avoiding penalties under the Internal Revenue Code that may be imposed on the taxpayer.