Much has been written about how 2020 was unprecedented, challenging and exhausting — take your pick of adjectives. It was also a white-knuckle ride for many Canadian defined benefit plan sponsors as they watched the funded status of their pension plans plummet sharply and then rebound.
Most plans’ funded statuses are now at, or even slightly above, where they were a year ago. This gives plan sponsors a welcome opportunity to catch their breath and reflect on the lessons learned from 2020.
1. Many pension plans are still very risky. Is yours?
Some plan sponsors were surprised in 2020 about the extent of their funded status’s volatility and how time consuming it was to address its implications. Senior decision makers found themselves discussing pension issues even as they needed to deal with many other pressing demands.
Plan sponsors in this situation should consider reducing volatility by lowering pension risk. A growing number of plan sponsors agree that the pension plan is not the appropriate venue to bet on equity and interest-rate movements. It’s just too hard to win at this game consistently.
For many plan sponsors, the conversation has evolved from asking whether to de-risk to how to de-risk.
2. Extreme market events are happening more frequently: anticipate them
Extreme market events are happening more frequently. Consider the technology meltdown of 2001/2002, the global financial crisis of 2008/2009, the debt crisis in 2011 and now the pandemic crisis of 2020/2021.
No one knows what will cause the next market downturn. However, it’s reasonable to assume that something will. And that it will happen sooner than we’d like.
Smart plan sponsors are testing the resilience of their plans to extreme events, and their ability to manage the resulting volatility. Many asset/liability studies focus on the average result — but history has taught us that markets are rarely average. Therefore, it’s best to anticipate extreme market events and test whether the pension plan is catastrophe-proof.
In the past, pension regulators have often intervened to provide relief during periods of higher uncertainty. But, in the future, regulators may be less inclined to bail out pension plans that consistently take on too much risk.
3. Be in the driver’s seat, avoid the passenger’s seat
Another chapter was written on the tale of two DB plan sponsors in 2020.
Plan sponsors that had already reduced pension risk were relatively unaffected by market events. Those pension plans’ funded statuses stayed constant and were not distractions from the sponsors’ core businesses. These plan sponsors acted strategically, exploiting market opportunities such as the excellent pricing of the annuity market in 2020.
On the other hand, plan sponsors with too much pension risk scrambled to understand the coronavirus pandemic’s impact on their plans before the market rebound rescued them. These plan sponsors were distracted from their core businesses and contemplated securing additional cash contributions at the worst possible time.
Forward-looking plan sponsors aim to be in the driver’s seat to maintain control. They want to avoid being forced to act by the whims of the markets or the rules of the regulators.
4. Asset/liability studies are evolving — don’t sub-optimize
The new trend in asset/liability studies is to consider all pension risks, including longevity risk, together. In the past, these studies tended to approach investment risks in isolation.
Similarly, consultants are taking a holistic view of de-risking options, proposing solutions that mix annuities with traditional investments. This makes sense as annuities perfectly hedge liabilities while outperforming a passive bond portfolio.
Plan sponsors and consultants who have not included annuities in their asset/liability studies could be sub-optimizing their portfolios and missing opportunities.
The markets have granted Canadian DB pension plans some much-needed breathing room. Plan sponsors can use this time to work with their consultants to re-evaluate their pension risk. That way, they can be confident that the pension plan impacts will be manageable when the next extreme market event occurs.
Isn’t it better to be in the driver’s seat?
This article was originally published by Canadian Investment Review on March 11, 2021 in English only.