Should employers review plan design?
Roughly one-third of the Fortune 1,000 offering defined benefit pension plans have now frozen those plans. Others have changed to a hybrid model, and 55 percent of the Fortune 100 now put new hires into a defined contribution plan. Employers need to reassess these decisions to see if this is the right strategy going forward, especially now that assets have rebounded. A recent Watson Wyatt survey reveals that traditional pension plans are highly valued by employees, so employers must consider the impact of changes on other HR objectives as well as the financial risks associated with interest rates, asset returns, longevity and inflation. If an employer is committed to a defined plan, sharing the risk with employees through a lump sum option, cash balance or a hybrid plan or moving the benefit calculation from a final average to a career average can help to mitigate the risks.
How can employers manage the volatility in asset returns?
Many employers were caught off guard by the quick drop in the market and were then reluctant to sell devalued equities for fear of missing the rebound. Given the improvement in equities, now may be a good time to revisit your company’s risk position in light of future funding requirements. Traditionally, many administrators favored high-risk positions offering higher long-term returns. Those positions no longer make as much sense because under PPA the risk is asymmetrical, meaning that the possible downside from high-risk investments exceeds the possible upside. In a recent survey conducted among 80 financial executives, two-thirds have made or are planning to make policy changes in 2009 and 2010 to asset allocations, while more than half have already made changes or are planning to make changes to investment lineups.
How has PPA impacted the assumptions and methods for calculating pension expense?
Key assumptions such as the discount rate, salary scale and long-term rate of return can impact the pension expenses reflected on a company’s financial statements, so it’s important to forecast cash and expense using a range of assumptions. For example, simply changing asset allocations from equities to a more conservative mix of bonds may cause auditors to reduce the expected rate of return in the assumptions. Since this can have a broad impact on company finances, including the interest rate paid on borrowed funds, it’s important to consider how an investment strategy integrates with funding and accounting strategy. Despite an anticipated adjustment in the accounting rules, for now, a holistic management strategy remains the best way to avoid the impact of the next crisis.
Pete Neuwirth is a senior consultant for the retirement practice at Watson Wyatt Worldwide. Reach him at (415) 733-4139 or [email protected].