A Qualified Commitment to DB Plans: Risk Management Amid a Steep Downturn
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A Qualified Commitment to DB Plans: Risk Management Amid a Steep Downturn

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The survey findings, developed with CFO Research Services, reflect survey responses and in-depth interviews with more than 400 CFOs, treasurers and other finance executives in the United States,......

The survey findings, developed with CFO Research Services, reflect survey responses and in-depth interviews with more than 400 CFOs, treasurers and other finance executives in the United States, Canada and the United Kingdom.

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  • 1. A Qualified Commitment to DB Plans: Risk Management Amid a Steep Downturn The 2009 Towers Perrin — CFO Research Services Pension Study y Key findings and business implications June 30, 2009 © 2009 Towers Perrin
  • 2. Today’s Agenda Describe the study Reveal the headlines Share some insights behind the headlines Put this in context and look ahead to the next few months and years Explore a decision-making framework that achieves desired p p g pension risk management objectives Proprietary and Confidential © 2009 Towers Perrin Not for use or disclosure outside Towers Perrin and its clients 2
  • 3. About the 2009 Study Third annual defined benefit pension study of senior finance executives Goal Gain corporate finance insights into impact of the financial turmoil on defined benefit (DB) plans — Funding, investment and business implications — Plan design and risk reduction alternatives — Future plans Methodology 439 senior finance responses from large U.S., UK and p g , Canadian organizations across all industries 18 senior finance executive interviews Conducted in April/May 2009 Incorporates financial data from Capital IQ Results segmented by: — Company size j — Investment objectives — Long-term DB plan commitment Proprietary and Confidential © 2009 Towers Perrin Not for use or disclosure outside Towers Perrin and its clients 3
  • 4. The headlines – funding perspective The financial crisis has hurt Which of the following best describes your DB operating performance and the plan funding policy 2 years ago and today? financial health of most DB plans Contribute enough to achieve explicit funding targets 29% 30% Impact on cash flow is of g greatest concern ( %), (57%), Contribute the amount that ensures the plan is f fully funded f 29% 25% followed by income statement and balance sheet Contribute the legal or negotiated 15% minimum payment 21% impact And although cash and credit Contribute the maximum tax- 14% deductible amount 10% are generally scarce, most companies (80%) are confident Make ad hoc decisions on pension 10% funding without a formal funding they ll they’ll have the cash to meet policy 9% plan funding commitments 4% Don't know/Not applicable With a number changing / 5% having changed the overall g g 0% 20% 40% funding policy Funding policy today Funding policy two years ago Proprietary and Confidential © 2009 Towers Perrin Not for use or disclosure outside Towers Perrin and its clients 4
  • 5. The headlines – commitment and investment Despite tough times, most executives remain committed to the financial health of their DB plans Investment Orientation and invest pension assets Reduce Increase with an eye towards risk risk returns management Viability 7 of 10 respondents Long-Term focused 54% 17% plan to pursue long-term DB Commitment Alternative te at e viability f th i DB i bilit for their focused 24% 5% plans rather than seek alternatives to DB plan p sponsorship p Over 3 of 4 say they will focus more on reducing risk than seeking additional investment returns Proprietary and Confidential © 2009 Towers Perrin Not for use or disclosure outside Towers Perrin and its clients 5
  • 6. The headlines – asset allocation Many respondents said the proportion Senior financial executives of equities included in the pension expect to keep equity content portfolio is lower, either because the lower lower than they had been market has depressed their values before this recent crisis took more or because of a change in target hold asset allocation In the last six months, has your company In your opinion, will recent market events cause adhered to a consistent portfolio a long-lasting change in the allocation of equity rebalancing strategy? investments in your company's pension fund? 11% No, 31% 42% 28% Yes, 69% 18% Yes, Yes likely to decrease allocation Yes, likely to increase allocation No, will not cause a long-lasting change Don't know Proprietary and Confidential © 2009 Towers Perrin Not for use or disclosure outside Towers Perrin and its clients 6
  • 7. The headlines – use of derivatives Synthetic products, such as swaps and futures, have become common pension risk management tools Nearly N l ½ of l f large U S companies (44% overall) use i t U.S. i ll) interest rate swaps t t and a similar number of U.S. companies use futures to manage interest rate risk Does your company currently use the following financial instruments to manage risk in its DB plan? Interest rate swaps 48% 42% 10% Interest rate futures 46% 43% 11% Call/Put options 38% 50% 12% Currency forwards 35% 53% 12% Credit derivatives 31% 56% 13% 0% 25% 50% 75% 100% Yes No Don't know Proprietary and Confidential © 2009 Towers Perrin Not for use or disclosure outside Towers Perrin and its clients 7
  • 8. Behind the headlines While most DB plans …1 in 5 respondents said their plans fared well – have been hurt and most of these companies were substantially financially… financially and consistently more likely to have used synthetic instruments to manage pension risk Percentage of respondents in each segment using financial instruments to manage pension risk 79% Interest rate futures 46% 22% 76% Interest rate swaps 46% 28% 74% Currency forwards 35% 29% 72% Call/Put options 33% 19% 70% Credit derivatives 39% 16% 0% 20% 40% 60% 80% 100% Negative effect No effect Positive Proprietary and Confidential © 2009 Towers Perrin Not for use or disclosure outside Towers Perrin and its clients 8
  • 9. Behind the headlines Those focused on Relative to “return-seekers,” those focused on minimizing risk act mitigating future risks appear to have adopted differently from those what seem to be more conservative investment pursuing higher strategies investment returns Suffered more damage from pension financial results in 2008 Rely less on synthetic hedging tools Less likely to increase equity exposure Proprietary and Confidential © 2009 Towers Perrin Not for use or disclosure outside Towers Perrin and its clients 9
  • 10. Behind the headlines Those seeking Relative to those pursuing long-term viability of alternatives to their DB their plans, those seeking alternatives: plans have a different Saw their financial statements hit harder by profile from those recent economic events committed to the DB plans well into the Are more likely to have design changes future underway Are less likely to use synthetic hedging instruments or own illiquid investments Are moving away from full funding as a contribution policy objective Proprietary and Confidential © 2009 Towers Perrin Not for use or disclosure outside Towers Perrin and its clients 10
  • 11. Behind the headlines While commitment to DB …that commitment has its limits and plans remains solid… shows signs of fraying Among those committed t DB plan A th itt d to l Has the recent financial turmoil made your company more or less likely to seek an exit viability, half (60% in U.S.) say the strategy for its DB plans? economic crisis has made them more likely to seek a DB exit strategy y gy Nearly half would consider settling More likely 61% part of their pension obligation through annuities for 105% of the No change 33% obligation (with another 18% going up to 120%) Less likely 4% Almost ¾ would reconsider their long-term long term commitment if pension accounting rules made income Don't know 2% statements more volatile 0% 25% 50% 75% Proprietary and Confidential © 2009 Towers Perrin Not for use or disclosure outside Towers Perrin and its clients 11
  • 12. Other noteworthy findings Plan design changes are a constant amongst large companies Less than 10% of respondents have neither made recent changes nor plan changes i th near f t h in the future Alternative investments remains a popular investment option 70% have some private equity investments — the rate is higher for the largest organizations and f those “i i f the l l i i d for h “in it for h long h l” haul” Half use “alpha-seeking” strategies and unlisted real estate The majority are likely to maintain their current investment levels, while a quarter expect to increase their use Survey findings were generally consistent across markets The most notable exceptions include: — Downturn has hit U.S. companies especially hard — U.S. companies are especially likely to shift away from equities; UK companies are more likely to shift toward equities — U.S. companies are more likely to seek termination as a result of regulatory changes Proprietary and Confidential © 2009 Towers Perrin Not for use or disclosure outside Towers Perrin and its clients 12
  • 13. Putting this in context Asset returns for a common U.S. DB pension plan 60% Equity (40% lg cap, 10% s/mid cap,10% int’l) 40% Fixed Income (35% BC Agg, 5% cash) 25% 20% 15% 10% 5% 0% -5% -10% 10% -15% -20% -25% Year 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 May 2009 Annualized % Return 17.1 13.2 -0.3 -3.6 -9.0 20.8 9.8 5.2 12.2 6.3 -22.8 3.5 YTD 2009 Annualized Return 10yr Dec 2008 = 2.4% Proprietary and Confidential © 2009 Towers Perrin Not for use or disclosure outside Towers Perrin and its clients 13
  • 14. Putting this in context Fixed income yields and rates Key Bond Yields (at end of month) 9.00% 8.00% 8 00% Proxy for pension 7.00% discount rates 6.00% 5.00% 4.00% 3.00% 2.00% Dec 98 Dec 99 Dec 00 Dec 01 Dec 02 Dec 03 Dec 04 Dec 05 Dec 06 Dec 07 Dec 08 30-Year T-Bonds 30-Year Swaps ML 10+ HQ Spreads Dec. 31, 2007 4.45% 5.03% 6.18% 1.73% Dec. 31 2008 D 31, 2.69% 2 69% 2.69% 2 69% 5.92% 5 92% 3.23% 3 23% May 31, 2009 4.34% 4.18% 6.62% 2.28% Proprietary and Confidential © 2009 Towers Perrin Not for use or disclosure outside Towers Perrin and its clients 14
  • 15. Putting this in context Funded status under varying investment strategies PBO Funded Ratio 135% 125% 115% 105% 95% 85% 75% 65% 55% Dec 97 Dec 98 Dec 99 Dec 00 Dec 01 Dec 02 Dec 03 Dec 04 Dec 05 Dec 06 Dec 07 Dec 08 Dec ’07 Dec ’08 May ‘09 60/40 Average Duration Fixed Income (FI) 92.7 66.0 69.7 60/40 Long Duration, Corporate FI 96.3 66.1 69.6 0/100 Long Duration, Corporate FI / Treasury STRIPS Duration 95.5 94.0 89.9 60/40 80% Hedged 111.7 97.4 87.1 Proprietary and Confidential © 2009 Towers Perrin Not for use or disclosure outside Towers Perrin and its clients 15
  • 16. Business implications of lower funded status Higher cash requirements at a time when cash and credit are scarce Impact may be greater in 2010 given recent funding “relief” in the U.S. Higher accounting cost on the Income Statement With further increases coming through in next few years if assets smoothed Also lower funded status shown on Balance Sheet Possible Pension Protection Act (PPA) implications Benefit restrictions (lump sum p y ( p payouts, benefit accruals, etc.) , , ) Employee notices Deferred employee retirements Given depressed 401(k) balances employees may need to work balances, longer Proprietary and Confidential © 2009 Towers Perrin Not for use or disclosure outside Towers Perrin and its clients 16
  • 17. So what comes next? In making both strategic and tactical decisions, companies must consider the range of economic and capital market conditions we may face in the coming years High Growth Good times Overdrive Pension ? + Pension Business + + Business Low inflation / High inflation / Low interest rates High interest rates Pension - ? Pension Business - - Business Perfect Storm Stagflation Low Growth Proprietary and Confidential © 2009 Towers Perrin Not for use or disclosure outside Towers Perrin and its clients 17
  • 18. In particular, funded status could recover slowly While assets may …discount rates could fall if high grade corporate bond yields continue their recent continue dropping stronger p g performance… Business confidence grows and bond yields decline Credit ratings decline and debt drops out of the relevant bond universe Global Equity Returns Note that any Treasury-based swaps in p y y p place before the YTD tightening would exacerbate the negative impact on 25-Jun-09 %Change funded ratio S&P 500 3.23% Russell 2500 Index 6.03% U.S. RATE:Link Bond Universe as of May 31, 2009 MSCI EAFE Index 6.38% 12% 11% 10% 9% 8% 8.00% 7% 7.00% 6% 6.00% 5% 5.00% 4% 4.00% Financial industry bond yields (May) 3% 3.00% Non-financial industry bond yields (May) 2% 2.00% Dec. 10-90th yield curve/all bond issues 1% 1.00% May 10-90th yield curve/all bond issues 0% 0 5 10 15 20 25 30 Maturity (Years) Proprietary and Confidential © 2009 Towers Perrin Not for use or disclosure outside Towers Perrin and its clients 18
  • 19. So what are you to do as a plan sponsor? It depends on your near-term and longer-term objectives Proprietary and Confidential © 2009 Towers Perrin Not for use or disclosure outside Towers Perrin and its clients 19
  • 20. Panel discussion Our Panelists Sylvia Pozezanac Sam Knox Managing Principal VP, Director of Research Retirement Risk Solutions CFO Research Services Towers Perrin Boston, MA New York NY York, (6 ) 345-9700, (617) 3 5 9 00, Ext. 243 3 (212) 309-3663 samknox@cfo.com sylvia.pozezanac@towersperrin.com Mike Archer Chief Actuary Towers Perrin Parsippany, NJ (973) 331-3562 michael.archer@towersperrin.com Proprietary and Confidential © 2009 Towers Perrin Not for use or disclosure outside Towers Perrin and its clients 20