2022 was a tough year for markets. Both equity and bond markets fell at the same time, which is rare and went against long-held notions of diversification. However, the upside for a typical corporate Defined Benefit (DB) Plan was that plan liabilities fell more than assets and solvency funded ratios generally improved. Many plan sponsors find themselves in a surplus position for the first time in many years.
As we move through 2023, global concerns around inflation and possible recessions have created continued volatility. Many sponsors are looking at their plan risks through a new lens and asking what they can do to lock in their plan’s strong funded position and reduce risk going forward.
To address this question, we are seeing more pension plans explore de-risking strategies. As a first step, many plans are reviewing their asset mix through an asset-liability study with the aim of protecting their plan’s funded status while still earning sufficient returns and maintaining reasonable risk. This can include investing a higher proportion of assets into fixed income investments that match plan liabilities, which is generally referred to as liability driven investment or LDI. In its simplest form, LDI portfolios invest in a mix of bonds that are designed to replicate the plan’s liabilities as closely as possible, providing an opportunity for the plan to significantly reduce its interest rate risk.
As plan financial positions improve, plans can consider further de-risking and cleaning up plan data to prepare for a potential risk transfer. Once sufficient assets are available, plans can eliminate their investment and longevity risk by purchasing buy-in annuities and those plan sponsors who are in a position to completely de-risk can declare a wind-up and fully annuitize their plan.
Internal resources are often limited or focused on core business activities and, as such, many plans choose to delegate the implementation, oversight, and administration of their pension plan, which can include their de-risking journey. This makes it seamless to effectively manage plan risks for any plan, big or small.