2023 Liability-Driven Investment Survey | Chief Investment Officer

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IBM’s Decision to Reopen Cash Balance Plan Will Likely Impact LDI Strategies

Those approaches may need to include more return-seeking assets.

IBM’s recent move to reopen its cash balance defined benefit plan puts into sharp focus its liability-driven investing strategy now that the technology firm is again adding employees to its pension plan.

LDI became popular over the last 15 years as many firms froze their pension plans. Plan sponsors sought ways to shore up underfunded plans by choosing a glide path that systematically reduced return-seeking assets as funded status improved. When funded status increased such that most or nearly all liabilities were matched, a number of plans transferred some pension obligations to insurance companies to further reduce liabilities.

IBM was the poster child for this trend. In 2008, it froze its already-closed pension plan. In 2022, when it reached a surplus funded status, it transferred $16 billion in obligations to Prudential and MetLife in one of the biggest pension risk transfer deals at the time.

Now that IBM has reopened its cash balance defined benefit plan, industry observers are re-thinking LDI strategies. Some pension plan experts say LDI strategies should continue to play a key role in defined benefit plans, since these strategies are a big part of why so many private plans are now financially healthy. Others say plan sponsors need to revisit how to manage risk and return going forward as they balance adding new members while retaining funded status.

Improved Funding Status

The Milliman Pension Funding Index, as of June 2023, showed the aggregate funded status of 100 large U.S. corporate pension plans were at or above 100%. The past decade showed LDI strategies are the reason why, says Jonathan Barry, managing director at MFS Investment Management in a research note. Glide path strategies will continue to be “critical” to manage legacy liabilities, he adds.

However, as plan sponsors pursued LDI strategies in the past decade-plus, they did not consider their next step once they reached full funding, says Jared Gross, head of institutional portfolio strategy at J.P. Morgan Asset Management. Additionally, the conventional wisdom has been that a pension is a stranded asset and needed to be moved off the books.

“I think a lot of the de-risking activity, somewhat by design, but also maybe somewhat unwittingly, put a thumb on the scale in favor of hibernation, and ultimately termination to insurance companies,” Gross says.

Rethinking LDI

Justin Owens, co-head of strategic asset allocation at Russell Investments, says LDI strategies prioritized the need to stay fully funded, rather than considering further improving a surplus.

Using pension surpluses to fund new benefits “completely changes the return needs and risk considerations once fully funded. … This also impacts the design of any glide path in place,” Owens says in a research note, as plan sponsors may seek to “re-risk” by including more return-seeking assets to help reduce future contribution burdens.

Barry acknowledges strategies may need adjusting to cover new benefit accruals. He suggests a cash balance plan’s asset allocation may need to include other fixed-income asset classes such as intermediate credit, global bonds or taxable municipals to improve its chances of meeting the interest crediting rate.

Those asset classes “could help to improve returns while still retaining (the) liability-hedging characteristics of the LDI portfolio,” he says, suggesting that plan sponsors consider using their equity allocation to potentially enhance returns.

Rick Ratkowski, director of investment strategies at NISA Investment Advisors LLC, says the idea that LDI strategies are only comprised of bonds, even in hibernated portfolios, is not correct. “That doesn’t have to mean 100% bonds. It may mean 20% to 25% in equity or return-seeking assets,” he says.

Improved Risk Management

Over the past 20 years, pension risk management techniques have evolved considerably, and plan sponsors learned lessons from poor portfolio allocation choices in the early 2000s and 2010s that led them to be underfunded. Both Ratkowski and Gross say today’s plan sponsors are in better positions to ensure proper risk mitigation in a fully funded plan. That may lessen the impetus for portfolio risk transfers to insurance companies.

“Why would you just hand your plan to an insurance company that essentially allows them to take all those gains and put it in their pocket?” Gross says. “You should keep this on your balance sheet and find ways to use that value over time.”

Ratkowski says overfunded pensions funds will not necessarily have the same risk profile as they did years ago, and they may not have the same employee base either.

“Those folks that are having new accruals may not be as material as the number of participants that were having accruals 20-plus years ago,” Ratkowski says. “So, given the size of the overall pension, that may not be a material increase in the plan size. That remains to be seen.”

Rethinking the End State

Ratkowski says changes to glide path design in a reopened portfolio will come in the strategy’s end state. He expects the amount of return-seeking assets to be marginally higher, and when the end state is reached, the funded status should be higher as well, around 110% or 115%.

“The expectation would be that the asset allocation a plan has in the end state could help offset future service costs … or use some of that surplus to cover any return shortfall,” he says.

Gross agrees. He and Michael Buchenholz, head of pension strategy at J.P. Morgan, have written that a modest level of excess return and low risk, relative to liabilities, is a more efficient and durable end game than traditional LDI strategies.

Dubbed “pension stabilization,” Gross and Buchenholz’s model seeks to deliver a stable level of excess return above liabilities with prudent risk. Their model incorporates four asset categories:

Traditional hedge assets, such as U.S. long-duration Treasurys and corporate bonds;
Hedge asset diversifiers, like securitized credit;
Traditional public and private return-seeking allocations, such as public and private equity; and
Alternatives diversifiers, like real estate or global infrastructure.

Plan sponsors can “build portfolios that deliver more-than-adequate returns to outperform liabilities with low risk in a way that is more diversified and more efficient than what insurance companies are able to achieve,” Gross says. “Ultimately, [plan sponsors] can do the job better. They just have to decide that they want to do it.” —Debbie Carlson

Methodology

The 2023 Chief Investment Officer Liability-Driven Investment Survey combines results from two surveys—one of public and corporate defined benefit plans among other asset owners that employ LDI, and the second of service providers that assist asset owners with implementing and managing LDI strategies.

Data from both surveys have been aggregated and organized to highlight industry trends and create provider summaries. Additionally, Top 5 rankings of provider data are given in many different classifications—e.g., the number of LDI clients and mandates, along with assets under management, for each provider, plus information about the regions and plan sizes in which the provider has mandates.

We received 37 responses to the asset owner survey. These provided feedback on LDI-related topics, including asset allocation, plan status, risk management, decisionmaking and sourcing strategies.

Nineteen service providers responded to the second survey, relating their experience and capabilities for working with their range of clients. Data collected include which regions and asset sizes have active mandates, as well as which regions and asset classes have assets allocated to them.

For more information on the data presented or to receive notifications to sign up for the annual Chief Investment Officer LDI Survey, please reach out to the research and surveys team at surveys@issmediasolutions.com. —Garrett Cox

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