Mercer: In the Wake of Interest Rate Lows, Pension Plan Sponsors Foresee Soaring Contributions

A new analysis by Mercer has shown that the funded status for most pension plans is anticipated to drop significantly with plan sponsors facing sharply higher contributions for 2011 and beyond.

(October 27, 2011) — Pension plan sponsors are anticipating soaring 2011 contributions as interest rates hit record lows, a new analysis by Mercer reveals.

“Falling interest rates have created an environment in which plan sponsors that have taken steps to de-risk — incorporating a liability-driven investing approach — have fared better than those who haven’t,” Craig Rosenthal, a partner in Mercer’s retirement, risk and finance business, tells aiCIO. Rosenthal describes the current market environment as a ‘pension perfect storm,’ characterized by declines in asset values, driven mainly by equities, coupled with growing liabilities due to falling interest rates. Amid the turbulent environment, the trajectory for cash contributions continues to point skyward, according to Rosenthal. “These dramatically increasing contributions could drive some employers out of the pension system,” he says.

In anticipation of a worsening pension perfect storm, Rosenthal adds that many of Mercer’s clients with the luxury of available cash have made additional voluntary contributions for the 2010 plan year so that their 2011 funded ratios would avoid further threshold tests and scrutiny, as mandated by the Pension Protection Act (PPA).

According to the consulting firm, the funded status for most pensions is anticipated to drop significantly in the wake of higher expected contributions for 2011, with about 50% of surveyed plans needing 2010 contributions in excess of the minimum required amount to prevent 2011 funded ratios from falling below 80%. This would potentially trigger benefit restrictions and onerous “at risk” funding rules, the consulting firm reveals.

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Low interest rates have been driven largely by US economic policy, and Mercer notes that “the full effects of this one-two punch won’t be fully felt until 2012 and beyond.” Huge and continuing cash calls, the slow economic recovery, and big potential increases in Pension Benefit Guaranty Corporation (PBGC) premiums under consideration in Congress could place many plan sponsors in a difficult position, the firm states in a release, adding that without changes to pension funding rules, the funded status for many plans in 2011 and subsequent years will likely continue to decline significantly, with the following implications:

1) Funded ratios fall

2) Required contributions soar

3) Credit balances wither

4) Cash contributions skyrocket – up eightfold in just two years

5) Additional contribution increases expected in 2012

Mercer’s study was based on an analysis of 849 private-sector single-employer plans subject to the PPA, with more than $191 billion in combined assets as of January 1, 2010, and covering more than 4 million participants.

The consulting firm’s analysis follows a research paper published in August by UBS’s Francois Pellerin, which showed that between 2003 and 2007, the funded status of plans in the US ballooned from 77% to 96%. According to Pellerin, a heightened level of contributions made by plan sponsors — fueled by the PPA — largely drove the increase – highlighting a prevalent misperception among sponsors that a pure increase in equities got them out of their rut, when the real driver was contributions.

“In analyzing the liabilities of 500 publically-traded companies with the highest pension exposure, I found that on average, the pension plan was 46% of the size of the company,” Pellerin notes, adding that “liability-driven investment has flourished to control volatility so that plan sponsors can worry about what they’re good at – whether its building cars, making widgets, or whatnot.” Thus, once a plan reaches a funded status it deems appropriate, it should be heavily committed to a de-risking program, the paper claims.



To contact the <em>aiCIO</em> editor of this story: Paula Vasan at <a href='mailto:pvasan@assetinternational.com'>pvasan@assetinternational.com</a>; 646-308-2742

Wisconsin Pension Pumps Up Investment in Hedge Funds

The State of Wisconsin Investment Board (SWIB) had invested a total of about $300 million in hedge funds as of August 31.

(October 27, 2011) — After a relatively late start into the hedge fund space — investing into the sector for the first time in February — the roughly $78.6 billion State of Wisconsin Investment Board (SWIB) has pumped up its investment into the asset class. The fund invested a total of roughly $300 million in hedge funds as of August 31, with an additional $100 million in October. There are no final numbers available for the month of September, the fund’s spokesperson Vicki Hearing told aiCIO. 

“SWIB’s move into hedge funds has been slow and deliberate beginning in January 2010 with the approval of the asset allocation that included a hedge fund strategy,” Hearing said, noting that the money used to fund the hedge fund portfolio came from rebalancing during market changes into cash, or a liquidity fund.

The investment by the fund into the hedge fund space was made by investing $100 million each for hedge funds portfolios managed by Claren Road Asset Management (in July) and Ascend Wilson Fund LP (in October). Other funds include MKP Credit LP and Capula with $100 million each earlier this year.

“The multiple manager hedge fund portfolio will be diversified by style, strategy, geography and manager,” Hearing said, adding that SWIB will continue to work with hedge fund consultant, Cliffwater, LLC, and is looking at funding a total of 15 to 20 managers. The allocation to the sector translates to a total of 2% of assets.

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In February, SWIB made its first-ever allocation to hedge funds. In January, SWIB said it had invested $600 million with two risk parity strategy managers to achieve diversification and continued solid returns. SWIB allocated $300 million each to AQR Capital Management and Bridgewater Associates’ All Weather vehicle. According to the board, the additional risk parity portfolios were part of a plan to offer further diversification. “We first approved this asset allocation in January, and we knew this would be a very slow process,” Hearing said in August of last year. 

The increasing attractiveness of hedge funds among institutional investors is supported by a report from Preqin released early this year that revealed institutional investors now constitute the largest piece of the hedge fund capital pie.



To contact the <em>aiCIO</em> editor of this story: Paula Vasan at <a href='mailto:pvasan@assetinternational.com'>pvasan@assetinternational.com</a>; 646-308-2742

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