De-Risking Drive Leads to Alternatives and Real Assets Push

(March 31, 2014) — Almost a third of US defined benefit (DB) pension funds are considering or are very likely to carry out a pension risk transfer transaction this year, according to a survey from Clear Path Analysis.

The survey, which was partnered by Prudential and questioned more than 60 North American pension plan managers and pensions sponsor representatives, found US funds’ attitudes towards pension risk transfers had turned markedly positive during the past three years.

And the decision to de-risk had led corporate pension funds to invest more in real assets, while underfunded public sector plans turned to alternatives to fill the deficit.

Unlike the UK pension fund industry, which has seen a high number of pension risk transfers since the onset of the financial crisis, the US industry was historically been more cautious on de-risking.

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In 2010, a Mercer survey of US defined benefit plan sponsors 2010 had found that 41% of US pension respondents would adopt a wait-and-see approach on changes to reduce their risk.

However, Clear Path Analysis report’s findings suggested that attitudes have changed, and that risk transfer has become more of a priority for US pension funds in the year ahead.

“We’re seeing companies look at ways of efficient risk reduction and transfer of liabilities as they consider their stock price and corporate cash flow,” said Glenn O’Brien, head of US Distribution for pension risk transfer at Prudential Financial.

“Plan sponsors are starting to realise that de-risking can be less expensive than keeping the liabilities on their balance sheets and transferring pension risk allows companies to focus on the day to day running of the business.”

The move towards buyouts had also impacted on pension funds’ asset allocations: Clear Path Analysis found corporate plans were shifting into real assets.

Elsewhere in the report, 71% of public sector plans said they planned to look at alternative assets in an effort to meet sponsor goals.

Dan Tremblay, director of institutional fixed income solutions at survey sponsor Pyramis, outlined what he saw as the likely shift in asset allocation over the next five years.

“While we’ve seen a closed plan switch to fixed income, open plans are very much looking to alternatives as results for this survey clearly indicate,” he said.

“Schemes are taking the impact of increased longevity on their liabilities more seriously and are considering buyout solutions, and improving returns through a switch to alternatives.”

The full Clear Path Analysis report can be found here.

(March 31, 2014) — The UK must learn the lessons of South Africa to avoid defined contribution (DC) members making the wrong decumulation choices, according to African investment consultants RisCura.

Petri Greeff, director at the firm, told aiCIO that the changes to DC pensions announced by UK Chancellor George Osborne earlier this month would lead to poor decisions being made by many beneficiaries.

“Giving members so much freedom led to them shooting themselves in the foot in the longer term,” he said.

“South Africa shifted to DC in the late 1980s to early 1990s, so we’ve lived through what happens when you offer too much choice.

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“Now in South Africa, we’ve gone full circle and are dialling back some of the choices available to members.”

Osborne’s Budget announcement included a number of changes for the UK pension industry, including removing the need for DC members to annuitise their pension pot at retirement.

In South Africa, where this situation has been in place for more than 25 years, the vast majority of members go into an income drawdown arrangement—as many as seven in 10, according to Greeff.

While income drawdown products aren’t necessarily a poor option, how the members make that decision has been openly questioned.

“Inadequate advice, inappropriate incentives by advisors, and short-term views by investors have led to a flourishing income drawdown industry and dwindling, unpopular annuity market. This in turn has led to many members retiring using an insufficient vehicle that robs them of the retirement they deserve, after diligently saving during their working lives,” Greeff said.

Equating moving into income drawdown as “the same as requiring them to suddenly become their own investment managers”, Greeff explained that many financial advisors had been persuaded to recommend the product because they received more commission than recommending an annuity or cashing the pot in.

This is thought to be less of a problem for the UK market however, as the retail distribution review has effectively banned commissions being paid to advisors for recommending products.

On a more positive note, the change to allow DC members to have more freedom around how to use their pension pot at retirement had led to innovation in South Africa, something which could also be seen in the UK.

Having initially adopted a pensions liberalisation attitude similar to the one Osborne announced earlier in March, the national treasury in South Africa has effectively performed an about-face: it is now pushing DC schemes to offer safe, default post-retirement products that have been vetted by the trustees of the DC scheme in terms of suitability and cost.

While most are planning to offer a vetted income drawdown product as their default, some of the larger DC funds have opted for a new breed of product, the in-fund annuity.

“Traditionally an in-fund annuity referred to a guaranteed annuity. In-fund annuities aren’t standard practise for most trust-based DC schemes in South Africa, and are mostly done on an ad-hoc basis,” explained Greeff.

“Even then, this is only by the larger DC schemes that have the capability of dealing with the added complexity this brings. It is an attempt by DC funds to still offer defined benefit (DB)-like benefits in a post-DB world.”

The DC schemes that do offer this take on DB-like risk: the asset side of the balance sheet is exposed to investment risk, and liability side of the balance sheet is exposed to mortality risk. The pensioners carry very little risk at all. In addition, the same selection of managers are used at the point of retirement at the same low fees, negotiated on an institutional basis.