Stable Funding Levels Will Lead to LDI and Risk Transfers, Says Mercer

S&P 1500 companies’ pension deficits are slowly shrinking, leading pension funds to consider ways to take advantage of the improved funding positions.

(November 4, 2013) — An equity rally and relative improvement in high-grade corporate bond yield rates, have led the biggest US corporates to sustained funding ratios at the end of October, prompting early discussions about pension risk transfers and liability-driven investing (LDI).

Data from consultants Mercer showed funding levels of pension plans sponsored by S&P 1500 companies remained stable during the month of October, with a funded ratio (assets divided by liabilities) of 91% at the end of the month.

This is equal to September’s figures, when it reached the highest level since October 2008. The total deficit of the S&P 1500 companies reached $185 billion at October 31, 2013, up slightly from $182 billion a month ago, but still a significant reduction from the estimated deficit of $557 billion at December 31, 2012.

Yields on high grade corporate bond rates (which are used to measure liabilities in the US) fell after congress passed the bill to raise the debt ceiling. The month ended with bond yields lower than the end of September, with the Mercer Yield Curve discount rate for mature pension plans falling from 4.58% to 4.45%, but still up 74 basis points year-to-date.

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“As we close in on year end for many sponsors, this funded status improvement is very encouraging,” said Jonathan Barry, a partner in Mercer’s retirement business.

“We are seeing many sponsors take advantage of this improvement as they plan to lessen the risk in their plan either through LDI or risk transfer strategies. We expect to see significant activity in these areas in 2014.”

Mercer isn’t the only one to be bullish about the US pension risk transfer market in the coming months: Glenn O’Brien, managing director of Prudential’s pension risk transfer business, told aiCIO the US was starting to see an increase in sponsors willing to transact.

“I was less optimistic [about the buyout market] at the beginning of the year, as companies were focusing on their year-end disclosures. But the macro-economic situation has improved and we’re starting to see a pick-up in interest in companies willing to deploy cash,” he said.

(November 5, 2013) — Collective defined contribution (CDC) models are unsustainable in the long term and won’t encourage more people to save, according to a survey of asset managers.

Cerulli’s European Defined Contribution Markets 2013 report, which questioned fund managers across Europe that represent more than $1.3 trillion in defined contribution funds, have almost unanimously shied away from CDC.

The strategy is a shared risk pension model popular in the Netherlands, which sees defined contribution assets pooled to allow for greater sharing of risks and more adventurous investment strategies.

Respondents to the survey told the research firm that “CDC pension systems are unsustainable in the long run” and “countries moving from a defined benefits-dominated pension system should go straight to individual DC, bypassing CDC altogether”.

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A belief that CDC could encourage greater saving levels in defined contribution also had doubt cast over it, with only a “luke warm” response to the suggestion, according to Cerulli.

The research arrives at an interesting point for the UK market, as the UK government’s pensions minister Steve Webb is actively considering introducing a form of CDC it calls Defined Ambition.

David Walker, senior analyst at Cerulli and the author of the report, said: “Policymakers across Europe are examining how best to get their citizens saving enough to finance their own retirement.

“Some of the options being discussed would fundamentally transform the DC pensions systems in numerous countries. The changes could also have a major impact on opportunities for asset managers that are trying to serve Europe’s growing DC pension markets.”

The asset managers questioned believe it is better to pursue an individual defined contribution path instead—even some of the Dutch practitioners are in favour of moving in this direction, saying they prefer the UK’s existing model.

Robin Ellison, a partner at law firm Pinsent Masons—which has hosted pan-industry meetings on the promotion of CDC use in the UK—told aiCIO he was “puzzled” at the outcome of the survey, and didn’t recognise the conclusion.

“Most of the surveys that have been done, mostly by the tomorrow’s investor programme at the RSA in the UK, suggest that the opportunity to have a 30% to 40% uplift in benefits with virtually no added risk is very attractive to both employers and the workforce,” he said.

“I’ve been in meetings with some of the major UK employers who are enthusiastic about the opportunity—provided the regulatory framework is reasonable, and does not re-invent the problems of defined benefit regulation that we currently endure.”

Ellison argued that this was not a question for asset managers to consider, but for “pension consumers”, ie employers and members.

Scott Lothian, a senior strategist in Schroders’ global strategic solutions team, told aiCIO that his firm was one of those who was against the wider introduction of CDC.

“We don’t feel this is the right route to go down. It’s a way for the politicians to kick the can down the road,” he said.

“It introduces cross-generational risks and it’s like going back to the days of with-profits.”

Asked whether asset managers were anti-CDC because of the costs involved, Lothian said while there might be downward pressure on fund managers as a result of the CDC framework, that downward pressure was already present.

“Unless CDC is mandated (by government), the set up costs would I guess have to be done by the asset manager, and perhaps in the longer run the costs could go back to the members,” he added.

The report also explored asset managers’ plans to develop cross-border products. While employers with multiple geographical locations want to use pooled arrangements, they’re not prepared to pay for them, Cerulli said—and neither are the asset managers.

Establishing cross-border pooling vehicles is too expensive for many asset managers, the report said. But the DC industry insists that having fewer, larger asset pools is an ideal way to drive efficiencies, and various cross-border pension pooling vehicles are ready and waiting to join in this process.

The full Cerulli report can be found here .