Mercer: Companies Changing DB Funding, Risk Strategies Due to PBGC Premiums, Capital Markets

In its new CFO survey, “Adventures in Pension Risk Management,” Mercer found that companies are changing defined benefit (DB) funding and risk strategies due to increasing Pension Benefit Guaranty Corporation (PBGC) premiums and capital market conditions.

“Two years ago, mortality assumptions dominated as the main influencing factor. Today, PBGC premiums and market conditions have emerged as most-cited reasons. Companies feel that the time is right to reduce or eliminate their pension funding shortfalls,” Mercer Partner Matt McDaniel said in a statement. “Continuing the trend we found in our 2015 survey, the migration towards pension risk transfer and de-risking carries on at an accelerated pace.”

Collecting 175 responses from CFOs, CEOs, and finance directors, 80% of which represent DB plan assets between $100 million and $5 billion, the survey found that nearly 80% of all respondents are now contributing more than the minimum level of funding to their DB plans due to wanting to reach specific thresholds or to fully fund the plan faster than regulations require. PBGC premiums tripled between 2011 and 2016—and are expected to quadruple by 2019.

On the topic of why funding has increased or if that has at least been considered, 40% of respondents chose to raise funding to reduce the cost of future PBGC premiums—with almost 33% considering to do so for the same reason.

“Rising PBGC premiums coupled with potentially falling tax rates really improves the business case for advance funding,” Scott Jarboe, partner, Mercer, said in a statement. “Even those sponsors without significant cash on hand are finding that borrowing at attractive rates to fund the DB Plan can have a significantly positive ROI, while not increasing their total debt load.”        

In the wake of plan sponsors freezing or closing their plans, almost 60% of respondents are intending to terminate their plans within the next 10 years, but a majority of the total respondents are looking for a way to close the funding gap. According to the report, more than eight in 10 either have a “dynamic de-risking strategy in place” or “are already considering one.” However, Mercer reports 55% of the respondents are struggling to find enough internal resources to manage their pension plan.

“Sponsors who want to develop a successful pension exit strategy have to make sure they create a process that evaluates and changes the asset allocation, lowering pension risk as frozen plans move closer to termination,” McDaniel said. “DB plan sponsors should weigh considerations such as the plan’s objective, their time horizon, the magnitude of their obligations, and the state of the economy.”

As companies seek to weigh the benefits and obligations of maintaining plans, they must consider costs for maintaining them (including PBGC premiums), funding levels, and the price of settling liabilities. Mercer reports that nearly 75% of respondents have already offered lump-sum payments to “certain participants” since 2012—up 59% from its 2015 CFO survey results. Roughly 50% of all respondents consider it likely that some form of lump-sum risk-transfer action will be taken in the next few years—a second or third lump-sum offer for many.

More than 55% of respondents have either completed annuity buyouts or are considering it. According to the report, 37% consider them to be “expensive,” while 25% consider them to be “very expensive.”

“Specifically, these respondents estimate that the cost of an annuity would require their pensions to post a Projected Benefit Obligation (PBO) of over 110%,” Mercer’s news release reads. “However, Mercer’s experience as the market leader in annuity placements shows that the majority of transactions occur between 100% and 110% of PBO.”