The capital market volatility of the past few months has been unsettling for pension plan sponsors and participants alike. Even before Standard & Poor’s downgrading of the U.S. credit rating, indicators pointed to deterioration in the financial position of most DB plans.
For one, accounting discount rates for many plans decreased by 50 to 60 basis points between Dec. 31, 2010 and Sept. 30, 2011, increasing accounting liabilities. The accounting funded ratio of the benchmark pension plan tracked by Towers Watson on a monthly basis decreased by 14.5% between Jan. 1, 2011 and Sept. 30, 2011.
Secondly, recent trends in commuted value discount rates and estimated group annuity purchase rates will likely lead to an increase in solvency liabilities for most plans—the solvency funded ratio of the benchmark pension plan tracked by Towers Watson decreased by 6.9% during the first nine months of 2011 (based on a growth portfolio asset mix).
The combination of slumping equity values and falling yields will result in declines in the financial positions of pension plans that have not significantly de-risked through investment strategy. While day-to-day funded status volatility is usually not a significant problem for retirement plans, it is prudent for plan sponsors to periodically reassess the size and scope of the exposure in their plans. Depending on the timing of the last forecast, plan sponsors should consider current market conditions and assess whether 2012 contribution and pension expense estimates need to be updated, and should include scenario analyses to understand the impact of possible outcomes between now and year-end. Over the longer term, to better mitigate adverse organizational impact during volatile periods, plan sponsors would be wise to explore alternatives and identify conditions under which additional risk mitigation techniques should be adopted.
Plan sponsors and administrators should also consider the possible impacts on their reporting obligations under accounting and pension standards.
For entities reporting under International Financial Reporting Standards, the corporate balance sheet disclosure in the quarterly interim financial statements should reflect material changes to the pension, and post-retirement and post-employment financial positions during the quarter. Organizations should consider the possible balance sheet effect of changes in market conditions leading up to and following each quarter end, to identify adverse effects as early as possible.
For Ontario-registered plans, a material decrease in the plan’s transfer ratio may trigger the requirement under Regulation 19 of the Pension Benefits Act to seek approval from the Superintendent of Financial Services to continue transferring commuted values from the plan. Plan administrators should ensure there is a process in place for monitoring the transfer ratio of Ontario-registered plans at least every three months.
Additionally, the role of effective communications and governance strategies should not be overlooked. Turbulence in capital markets can stir anxiety among employees (particularly those participating in DC plans) and may lead to significant organizational ramifications if older employees delay retirement to rebuild retirement savings. Through employee surveys or data gathered by call centres and service providers, plan sponsors can assess how members are reacting to market instability and investment uncertainty. Armed with this information, plan sponsors can then determine if their communication strategy will reasonably ensure that members understand their pension program and are equipped to make informed investment choices.
A key lesson of the 2008 financial crisis was the importance of recognizing and assessing financial risk and considering the possible outcomes of improbable events. The market volatility over the last few months illustrates the continued importance of implementing adequate monitoring processes and an action plan for retirement plan management.