De-risking in 2017

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The last decade has seen much written and discussed about de-risking and in fact as I look back I started seeing this discussion emerge twenty years ago. The 1990s was a period of good investment performance but also a time of declining interest rates.  At that time leading actuaries and investment advisors were showing plan sponsors how a reversal in equity returns could impact their pension funding. This ‘better’ education of plan sponsors came at a time when pension plans in Canada were maturing and the negative consequences of mismatching assets and liabilities was growing to uncomfortable levels for many sponsors.

The bust of the early 2000s woke up many plan sponsors that had previously ignored these perils – but for many sponsors it seemed too late. By the end of 2000 yields on long-term Government of Canada bonds were below 6% per annum and many experts and non-experts thought that the opportunity to profitably hedge pension liabilities with a shift to long-term bonds had passed.  If we knew then what we know now…..

Over the past 15 years I have watched our clients look at the question of de-risking. Many have taken de-risking measures by changing their plan terms – reduction in benefit promises, increases in employee contributions, conversions to DC and wind-ups have all been used in one combination or another.  However, on the investment side, although some clients have ‘de-risked’ with a shift to bonds or the purchase of annuities, many have not.  The founding principal to not de-risk a pension plan’s asset mix has been that interest rates have been too low and clients have been convinced that a return to higher interest rates will pay back the losses accrued over the past number of years as a result of liabilities growing faster than assets.

Although we don’t give investment advice at ASI, I was not bothered by clients that chose to stay invested in equities.  For a long time I have truly believed that equities will outperform bonds over the long-term. But what I have learned over the past twenty years is that most plan sponsors don’t actually operate in the ‘long-term’ – whatever that means. Changes in pension costs often matter in the short-term and many sponsors haven’t been able to stomach the volatility in contributions even if the total long-term cost is one that they can afford to bear.

I won’t spend a lot of time inserting my long-time complaint about how our governments force sponsors to fund pension promises.  I will simply observe that had we instituted a less volatile approach to funding pensions we would have likely saved many more DB plans in the private sector. As we head into 2017, Ontario is thinking about a new system for funding pensions – probably a decade or two after private sector workers needed this effort.

The other thing that has happened over the last twenty years is that time horizons are shorter. When I started in this business we definitely thought the long-term was 50+ years and our calculations ran for 100 years. We now have a number of clients that have frozen DB plans that are close to fully-funded and we expect many sponsors to fully de-risk in the next decade. The question isn’t ‘if?’ it is ‘when?’ Even our clients with fully open DB plans are operating more mature plans – more retirees per active worker – and as a result the risks of these plans are different than in years past.

So where are we now? We have rising interest rates – at least for the moment. Are the rising rates a result of the US election or do we have some new insight into the economy? Your guess is as good as mine. Will interest rates keep rising or is this a blip before they head back down?  Your guess is as good as mine.

What I do know is that sponsors that have been waiting for interest rates to rise and think equity markets are at a high point, really should be looking at their investment policy to decide if they want to keep things as they are or if now is the time to shift their approach to risk and return. But to say this perpetuates a myth that I am trying to fight. Timing the market is a game that I have rarely seen people win through good planning and thoughtful decision making – sometimes sponsors do get lucky though. What I really believe now is that sponsors should be reviewing their investment strategy regularly (the bigger the risks the more frequent the review) and be ready to make changes quickly as the economy shifts. I would like to see every plan sponsor reach the end of 2017 satisfied in retrospect with the risks that they took this year and the results that they achieved.



Joe Nunes
Joe Nunes
Joseph Nunes, Co-founder and Executive Chairman of Actuarial Solutions Inc., has practiced in the area of pensions and retiree health plans for over 30 years. He has experience with many types of plans including single-employer, multi-employer, private sector, government, unionized, non-unionized, as well as registered and non-registered executive plans.

1 Comment

  1. Avatar Bob T says:

    The concept of de-risking or “immunization” as it was known arose in the 70’s but the higher interest rates and investment returns led to the issues/problems we face now.

    As to the government forcing unreasonable funding assumptions, I disagree to some extent. In the old days, many plans used level premium funding methods and the valuation interest rates were less than insurance annuity rates.

    Due to the high experience deficiency payments in the 70’s, Ontario introduced solvency funding in the late 80s as the first funding relief.

    Unfortunately due to additional issues such as surplus ownership, most plans moved to unit credit methods which were less expensive to fund and created surplus in the transition.

    This was used to improve benefits, run Windows to change the demographics of the organization and take contribution holidays.

    I recall as Chrysler came out of bankruptcy, it was recommended they buy annuities for their retirees to eliminate the large retired population. Annuity rates were in the low teens. The answer was investment returns were much higher so why throw money away.

    Then the governments decided that they should not limit assumptions, leave it to the actuaries and plan sponsors to act responsibly and accounting rules came into place. The result was assumptions rising while long term rates dropped.

    Solvency valuations driven by lower rates produced deficits that were always or should always have been expected but as mentioned short term thinking by many just wanted to close their eyes and hope that at the next valuation things would be better.

    I think it was in the late 80’s with the intro of the accounting rules, GM in the US outlined it was now in the business of selling cars to be able to pay its retirees. So the problem was known or should have been and none wished to address it.

    In the end the solution is to kill the DB plan, not address what went wrong. Of course our governments have always led the way in these activities, however, plan sponsors go away and governments do not.

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