More Than Half of Companies Surveyed Consider Pension-Related Risk to Be Significant Risk Management Issue
STAMFORD, CT, MARCH 22, 2006 — While senior financial executives in the U.S. tend to see defined benefit pension plans as posing a major risk management challenge, more than two-thirds participating in a recent survey believe that available solutions are usually too expensive or ineffective, according to Towers Perrin, a global professional services firm.
The findings are included in a Towers Perrin research report, A Problem in Search of Solutions: A Study of Defined Benefit Pensions. The report is based on a series of interviews and online surveys with more than 100 CFOs and senior financial executives who were asked how they manage and make decisions regarding defined benefit pension plans.
“The role of the defined benefit pension in corporate America will continue to change significantly,” said Cecil Hemingway, principal and head of the Legacy Pension Solutions unit at Towers Perrin. “While these plans are still an important employee benefit at many companies, CFOs and other financial executives are increasingly focused on risk management and risk reduction. They see a clear link between plan risk and its potential impact on cost of capital, rating changes and other threats to their business plans.”
Pension-Related Risk Seen as Significant
Plan sponsors are facing a complex mix of challenges that include an aging workforce, changing regulations and a financial environment characterized by low, long-term interest rates and considerable market volatility over the past five years. For many companies, these factors have significantly increased the financial risks posed by defined benefit pension plans. While executives feel comfortable in their firms� understanding of these risks, they recognize the significance they pose to their organization — 57% of companies interviewed considered pension-related risk important relative to other financial and operational risks they face.
A Coming “Ice Age” for Pensions?
The potential financial impact of a pension plan on an organization is clearly top of mind among plan sponsors and would be significant enough for many executives to consider freezing their plans. In fact, many companies have already taken steps to curb the financial impact of further liability growth. Of those companies included in the survey, 32% had closed their plan to new entrants.
The most likely reason for companies to freeze their active pension plans would be the plan�s negative effect on company cash flow (60%), followed by negative effects on company earnings (48%) and the cost of capital/lower credit rating (43%). Proposed regulatory and accounting changes, including the possible loss of smoothing mechanisms, prompt widespread concern, even for sponsors of frozen plans.
Freezing a defined benefit plan is only a half-measure that slows the growth of the plan, but does little to alleviate the associated market and mortality risk,” added Hemingway. “It is for this very reason that most senior finance executives are examining a variety of solutions to contain growing pension risks. However, they are dissatisfied with the range of currently available options and, to some extent confused or put off by the competing claims of potential solution providers.”
Many Solutions, but Nothing Solved
According to the survey, senior financial executives feel the current range of pension solutions is either too expensive — in the case of an annuity purchase, for example — or ineffective at managing the underlying risk.
In particular, companies with poorly funded plans are in the greatest need of help yet are most constricted in their ability to manage risk and have fewer options available to them. However, there is an appetite for holistic and other risk management solutions that enable them to better manage and off-load risk — provided that these solutions have been validated and tested.
“Our research also suggests that comparatively few companies have adopted sophisticated processes for evaluating pension risks holistically and over the longer term,” Hemingway added. The research also revealed a degree of confusion created in the marketplace by competing solution providers, such as investment banks, private equity firms and insurance companies.
“As new solutions become available, plan sponsors need to expand their abilities to assess and evaluate these choices to ultimately determine which best fits their companies’ pension situation,” Hemingway said.
Towers Perrin’s Legacy Pension Solutions unit combines actuarial and pension expertise with leading-edge risk management capabilities to assess, structure, price and execute a wide range of pension risk mitigation solutions.
About This Survey
Towers Perrin undertook this research to assess the perspectives of senior finance executives and to explore how companies manage and make decisions regarding their defined benefit plans. Respondents represented companies with pension assets exceeding $100 million and across a wide array of industries. For information on the research, or to request a copy of the report, send a request via e-mail to [email protected]
About Towers Perrin
Towers Perrin is a global professional services firm that helps organizations improve their performance through effective people, risk and financial management. Through its HR Services business, Towers Perrin provides global human resource consulting that helps organizations effectively manage their investment in people. Areas of focus include employee benefits, compensation, communication, change management, employee research and the delivery of HR services. The firm�s other businesses are Reinsurance, which provides reinsurance intermediary services, and Tillinghast, which provides management and actuarial consulting to the financial services industry. Together, these businesses have offices and business partner locations in 25 countries. More information about HR Services is available at www.towersperrin.com/hrservices.