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Aon Retirement and Investment Blog

Brexit Implications for U.S. Pension Plans with Dynamic Investment Policies

Aon Hewitt’s Pension Risk Tracker tracks the daily funded status for S&P 500 companies with defined benefit pension plans; the rally in U.S. Treasuries year to date has resulted in a meaningful decline in funded status for most U.S. corporate pension plans – U.S. Treasuries have rallied further following Brexit. This could have implications for the investment strategies of many plan sponsors.
Recent Declines in Funded Ratios
As can be observed from the chart below, recent experience from Aon Hewitt’s Pension Risk Tracker shows the high-water mark for S&P 500 corporate pension plans (“corporate plans”) was achieved on December 27, 2013, at which point the funded ratio had reached 91.1%. With mounting uncertainty spawned by Brexit, investors rushed to safety assets in late June 2016, pushing Treasury rates close to the historic lows seen in late July 2012. Consequently, the aggregate funded ratio for corporate plans experienced a downward trend, dipping as low as 75.0% on June 27, 2016 due to the steady increase of pension liabilities, as liabilities increased by more than 10% since December 31, 2012.
Funded ratios dipped over 16 percentage points from their peak in late 2013, including 8.4% percentage points since June 23, 2015.  This has been caused by a combination of factors, including decreasing discount rates, lackluster asset returns, mortality improvements, and legislative relief for minimum contribution requirements. 

*Note: Aon Hewitt tracks the daily funded status of 350 S&P 500 companies with defined benefit pension plans. The above analysis reflects the roll-forward of the total defined benefit pension plan information from the FYE 2015 10-K disclosures.
Investment Changes
Many pension plans in the U.S. private sector have dynamic investment policies in which the policy asset allocation target depends on the funded ratio. 2013 marked the best calendar year for equities since the 1990s, returning 32.2% and being a principal driver (alongside higher discount rates) leading to the high-water mark at 12/27/2013 detailed above. Even as the typical plan’s funded ratio has declined, some plans have hit new high-water mark funded ratios due to plan-specific factors such as contributions and demographic and investment experience.  This has allowed some plan sponsors to de-risk during high points to reduce exposure during down periods. 
Potential Opportunities that Lie Ahead
Recent declines in funded ratio due to Brexit provide a window of opportunity for plan sponsors to consider re-risking their portfolios. We find dynamic investment policies address re-risking in one of three broad ways:

  1. Allowing automatic re-risking as the funded ratio declines, often only after a predefined drop from the high-water mark.
  2. Requiring the plan sponsor to formally consider re-risking if the funded ratio drops in excess of a predefined amount.
  3. Not allowing re-risking. 
As funded ratios have declined by 10% to 15%, or more, for many plan sponsors, these policy features could be triggered. As of the date of publication, about 20% of AHIC’s clients utilizing delegated services have re-risked along their glide paths. If we also consider clients that re-risked from an interest rate perspective only, about one-third of the clients have re-risked at a policy level in total. We expect additional clients are considering re-risking at the committee level and we advise plan sponsors to complete a risk budget review before adjusting their pension risk management policies.
Regardless of how a plan sponsor’s dynamic investment policy is written, a large decline in funded ratio may suggest that the plan circumstances have changed enough to warrant reconsideration of its investment positioning. 
Jutiliano Rodriguez and Mike Kelly are Actuarial Associates in Aon Hewitt’s Retirement and Investment practice in Somerset, New Jersey.  

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