Funded Status Volatility: Why It Matters For Pension Plans

Let’s get right to the point: Funded status volatility creates problems. Reducing that volatility can help mitigate those problems.

Profits, Boom, Economy, Woman, Write

Significant drops in funded status can lead to larger, unexpected contribution requirements for plan sponsors, if a plan’s funding drops below a certain level. And funded status volatility can also impact Pension Benefit Guaranty Corporation (PBGC) premiums. If a plan’s funded status drops at the wrong time, PBGC premiums can increase significantly due to that funded status decline.

Learning from the past

We had observed in prior risk-off events, like the Global Financial Crisis, that many defined benefit (DB) plan sponsors experienced unpleasant surprises in the form of material funded status declines. We’ve heard from our own plan sponsor clients today—who are understandably wary, due to their own past experiences—that they want to avoid any sudden, dramatic drops in funded status. This is why, aside from a general client desire for no surprises, we believe the best OCIO providers focus on risk management—alongside traditional return generation strategies—to guard against potential funded status losses.

A low-vol approach to funded status: The three-legged stool

We believe that plan sponsors should take a holistic perspective to managing total plan risk. And we advocate a three-legged risk management approach that focuses on the following:

  1. Diversification of the asset portfolio.
  2. Management of liability sensitivities to interest-rate changes.
  3. Consideration of the interaction between these return-seeking and liability components.

Does it work? The proof is in the pudding.

As a case study to the validity of this approach, we can point to the results of our own clients in 2020. Data shows that our investment approach mitigated funded status risk. Corporate DB plans managed by Russell Investments experienced significantly less volatility of funded status movements over the last five years, when compared to industry estimates. Incidentally, these client plans also experienced a greater improvement in funded status over this time frame.

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