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Liability Driven Investing Gains Favor with Corporate Pension Plan Sponsors

By Mark Johnson, Ph.D., J.D.

 

Kraft Foods Group actively seeks to reduce pension plan funding volatility with a liability-driven investment (“LDI”) structure, according to a company release for the fourth quarter of 2012. Many other Fortune 500 pension plan sponsors, as well as some municipal plans, are following a similar risk management strategy.

 

Liability-driven investing is an increasingly popular investment technique being used to match pension plan assets with liabilities. Pension plan sponsors with responsibility for defined benefit plans are reducing their exposure to the equity markets by using more predictable investments, such as bonds, to fund future obligations.

 

Top 10 Pension Funds using a Liability-Driven Investing Strategy

 

Pensions and Investments identifies the pension funds listed below as the leading domestic LDI adopters, as of September 30, 2012. The amount of total defined benefit assets (not necessarily assets in an LDI investment program) for each plan sponsor is provided in parentheses.

  • General Motors ($101.9 billion)

  • Boeing ($55.5 billion)

  • IBM ($53.4 billion)

  • Ford ($42.2 billion)

  • Alcatel-Lucent ($34.3 billion)

  • Missouri Public Schools ($28.4 billion)

  • Verizon ($25.5 billion)

  • UPS ($25.1 billion)

  • United Technologies ($22.5 billion)

  • FedEx ($17.9 billion)

More than half (57 percent) of corporate pension sponsors adopt some form of liability-driven investing, according to a 2012 poll conducted by SEI, a public company that provides investment management business outsourcing solutions. Of those plan sponsors who use LDI, more than half (52 percent) invest at least 40 percent of their portfolio assets in a liability-driven program.

 

LDI Programs Affect Discount Rate Assumptions

 

Kraft announced a significant reduction in their assumed rate of return on assets (from 7.75% to approximately 5.5%) as they rebalance their portfolio to meet a goal of 80% fixed income and 20% equities. Higher rates of return on today’s buoyant stock market are attractive, but Kraft seeks to improve transparency, simplify accounting, and reduce corporate cash flow volatility under the LDI program. The firm is also moving to adopt mark-to-market accounting for its pension plan.

 

Funded status may take priority over interest rates under an LDI program, which can be a difficult adjustment for defined benefit plan managers. Better levels of predictability, however, can help plan sponsors to more effectively meet pension funding rules in regard to balance sheet and cash-flow requirements.

 

Decision Factors in Liability-Driven Investment Programs

 

Industry consultants suggest that plan sponsors address basic planning concepts during the implementation and management of an LDI strategy, including:

  • Establish a timeline for meeting risk reduction goals through asset allocation

  • Evaluate the transfer of obligations to a third party

  • Maintain a close watch on funded status of a plan

  • Avoid the distraction of higher interest rates associated with more risky investments

Additional liability reduction options may include lump sum payments, buy-in and buy-out strategies, and annuities.

 

Background on LDI Programs

 

LDI is a structured investment program designed to finance a predictable stream of future payments. In the case of defined benefit pension plans, for example, plan participants are scheduled to receive known future pension payments based on length of service, salary, and other factors.

 

The appeal of a liability-driven investing program to a plan sponsor is the ability to reduce or hedge risk by aligning investment programs with future retirement benefits promised to plan participants.

 

Summary

 

Liability-driven investing continues to be a popular risk management strategy. It is being rapidly adopted by leading Fortune 500 pension plan sponsors that seek to reduce pension plan funding volatility. LDI strategies can increase financial transparency while also helping a sponsor to comply with stringent accounting and pension funding requirements.

 

May, 2013

 

 

ABOUT THE AUTHOR: Mark Johnson, Ph.D., J.D.

Mark Johnson, Ph.D., J.D., is a highly experienced ERISA expert. As a former ERISA Plan Managing Director and plan fiduciary for a Fortune 500 company, Dr. Johnson has practical knowledge of plan documents as well as an in-depth understanding of ERISA obligations. He works as an expert consultant and witness on 401(k), ESOP and pension fiduciary liability; retiree medical benefit coverage; third party administrator disputes; individual benefit claims; pension benefits in bankruptcy; long term disability benefits; and cash conversion balances.

 

ERISA Benefits Consulting, Inc. by Mark Johnson provides benefit consulting and advisory services and does not engage in the practice of law.

 

© ERISA Benefits Consulting, Inc.

 

Contact ERISA Expert Dr. Mark Johnson

 

You can reach Dr. Johnson via email or by phone at 817-909-0778. He is available to confidentially discuss a benefits matter.

 

Click on the link to read about his representative ERISA cases.

 


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