Tax reform, developing an investment governance model, and keeping a keen eye on monetary and fiscal policy levers were among the 10 items defined benefit (DB) pension plan sponsors should focus on, according to a 2018 investment outlook from global consulting firm Mercer.
As the year begins to build from the steady first month, understanding the new tax reform and its time-sensitive implications for pension funding strategies topped the list. Mercer’s studies found that after assuming lower taxes, 75% of plan sponsors had either considered accelerating their pension funding or had done so in 2017. An additional driver for meeting shorter funding thresholds was reducing Pension Benefit Guaranty Corporation (PBGC) variable rate premiums and funding over a shorter duration.
Mercer determined that many DB plans will take the reductions sooner rather than later, basking in the potential benefits of better earnings, reduced premiums, neutralized impact on deferred tax assets, and a ramped-up movement along an existing glide path. Upon the realization of these benefits, Mercer also expects contribution increases to rise.
The second priority DB plans have is preparing for a transition from quantitative easing to tightening. Monetary and fiscal policy levers are weaving in opposing directions due to a federal tightening as the administration seeks fiscal stimulus expansion. Although markets are still bullish, this could cause funded status to either fall or move sideways. Pension liabilities will also be extremely sensitive to movements in discount rates.
“DB plan sponsors face a host of challenges and powerful, priority opportunities in a rapidly changing environment of corporate tax reform, Fed tightening and emerging inflationary pressures. All of these factors could have a significant impact on pension funding and risk transfer,” Michael Schlachter, US Defined Benefit Leader, Mercer, said in a statement. “As a result, plan sponsors are looking to take bigger deductions from increased contributions, address shrinking investment returns during the late stage of the credit cycle, and prepare for accelerated risk transfer.”
In addition to identifying proper risk transfer strategies, driving the performance of investment returns, and managing private asset classes, backing up equities and riskier investments with a strong defense against shocks and declining optimism was also high on Mercer’s list. Economists have said that a market correction is on the horizon for some time, and each day brings us closer to that reality. In addition, geopolitical tension is also an issue as well as speculation of the end of an economic cycle. The firm suggests pension plans prep for the possible implications by ensuring their bond portfolios are tailored to the specific liabilities and investment strategies of each plan. Mercer also says pension plans could also consider explicit and implicit hedges, accelerated glide paths, defensive tilts, and high-quality cash for added flexibility.
Outsourced CIOs (OCIOs) have become a growing trend across pensions, and Mercer has identified that if more plans are willing to do this, they need to develop an investment governance model to see what can be gained from this move before jumping to a new model. Another concern is the need to address data gaps and challenges before de-risking.
“Plan sponsors who understand and implement available smart strategies to address market and regulatory dynamics will be better positioned to maintain resilient, fiscally sound DB plans,” Schlachter said. “We’re entering a period of unprecedented change marked by a combination of simultaneous factors never seen before. Managing a fund to successfully meet its obligations and deliver winning outcomes requires keen insight and commitment to data analytics and agility.”
The full whitepaper can be accessed here.