As Seen in CFO Studio Magazine Q3 2016 Issue
NO ONE-SIZE-FITS-ALL APPROACH BUT GUIDANCE NEVERTHELESS
De-risking benefit and pension plans, a trend set in motion by the recession, new reporting requirements for pension liabilities, and waves of baby boomers reaching retirement age, was the discussion topic at a World-Class Companies CFO Dinner held recently at MetLife Stadium, and hosted by CFO Studio. The unfunded liabilities that pensions represent on a business entity’s balance sheet can hurt the company’s ratings from debt agencies and its attractiveness to investors. De-risking strategies are intended to mitigate three primary issues: the effects of market volatility on monies invested in the pension fund, interest rate risk, and consequences of events that do not meet actuarial assumptions, such as having a large number of employees reach retirement at the same time.
“There are always differences between reality and those assumptions,” explains Claude Draillard, Vice President, Finance, Dassault Falcon Jet Corp., the evening’s discussion leader. Two frequently encountered discrepancies are “when the population changes dramatically and when the rate of return on the assets is much lower than planned. In both cases, you need to fund those differences at some point … and that could impact your cash.”
There is no one solution related to de-risking a pension plan. “De-risking can take widely different forms once you have analyzed your population,” said Mr. Draillard.
Some de-risking strategies include offering retiree buyouts or purchasing an annuity that effectively transfers pension obligations to a private insurance company. “Is it in your company’s best interest to offer retirees a lump-sum payout instead of monthly pension payments? These are questions that must be kept in mind,” says Mr. Draillard. “It’s important to analyze the situation all the way to its final outcome.” He adds, “Decisions made today about pensions will have their full effect for the company’s financials in as long as 30 or 40 years.”
New Job for CFOs
Pension plan management, once an assignment of the benefits department, is now on the finance agenda. The actions the CFO takes depend on the circumstances of the company’s populations and how the pension plan relates to your long-term strategy, explains Mr. Draillard.
“There are many questions regarding this. Where is the emphasis in your company? Is it in keeping cash for the short term or is your company more interested in making sacrifices with an eye to the future?” he asks.
“Pensions are an important tool in the box to help with retention,” says Mr. Draillard. His company’s plan is richer than most in order to do so. “It has become not only a retention tool but it helps us attract seasoned professionals. Aircraft mechanics make up a shrinking population. A pension is meaningful to a mid-40s [FAA-licensed] professional. It isn’t as important to millennials as it is to these seasoned professionals.”
Cash-flow Negative
According to Cerulli Associates, a leading research firm specializing in asset management and distribution trends worldwide, America’s pension system will turn cash-flow negative this year. This deficit will continue to increase as baby boomers retire. “This has significant impact on CFOs and must be kept in mind when creating a de-risking plan,” asserts Mr. Draillard.
A CFO Studio business development partner, Isaac Buchen is Leader of PwC’s Pension Risk Management practice. At the dinner he recommended “a series of steps that will allow plan sponsors to understand the nature of risks embedded in the current plans, establish key risk-management approaches, and embed a culture of periodic monitoring to make sure that the risk-management steps are having the desired effect.”
Mr. Buchen explained in an interview that “plan sponsors generally have four levers at their disposal to address pension risk:
• Benefit lever or changes to the plan design, including offering lump sums to terminated vested participants,
• Investment lever or changes to the overall asset allocation,
• Contribution lever or developing a strategy of how to fund the plan and potentially making non-cash contributions, and
• Insurance lever or buying annuities for participants from an insurance company.”
As the dinner discussion drew to a close, the group gathered in the Jets Green Room at MetLife Stadium overlooking the field where the CFO guests watched the New York Jets play the Buffalo Bills.
Participants left the discussion with an understanding that there is a clear trend toward de-risking benefits and pension liabilities, and that the actual approaches taken are many, depending on the industry, the composition of groups covered by the pensions, and strategic priorities.