Market volatility is causing plan sponsors in the US and scheme sponsors and trustees in the UK to identify Underfunding of Liabilities in the US and its UK counterpart, Funding Deficits, as the most important risk affecting their defined benefit (DB) pension schemes today. However, this risk is reported as only the 11th most successfully managed risk by those in the US and 12th in the UK – demonstrating that the importance ascribed to certain risks does not always correlate to the reported success at managing them. Comparing Pension Risk Attitudes and Aptitude in the United Kingdom and United States, a new MetLife report released today, juxtaposes these and other findings from two studies, the 2011 MetLife US Pension Risk Behavior IndexSM and the 2011 MetLife Assurance UK Pension Risk Behaviour IndexSM.
The studies surveyed plan sponsors in the US and scheme sponsors and trustees in the UK on 18 investment, liability and business risks to which their schemes are exposed. Data from each survey were used to assess respondents’ attitudes toward and aptitude for managing pension risk. The new comparison report, which also contains a primer on the US and UK DB pension landscapes, is available for download at http://www.metlife.co.uk/metlifeassurance/knowledge-centre/.
Both Countries Take a More Deliberate Approach to Pension Risk Prioritization
The new comparison report reveals that respondents are taking a more selective approach to pension risk management. This is evidenced by the Importance Selection Rate (www.metlife.com/ukuspensionchart) that respondents ascribed to each risk or, said another way, the number of times a risk factor was selected as the most important when it was presented to respondents.
In the US, the most important risk factor – Underfunding of Liabilities – was selected 66% of the time, and the least important risk factor – Early Retirement Risk – was selected 4% of the time. In 2010, the most and least important risk factors were selected 29% of the time and 21% of the time, respectively.
In the UK, the range between the most important risk – Funding Deficits – and least important risk in 2011 is 57 percentage points, with the most important risk being selected 58% of the time, and the least important risk – Inappropriate Trading – selected just 1% of the time. This compares to a range of just eight percentage points in 2010.
Liability-Related Risks Rise to the Top in US and UK
The economic downturn and subsequent volatile economic environment is leading plan sponsors in the US and scheme sponsors and trustees in the UK to focus more intensely on their scheme’s liabilities. In addition to ranking Underfunding of Liabilities (US) and Funding Deficits (UK) as the most important risk factor, Asset and Liability mismatch ranked second in the US and third in the UK.
In the UK, the emphasis on Funding Deficits has also been accompanied by a concentration on the Employer Covenant, selected as the second most important risk in 2011. While Employer Covenant was ranked second in importance in 2010, the number of times it was selected as important increased from 28% in 2012 to 49% in 2011.
“While plan sponsors in the US and scheme sponsors and trustees in the UK are both focused on liability management, there are key differences in their approaches,” said Cynthia Mallett, Vice President, Corporate Benefit Funding, MetLife. “Our research shows that UK respondents may be more concerned about securing contributions to their scheme in order to meet their obligations, whereas US plan sponsors are more concerned about seeking excess returns from their assets to meet their liabilities.”
“This marks a fairly significant turning point in the U.S. away from seeing absolute asset performance as a key driver of meeting pension obligations, and moving to managing assets in the context of plan liabilities,” Mallett added.
“The prominence of Funding Deficits and Employer Covenant demonstrate how critical the role of the sponsor as ultimate guarantor of the scheme is in the UK. Trustees play an incredibly important role in assessing and routinely monitoring the company’s financial ability – and ongoing willingness – to support the scheme,” said Emma Watkins, Director of Business Development at MetLife Assurance Limited.
“Given trustees cannot rely on investment performance alone to address deficits, particularly in volatile financial conditions, the strength of the employer covenant is critical in driving investment risk decisions and determining the ability to meet often increasing contribution demands,” Watkins further commented.
Alignment Between Importance and Success Reveals Some Inconsistencies
In the UK, 80% of scheme sponsors and trustees say they are successfully managing risks facing their plans, and 79% of plan sponsors in the US report the same.
However, the comparison study also found that some risks identified as highly important were reported to be low in success, even though they should garner more attention than risks that are identified as low in importance but reported to be successfully managed.
In addition to Underfunding of Liabilities (US) / Funding Deficits (UK) reported as not being successfully managed in the US and UK, Asset and Liability Mismatch, which is the second most important risk factor in the US and third most important risk factor in the UK, was reported to be only the 13th most successfully managed risk in the US and the 11th in the UK.
“The good news amid a challenging economic environment is that both plan sponsors in the US and scheme sponsors and trustees in the UK are tackling the measurement of their liabilities. This is the first step in successfully managing the risks facing their plans,” said Mallett. “Moving forward, we expect plan sponsors in the US and scheme sponsors and trustees in the UK to refine and deepen their focus on a core set of risks, and over time to implement new strategies to successfully manage them.”
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