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July 13, 2018
Mercer Recommends ‘Hibernation’ Approach for Certain DB Plan Sponsors

Following a flood of investment derisking activity after the 2008 global financial crisis, defined benefit (DB) plan sponsors now face the fallout from years of rising demand for insurer buyouts of pension benefit obligations (PBOs). 

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Until now, many plans have found it easy to transfer liabilities to a receptive insurance market with voluntary lump-sum and bulk annuity buyouts, which are seen as cost-effective ways to reduce or eliminate legacy pension obligations.

But growing pressure on insurers’ capacity to absorb more pension risk transfers (PRT) from an upswing in plan terminations is expected by benefits consulting firm Mercer LLC to continue and be “more widespread in the near future.” 

“[W]e also foresee a parallel growth in those fully funding and winding down their plans on balance sheets over time,” the firm said.

So how should DB plans proceed that are still seeking to remove PBOs from their balance sheets—or are still responsible for reduced pension plans remaining with non-standard features after partial derisking?

Steady-State Investing

Mercer, in a May white paper titled “Pension Investing for the Long Term: An Alternative to Risk Transfer” (available here, with registration), recommended a “hibernation” approach to many DB plans’ pension investing for now. Hibernation investing involves putting plans in a steady state while winding them down over time or gradually preparing for PRT over a longer period, according to Mercer.

Hibernation investing has some similarities to liability-driven investing (LDI) by pension plans but is often viewed as more complex.

For a plan entering a hibernation period, four key priorities stand out. Mercer said DB plan sponsors will want to:

  • Minimize residual expenses;
  • Maximize their asset returns in a low-risk state;
  • Minimize residual risk in the plan’s end state; and
  • Minimize the capital deployed in excess of pension obligations to keep the plan self-sufficient and removed from volatility.

“Ultimately, the need for close integration between asset and liability management will be more acute than ever, as DB obligations navigate to their many destinations,” said the white paper, which outlines strategies to address the four priorities in greater detail.

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