The BCG Pension Insider
April 2023 – Volume 138, Edition 1
Spotlight Series – Q&A with Goldman Sachs Asset Management
Why Conditions Remain Ripe for Pension De-Risking
Goldman Sachs Asset Management
|Headquarters||New York, NY|
|Traditional AUS1,2||$2.3 trillion|
|Alternatives AUS1,2||$450 billion|
1 As of December 31, 2022
2 AUS represents Assets Under Supervision
Michael Moran, CFA
Managing Director, Asset Management – Client Solutions
Michael Moran is a pension strategist in Goldman Sachs Asset Management, where he produces thought leadership on issues pertaining to defined benefit, Taft-Hartley and defined contribution retirement plans. In this role, he advises clients on a wide range of topics related to asset allocation, pension risk management and the impact of regulatory and financial reporting changes.
Michael Moran can be contacted at Michael.Moran@gs.com
BCG: How does Goldman Sachs Asset Management work with US defined benefit pension plans?
Moran: We have a long history of working with US DB plans dating back to the 1980s. These engagements can take on several forms, including managing the entire portfolio in an Outsourced Chief Investment Officer (OCIO) capacity or through a single asset class. Across all investor types, we are one of the largest US OCIO providers as ranked by assets under supervision, and DB plans make up a substantial amount of that business for us. We are also a leading provider of Liability Driven Investment (LDI) strategies with $74 billion of assets under supervision globally (as of 12/31/2022). For pension plans that are still open or have a deficit they are looking to close, we work with them across both public and private market strategies to find innovative investment opportunities to help enhance the plan’s return profile.
In the current environment with interest rates and plan funded levels at their highest points in years, much of our conversations with clients today revolve around helping them think through various actions to reduce risk with their pension plans. This oftentimes involves implementing some sort of customized LDI strategy or helping them work through a pension risk transfer. Part of the reason our corporate DB OCIO business has grown so much in recent years is clients are looking for a partner to help them navigate this new phase of their plan’s life cycle.
BCG: Equity and fixed income markets have been quite volatile over the past year. How has this impacted corporate defined benefit pension plans?
Moran: Despite this volatility, corporate pension plans are at their highest funded levels since before the global financial crisis. The system ended 2022 fully funded and many individual plans are now significantly overfunded. While plan assets declined notably last year as both equity and fixed income valuations fell, plan liabilities fell even more, as rising interest rates allowed plans to use their highest discount rates in over ten years. Historically high inflation was a source of much angst for investors in 2022, but corporate plans benefited given the revaluation of their liabilities. In many ways, corporate plans have been waiting for the inflation we have seen.
BCG: Given this position of strength, what actions do you suggest plan sponsors consider in 2023?
Moran: We believe many plans should be actively looking to reduce risk given the dramatic rise in funded levels over the past two years. That could entail shifting asset allocation from equities to fixed income to better align plan assets with plan liabilities to reduce funded status volatility. It could involve a partial pension risk transfer, or a full plan termination whereby pension obligations are offloaded to an insurance company through the purchase of a group annuity contract. Sponsors should be thinking about what an appropriate “end state” portfolio may look like for their plans given their unique circumstances, profiles and goals.
We are at an important inflection point. The key is that sponsors should be considering all this right now. Funded levels have moved significantly higher, and sponsors will want to take action within their asset allocation to protect those gains. In addition, the pool of insurers engaged in pension risk transfer has grown in recent years leading to a robust and competitive market and providing an opportunity to potentially shed risk. This is not the time for sponsors to be lulled into complacency by their well-funded or overfunded pension plans. They should be taking actions because their plans are well-funded or overfunded.
BCG: You discuss potentially increasing the allocation in pension portfolios to fixed income, but some sponsors may be hesitant to commit more to that asset class today when inflation is still running above historical levels. How do you respond to that?
Moran: This is not about making a call on interest rates or inflation or equities. Rather, it is about prudent risk management. A significant risk plan sponsors face is a fall in interest rates given that pension obligations rise when rates decline. The rise in rates means the risk of whether they will move higher or lower in the future is now more symmetrical than it has been in many years.
The key metric for plan sponsors isn’t the level of interest rates or inflation, it’s plan funded status. As funded status moves higher, sponsors should consider actions to protect those levels. Increasing the allocation to fixed income provides a matching of plan assets with plan liabilities. As we saw recently in the regional banking crisis, an asset liability mismatch can be a real and painful risk.
BCG: A way to not only reduce risk but remove risk is through a pension risk transfer that you highlighted earlier. What is your outlook for that market in 2023?
Moran: We saw a record amount of pension risk transfer activity in 2022 and we expect 2023 to be another active year, especially if interest rates and funded levels remain elevated. These transactions can oftentimes take 6 to 12 months from beginning to end. Given the rise in funded levels over the past 2 years, some sponsors kicked off a process in 2022 or early 2023. Many of those transactions will close before the end of this year.
There continues to be several factors leading sponsors to undertake either a partial pension risk transfer or a full plan termination. A desire to reduce financial risk given the negative ramifications funded status volatility can have on a sponsor’s balance sheet, income statement and cash flow is usually one of the driving factors. But there is also usually a desire to reduce the costs associated with maintaining the plan, in particular premiums paid to the Pension Benefit Guaranty Corporation.
Finally, some sponsors that have closed or frozen their plan view their pension obligations as a “legacy liability” and not something they want to devote substantial internal resources to manage. Reducing the liability through a pension risk transfer allows the sponsor to focus more on running their core business.
BCG: What are the potential downsides or other considerations that sponsors need to take into account with pension risk transfer?
Moran: If a plan has unrecognized actuarial losses, which is the case for most plans today, some or all of those losses may need to be recognized immediately through the income statement as part of settlement accounting. The need to crystalize some of these deferred losses through the income statement and earnings per share may be a non-starter for some sponsors.
When effectuating a transaction, a premium above the carrying amount of the liabilities to be transferred may need to be paid to the insurer. While retirees can often be annuitized at or close to the accounting carrying value, transferring other cohorts may require a not insignificant premium to be paid to the insurer. This could, at times, require the sponsor to make a contribution to the plan as part of the transaction.
Also, as mentioned earlier, these transactions can take many months to complete which can be a drain on management’s time. If it is not a complete plan termination, the remaining plan will look much different, often with a longer liability duration. This may necessitate a new investment strategy for the remaining plan. All of this may take management away from spending time on managing its core business.
BCG: How may a plan’s current asset allocation play into any pension risk transfer?
Moran: For larger transactions, many sponsors will pay for the annuity with an in-kind transfer of existing assets from the plan. Given the fixed-income-heavy focus of insurer portfolios, it is not surprising that they often will look for those assets as part of any in-kind transfer. This is yet another reason for sponsors to consider augmenting their allocation to this asset class.
Some DB plans have increased their allocation to alternative asset classes in recent years, such as private equity, hedge funds and real estate. That has, at times, and may continue to, complicate the pension risk transfer process since these assets cannot necessarily be easily liquidated and insurers likely will have limited or no appetite for those assets as part of the transaction. Or, if an insurer is willing to accept these assets, it will likely come at a heavily discounted valuation. As asset allocations have become more sophisticated, so must the solutions when faced with a more complicated in-kind transfer. When it comes to a plan termination, we believe addressing alternative assets early into, or preferably before even starting, the termination process can be critical to ensure a satisfactory outcome.
BCG: So in practice, how do you see sponsors evaluating all of these different alternatives with respect to pension plan risk management?
Moran: Many plans look at this through an economic lens and evaluate what is the most cost-effective way to defease the liability. The range of potential de-risking approaches spans from hibernation or “self-sufficiency” at one end to complete plan termination at the other and a mix of strategies in between.
An important part of this process is getting an independent, objective assessment on the course of action. It’s important that sponsors receive guidance that takes into account the specific goals and objectives of its organization. That guidance should also incorporate views on the overall pension risk transfer market, such as whether there is an optimal time in the year to transact given other activity. The decision to work with an unbiased adviser as the sponsor considers various alternatives can be critical to helping to ensure a positive outcome.
About BCG Pension Risk Consultants | BCG Penbridge (“BCG”)
BCG specializes in assisting defined benefit plan sponsors with managing the costs and risks associated with their pension plans. Since 1983, BCG has successfully helped over 2,500 organizations achieve their pension de-risking goals.
ANNUITY PURCHASE RATES
Sample Interest Rates for a Pension Annuity Buyout
(Assumes no lump sums, disability, or unusual provisions)
Retirees (duration of 7) – 4.52%
Term Vesteds (duration of 10) – 4.52%
Actives (duration of 15) – 4.45%
Annuity Purchase Rates as of April 1, 2023