New Report from Cambridge Associates Encourages CFOs and Financial Executives to Consider Three Events on the Horizon that will Impact Future Pension Obligations
BOSTON (August 14, 2018) – Many US corporations have been taking steps to make big contributions to their pension plans and close funding gaps because of current tax advantages, which have a September 15, 2018, deadline. But investment firm Cambridge Associates cautions that a focus on this near-term opportunity should not cause plan sponsors to overlook the rising long-term challenges to funded status that lie ahead.
While the near-term result could be improved funded status for a given plan and company, it does not promise relaxed contribution obligations going forward. In a new report by Cambridge Associates, Time for a Reset? Rethinking Contributions Policy, the firm encourages chief financial officers and other financial executives to consider three events on the horizon which could increase many companies’ pension contribution obligations over the next five years: new mortality tables, the trailing off of regulatory funding relief programs for pensions, and the gradual depletion of many pensions’ ability to carry forward a “credit balance.”
“Even if a company has made a large pension contribution to maximize the tax benefits and realize significant cost savings, there’s likely no pension funding ‘vacation’ on tap. In fact, minimum contributions may rise over the next several years,” says Justin Teman, Senior Actuarial Investment Director and author of the report.
“Forward-looking corporate financial executives need to hone in on and assess a confluence of events that may increase pensions’ obligations in the not-too-distant future – and ensure that their pension teams have an investment strategy that helps protect any new funded status improvements they’ve achieved lately,” he added.
What’s on the Horizon
The Cambridge Associates paper illuminates three variables that, individually and combined, will have a meaningful impact.
- Mortality tables, the actuarial calculations of pensioners’ probable lifespans. The Internal Revenue Service has required updated mortality tables to be used in liability calculations. “The new requirement to use the updated tables will increase many pension plans’ liability and thus make required contributions higher,” Teman says.
- The erosion and eventual expiration of a federally sponsored pension funding relief. Multiple rounds of relief over the past decade have allowed pension sponsors to use artificially high interest rates to discount liabilities for contribution purposes, resulting in lower liabilities for a period of time. “This relief is going away slowly and will eventually end, so the liabilities that pensions are using for contribution calculations will gradually rise,” he says.
- The running out of many pension plans’ “credit balances,” the carry-forward of excess contributions made in previous years that have been applied to subsequent years’ obligations in lieu of actual contributions. Plans that are accustomed to using these credit balances will ultimately have to begin making actual contributions, according to Teman.
“While not every plan faces an uphill road when it comes to future contributions – some may even be over-funded for for years to come – these factors will have some effect on nearly every plan,” Teman says.
What Savvy Financial Executives Can Do Now
Rather than exclusively focusing on making extra contributions in advance of September 15, 2018, or neglecting to consider the pension in corporate financial planning, Cambridge Associates says that forward-thinking executives can take several important steps:
- Outline a realistic “forward picture” of future pension obligations, with the three near-term events – new mortality tables and the winding down of funding relief and credit balances – factored in.
- Evaluate and quantify the tradeoffs and advantages to the company balance sheet either by increasing contributions in the near-term or deploying the money for other purposes, like capital expenditure, debt reduction or stock repurchase. Some companies may find that increasing the funded level of their pensions is financially advantageous, partly because it reduces the expense of Pension Benefit Guaranty Corporation (PBGC) premiums.
- Establish (or revisit) a dynamic, diversified investment strategy that helps the plan allocate money, including new contributions, in the most advantageous way in the context of funded status and the plan’s “forward picture.” “If the plan has changed its funded status significantly, it must be focused on preserving those gains, as it would be problematic to lose those, say, in an equity sell-off,” he says.
“It’s a good idea to use the event of the extra contributions made in advance of the mid-September deadline for tax advantages to establish a dynamic contribution and investing roadmap, especially given the potentially mounting contribution requirements ahead,” Teman says.
Perhaps most important from a holistic risk management perspective: executives should consider how the strategic choices around contributions influence the future of the plan and play a role in managing pension risk among the other key levers at the executives’ disposal (asset returns, liability hedges, contribution policy, and benefit management). For more on balancing these levers for a most effective long-term pension risk strategy, read A Balancing Act: Strategies for Financial Executives in Managing Pension Risk.
Cambridge Associates brings over 40 years’ experience as a global pension investment manager, partnering with owners of complex asset and liability pools across the full pension investing life cycle, including enterprise review, investment policy creation, asset allocation strategy, glide path design, manager research, de-risking, and risk transfer. The global pension practice has published several resourceful reports for pension leaders and financial executives, including A Balancing Act, Thought Mortality Was Dead?, The Liability-Hedging Handbook, and more.
About Cambridge Associates
Cambridge Associates is a leading global investment firm. We aim to help endowments & foundations, pension plans, and private clients implement and manage custom investment portfolios that generate outperformance so they can maximize their impact on the world. Working alongside its early clients, among them leading university endowments, the firm pioneered the strategy of high-equity orientation and broad diversification, which since the 1980s has been a primary driver of performance for institutional investors. Cambridge Associates delivers a range of services, including outsourced CIO, non-discretionary portfolio management, and investment advisory services.
Cambridge Associates maintains offices in Boston; Arlington, VA; Beijing; Dallas; London; Menlo Park, CA; New York; San Francisco; Singapore; Sydney; and Toronto. Cambridge Associates consists of five global investment consulting affiliates that are all under common ownership and control. For more information, please visit www.cambridgeassociates.com.