TORONTO — A new survey released by Hewitt Associates, a global human resources consulting and outsourcing company, reveals that many companies around the world have not taken adequate measures to guard against defined benefit (DB) pension risk. Even in the face of weak economic conditions and poor market returns, most companies have taken only small and conservative steps to risk management. The issue is particularly pressing in Canada, which survey results indicate has the highest proportion of DB plans open to new entrants, as compared to companies from other countries responding to the survey.

Since the start of the credit crunch in the last quarter of 2007, pension plan assets on a global level have plummeted by US$4 trillion. Against this background, Hewitt conducted a survey of 171 plan sponsors in 12 countries in summer 2008 to determine their approaches and attitudes to managing pension risk.

"The current financial environment underscores the need for organizations to manage retirement risk in the same way they handle general business risk—by determining their risk tolerance and being vigilant," said Rob Vandersanden, a senior pension consultant in Hewitt's Calgary office. "We're not advocating that companies eliminate risk entirely—that would minimize investment returns—but we do recommend that they understand the risk they've assumed and ensure it is appropriate for the return it is likely to generate."

In terms of the factors that influence a company's attitude towards managing pension risk, accounting issues dominate globally, principally in terms of the impact on the profit and loss statement. Canadian organizations, due to differences in accounting standards between Canada and the rest of the world and our solvency funding regime, are more concerned with cash funding requirements.

The impact on a plan sponsor's financial resources is so significant that organizations, particularly in Canada, are moving pensions out of the realm of human resources and under the management of their finance teams.

Strategy versus Knee-Jerk Reaction

Survey respondents were asked about the measures they use to quantify their risk exposure and how frequently they measure risk:

• Pension risk is still typically looked at in isolation, with nearly half of responses supporting this view. Around one in six respondents indicated that pension risk is considered in the context of their overall enterprise risk budget.
• Over one half of participants use asset liability modeling to determine their pension risk. In addition, one third also look at numerical values for pension risk drawn from deterministic shocks (e.g., a 20 per cent fall in equities) and another one third use a Value at Risk metric on a local or global basis.
• Surprisingly, one third of Canadian participants say they have no formal quantified measure of their pension risk.
• The most typical risk monitoring pattern for Canadian organizations is a quarterly update on asset values (45 per cent of respondents), but an annual update of liability values, and risk measures (45 per cent of Canadian respondents) is also common. However, the frequency of risk monitoring may have increased in recent months with higher market volatility.

Despite the fact that companies may not have a good idea of their risk tolerance or a timely indication of their risk exposure, some are taking steps to minimize risk, primarily with respect to their investment portfolios. They are moving away from conventional holdings of equities towards more liability matching solutions and alternative investments, such as real estate, hedge funds, commodities, private equity and infrastructure.

"Taking early action to move to more secure, lower-risk investments makes sense when markets are volatile," said Vandersanden. "However, ideally an organization would want to change strategy only after it had identified its particular comfort level with risk and quantified its current risk against its identified risk tolerance. At that point, it could examine its options to ensure that any changes made will achieve the balance between risk and return that it deems acceptable. The key is to avoid making any hasty short-term decisions before considering long-term repercussions."

Canadian DB Plan Sponsors Not Prepared

It is still early days for pension risk management in Canada—although plan sponsors in this country recognize the opportunity to learn from experiences in the U.K. Nearly 40 per cent of Canadian plans have no policy for dealing with their interest rate and inflation exposures, despite the fact that they rate interest rate risk as the biggest component of their overall risk budget.

Consequently, Canadian plan sponsors do not appear to be fully prepared to act quickly when market conditions present themselves that could allow them to reduce risk.

A more disciplined approach to pension risk management not only helps to minimize the impact on the company's bottom line, it means employees can rest easy that liabilities are not going to sink the pension plan and their retirement income is safe. Hewitt recommends that plans take the following actions to handle pension risk effectively:

• Consider whether pension risk should become part of an overall risk management framework.
• Rather than relying on asset-liability studies or scenario testing to measure pension risk, use Value at Risk measures and metrics that break out risk factors separately, such as mortality, currency fluctuations, interest rates and equity returns, in order to have better risk control.
• Identify and measure risk exposures within agreed corporate risk tolerances—and then reassess them frequently.
• Multinational organizations should consider consistent approaches globally, especially with respect to pension risk measurement.
• Do not lose sight of the other aspects of pension risk beyond the financial considerations.  Pension plans should still meet strategic talent needs, and should still have clear governance guidelines and reporting, while the need to monitor regulatory changes and local plan compliance is greater than ever.

About Hewitt Associates

For more than 65 years, Hewitt Associates (NYSE: HEW) has provided clients with best-in-class human resources consulting and outsourcing services. Hewitt consults with more than 3,000 large and mid-size companies around the globe to develop and implement HR business strategies covering retirement, financial and health management; compensation and total rewards; and performance, talent and change management. As a market leader in benefits administration, Hewitt delivers health care and retirement programs to millions of participants and retirees, on behalf of more than 300 organizations worldwide. In addition, more than 30 clients rely on Hewitt to provide a broader range of human resources business process outsourcing services to nearly a million client employees. Located in 33 countries, including Canadian offices in Toronto, Montreal, Vancouver, Calgary and Regina, Hewitt employs approximately 23,000 associates. For more information, please visit www.hewitt.com.