Ask Our Expert gives you an opportunity to ask questions, get answers, and gain insights from our thought leaders on the latest trends in HR. We address a variety of strategic areas that impact employers and their employees around the world.
To answer these questions on pension investment and risk management, we've turned to our expert, Phil Kivarkis, a senior actuarial and investment consultant in Hewitt's Global Investment Practice. If you'd like to ask a question on pension investment or risk management, or any other pressing human resources challenges you might be facing, email us, and we'll share responses to selected questions on a regular basis.
The changing pension plan landscape has heightened the awareness of the financial impact pension plans have on the bottom line, and increased the need to control and manage risks. The ability of plan sponsors to take risks within the pension plan is often dictated by corporate preference, plan demographics, funded status, and size relative to the overall company — the larger the pension plan relative to the size of the corporation, the more significant of an impact the plan has on the overall financial health of the company. Given recent regulatory changes to the pension funding and accounting rules, which will increase annual cost volatility, now is the time for plan sponsors to evaluate the risks within their plans and to educate themselves on pension risk management solutions.
Ask Our Expert: Pension Investment and Risk Management
Question: Our company is looking into ways to control the risk associated with our pension plan. Where do we begin?
Answer: The first step in this process is a holistic evaluation of the risks inherent in the pension plan. We suggest a five-step approach to pension risk management: 1) Identify the goals and objectives for the plan; 2) Quantify the level of risk and the rewards associated with risks; 3) Act to implement the ideal risk management solution; 4) Review the plan and objectives periodically; and 5) Monitor the risk strategy on an ongoing basis.
Plan sponsors need to closely align the pension assets and liabilities to appropriately manage both cost and risk. There are many solutions available to help companies manage pension risks. Adjusting the pension investment strategy is commonly the simplest, most practical, and most cost-effective solution available.
Question: Our CFO asked the benefits committee to consider a Liability-Driven Investment (LDI) strategy for the pension plan in order to control pension risk. What is an LDI strategy, and what are the benefits of implementing such a strategy?
Answer: Interest rate risk hedging strategies, commonly referred to as liability-driven investing (LDI) strategies, focus on closely matching the asset and liability durations in order to manage the interest rate risk exposure (i.e., the asset-liability mismatch) of the pension plan. The investment risks and returns are measured in the context of the plan's funded status (i.e., the value of assets less the value of liabilities). The focus of the pension asset management becomes the volatility of funded status, which drives annual cost and balance sheet volatility.
LDI strategies can help remove annual cost and balance sheet volatility. We've assisted many clients in developing simple, yet very effective, LDI strategies which can minimize funded status volatility without sacrificing expected return, or adding to the annual cost.
Because the pension asset allocation drives a considerable level of pension risk, it's a critical part of the pension risk management strategy. As part of the risk management process, the plan sponsor should determine the most appropriate pension asset allocation, via a comprehensive pension asset-liability study, to evaluate the risk/reward characteristics of several portfolios within the context of the pension plan.
As a pension plan sponsor, you must determine which strategy is most appropriate for the company based on your specific situation — there is no one-size-fits-all solution. After you have implemented the right plan for your company, you will need to closely monitor your pension investment portfolio to ensure it continues to satisfy the goals and objectives of the fund and of your company.
For more information on pension investment and risk management services, click here.
To read our current research report on the evolution pension investment and risk management in the U.S., click here.
To listen to our Webcast titled "Managing Risk from Both Sides: Liability-Driven Investment (LDI) Strategies" featuring Hewitt investment consultants Phil Kivarkis and Bryan Ward, along with Rene Martel, VP and Product Manager for Liability-Driven Investments, PIMCO, click here.
About Our Expert
Phil Kivarkis is a senior investment and actuarial consultant and the director for U.S. Pension Asset-Liability Studies at Hewitt. He also serves as the actuarial expert and conducts capital market research for Hewitt Investment Group.
Phil has been with Hewitt since 1994. He is a Fellow of the Society of Actuaries, a Member of the American Academy of Actuaries, an Enrolled Actuary, and a CFA Level 3 candidate. Phil holds a BS degree in Actuarial Science from the University of Illinois. He has co-authored retirement reports and articles. Phil advised the Illinois Business Roundtable on the State of Illinois pension funding policy, and has been quoted as an actuarial expert by "Forbes on Fox," on the Fox News Channel.
