A new survey from Vanguard finds that sponsors of pension plans say they value lower-risk plans, but don’t always succeed in avoiding risk in their plan design. The report suggests that sponsors of plans may have trouble understanding the level of risk they are taking. The survey also found a continuation of the trend showing that pension plan sponsors are continuing to adjust their plans in ways designed to reduce liability and risk.

The new report is the fifth in a continuing series of surveys, going back to 2010. The survey included responses from decision-makers at 117 organizations that sponsor corporate pension plans. The report’s authors said that the information gathered represented a wide range of plans in terms of size, status, and plan design.
Risk averse—in theory more than in practice
The study’s most interesting finding is also one of the most consistent; according to Brett Dutton, head of investment strategy and analysis for nonprofit, pension, and insurance solutions at Vanguard, who said previous studies also found that pension plan sponsors say they are risk averse, but their plan designs include notably more risk than they say they are comfortable with.

“It’s been a consistent finding every year, and it consistently surprises us,” Dutton said. The survey this year showed that 91% of plan sponsors reported that their tolerance for an acceptable level of downside variation in funded status was 10% or less. And 46%–nearly half—said that only a downside variation of 5% or less was tolerable. But the amount of risk actually found in the plans was higher—11% or more downside variation for all but 9% of plan sponsors. “Our risk models show a downside variation in funded status significantly higher than the stated acceptable risk tolerance for the average pension plan,” the report said.
According to Dutton, the higher level of risk to these plans is not necessarily problematic. “There’s nothing wrong with maintaining a [higher] level of risk,” he said. “We’re not saying that amount of risk is wrong—it’s really just that there’s a gap between what a typical plan sponsor thinks they’re bearing in terms of risk, and what our findings indicate they are.” He added that the problem may simply be due to a lack of education with plan sponsors; they may not understand the potential risk their plans currently have.

Plan design and objectives
The new analysis noted that earlier surveys may have underestimated the number of open and active plans—plans that have no membership restrictions. In 2015 and 2018, the survey found that 30% and 33% of plans, respectively, were considered open and active. In 2022, the analysis showed that 51% of plans were open and active. The report noted that there likely was not actually an increase in open plans, but that the definitions and data were drawn more rigorously in 2022, causing the change.

Another interesting analysis of the report is that defined benefit pension plans may not be declining quite as much as some would expect. The report noted that there has been a trend in retirement investment toward defined contribution plans and away from defined benefit plans. Dutton said the leveling off of open plans suggests that there are “true believers” in the defined benefit model who may continue to use that approach into the future.

“Defined contribution is generally seen as a more portable benefit, and so in today’s workforce where a lot of individuals have numerous employers over the years, defined contribution seems to fit that better. But for organizations or industries where there is a prioritization of attracting and retaining individuals with specialized knowledge for a long career, that can be a case where a defined benefit plan provides some of that retention incentive,” he said.

The survey also found that nearly 80% of respondents said they intended to make a change to their pension plan. Dutton said that this indicates that plan sponsors are seeking to adjust the liability and risk in their pension plans, and added that again, there may be a benefit for plan sponsors to seek more education and assistance with such changes. For example, some plan sponsors purchase annuities for retirees, thinking that will reduce risk. Purchasing those annuities in effect puts the retired population in an insurance plan, reducing the size of the remaining pension plan. “But really they find that managing the plan after the annuity purchase is no easier and actually may be more challenging,” Dutton said. “The plan sponsor is left holding the bag with all the riskier portion of the plan population.”

A response to inflation and rising interest rates
The survey also showed signs that sponsors may be concerned about current economic trends such as rising inflation. For example, inflation was listed as an important risk concern by 33% of respondents in 2015, and by 39% of respondents in 2018. In 2022, however, that number jumped to 55%.

Dutton said that this may show plan sponsors reacting to the news of the day, when in fact inflation and higher interest rates are not necessarily a bad thing for pension plans. “For a lot of investors inflation has been all bad because equities are down, fixed income is down… but for pension sponsors it’s more of a mixed bag,” he said. “Certainly, rising and unexpected inflation has hurt the equity market, but it’s actually caused the increase in interest rates, and increases in interest rates generally help plan sponsors, it reduces the size of their liability.”

The report concluded by noting the growth in the use of outsourced chief investment officer (OCIO) services. “From 2015 to 2021, the global OCIO market nearly doubled,” the report said, “with defined benefit pension plans representing the largest share of the OCIO market.” In addition, the percentage of respondents in the Vanguard survey that used OCIO services increased from 33% in 2018 to 49% in 2022.

“Overall, these findings mirror our view that more and more plan sponsors are looking to cede direct control of their pension assets and partner with an expert to improve financial outcomes,” the report said.

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