WHAT A DIFFERENCE A YEAR MAKES: MARKET VOLATILITY LEADS TO BROADENED VIEW OF U.S. PENSION RISKS, ACCORDING TO METLIFE STUDY

WHAT A DIFFERENCE A YEAR MAKES: MARKET VOLATILITY LEADS TO BROADENED VIEW OF U.S. PENSION RISKS, ACCORDING TO METLIFE STUDY

New York, NY, February 23, 2010

What a difference a year makes. Against the backdrop of one of the most volatile market environments in recent memory, risk management priorities for the largest U.S. defined benefit (DB) pension plans have expanded significantly in the last twelve months. According to MetLife’s second annual U.S. Pension Risk Behavior Index Study^SM, a survey of 166 corporate plan sponsors from among the 1,000 largest U.S. defined benefit (DB) pension plans, plan sponsors are now taking a much broader view of the 18 investment, liability and business risks to which their plans are exposed. As a result, most plan sponsors believe that they’re doing a better job implementing risk management measures this year than they did last. Despite a broadened view and greater self-ascribed success, the gap between the risk factors plan sponsors identify as “important” — and their reported “success” at managing those risk factors — has widened considerably.

Greater Attention Paid to Liability-Related Risks
With a broader view of pension plan risk, plan sponsors are no longer largely concentrating on the asset side of the asset-liability equation — a major change from 2009. In this uncertain market environment, liability-related risks — which were all but ignored just one year ago — have taken on much greater importance.  This year, Liability Measurement (routinely reviewing liability valuations and understanding the drivers that contribute to plan liabilities) and the Underfunding of Liabilities (designing and executing investment strategies to comfortably manage funding contribution levels) are the two risk factors identified by plan sponsors as being the most important, up from numbers six and three, respectively, last year.  At the same time, Asset Allocation and Meeting Return Goals, which occupied the two top spots in 2009, moved down in the importance rankings.  In 2010, Asset Allocation dropped to number four, and Meeting Return Goals dropped significantly to 14.

Other liability-related risks, which were deemed relatively unimportant in 2009, also climbed in importance this year. Last year, plan sponsors believed that Early Retirement Risk, Mortality Risk and Longevity Riskwere relatively insignificant risks. However, Longevity Risk and Early Retirement Risk are now both ranked tenth in importance, up year-over-year from 16 and 18, respectively.

“When we examined the year-over-year changes in the ways in which plan sponsors think about and manage pension plan risks, plan sponsors are becoming much more ‘liability aware,’ as we predicted in last year’s study,” said Cynthia Mallett, vice president, Product and Market Strategies, in MetLife’s Corporate Benefits Funding group, who oversaw the study. “While clearly this shift in focus was spurred by the market environment, it also may signal an acknowledgement that traditional methods of mitigating risk by diversifying the investment portfolio may no longer be viable as a sole or primary means of pension risk management.”

Plan Governance Gains in Importance
This year’s U.S. Pension Risk Behavior Index Study^SM found that as plan sponsors’ priorities shift, so do their risk management and risk mitigation needs. In the face of rapid external changes brought about by economic turmoil, Plan Governance has moved up in importance from the ninth-ranked risk factor in 2009 to the third-ranked risk factor in 2010. Advisor Risk and Inappropriate Trading have also increased in importance in 2010.

The “Democratization” of Risk Factors
Between 2009 and 2010, the differential between the risk factors selected as “most” and “least important” narrowed substantially, pointing to a “democratization” of risk factors. According to the study, the range between the “most” and “least important” risk factors was just 8% in 2010 — compared to 51.5% in 2009.

Plan sponsors deemed nearly all 18 risk factors as somewhat important in the most recent study. This year’s top risk factors include Liability Measurement (selected 29% of the time), Underfunding of Liabilities(selected 28% of the time), Plan Governance (selected 28% of the time) and Asset Allocation (selected 27% of the time).

With Broader Attention Comes Greater Perceived Success
In addition to measuring the importance ascribed by plan sponsors to each of the 18 risk factors, the U.S. Pension Risk Behavior IndexSM tracks how successfully plan sponsors believe they are managing these risks. Despite a difficult year due to the uncertainty of the market, plan sponsors report they’re doing a better job implementing risk management measures this year than they did last. In fact, year-over-year, their self-ascribed success rating increased for 14 of the 18 risk factors, it decreased for three risk factors and remained unchanged for one risk factor.

“As the challenging market environment compels sponsors to sharpen their focus on risk management, many believe their performance has improved,” added Mallett. “However, in this case, this perception may be driven more by expanded engagement than it is by reality in practice. In fact, the gap between the risk factors that plan sponsors report as ‘important,’ and their ‘success’ at managing those risk factors, has actually widened considerably.”

Gap Between Importance and Success Widens
To compare importance and success, three different statistical measurements are used to determine the consistency with which individual respondents are successfully managing the risks to which they give the greatest attention. Across all three measures of consistency that are part of the study’s analysis, there is less consistency between ‘importance’ and ‘success’ measures in 2010 than there was in 2009. In fact, in 2010 just 15% of plan sponsors surveyed passed all three consistency ratings, while more than double (31%) passed all three tests in 2009 — suggesting that the Importance dimension has developed more quickly than the Success dimension.

“Holistic” Approach Does Not Mean “One-Size-Fits-All
This year’s study underscores the need for new tools and strategies to help plan sponsors manage and mitigate a broader range of risks, especially liability-related risks, which many may not have paid as much attention to in the past. Over the next 12 to 24 months, MetLife expects the industry to develop new practices and tools to monitor and successfully manage these risks.

“While engagement doesn’t necessarily translate into success, we’re encouraged by the fact that plan sponsors are taking steps to control and prepare for the risk their plans face,” said Duane Bollert, head of MetLife’s U.S. Pensions business. “While certain risks will remain more important than others, it’s critical that plan sponsors develop a risk management plan that fits their individual organization and pension plan.”

It’s also important to note that a “holistic” approach to pension risk management does not mean “one-size-fits-all.” How firms implement risk practices and tools — and the actions they take — will remain largely firm-specific.

U.S. Pension Risk Behavior Index^SM Value: A Slight Decline Year-Over-Year
The second annual value of the U.S. Pension Risk Behavior IndexSM is 79 out of 100, roughly on par with last year’s score.¹ The Index calibrates the importance that the plan sponsors surveyed ascribed to each risk, their success at implementing comprehensive practices to manage each risk and the consistencybetween the two, effectively measuring both attitudes toward, and aptitude for, managing pension plan risks.

“This year’s Index value is consistent with broader awareness preceding effectiveness, which at this point, is to be expected,” said Mallett. “One of the major implications of the 2010 study appears to be that, while plan sponsors are viewing risk more holistically, implementing the management of all of these risks is a work in progress.”

Several factors might contribute to uneven implementation: first, it takes time to move to action once a new risk has been identified as meaningful; second, the sheer number of risk factors has been too challenging to manage given the economic environment; or third, more time is needed to become proficient at managing newly identified risks.

“As the markets recover and plan sponsors become more confident in their ability to assess the expanded range of potential risks, we expect to see the pendulum move back toward the center, where sponsors differentiate among risks to a greater degree and become better able to address these core risks. We also think it’s likely that a balanced view of asset and liability related risks will become common to most sponsors,” concluded Mallett.