Apr 29, 2014, 10:33 PM ETConference Presentation, Panel

Pension Funds and the Economics of Retirement: Demographics Drive Evolution

2013 Funding Recovery: The funded status of defined benefit (DB) plans improved significantly in 2013, with Towers Watson reporting an increase from 77% to 93% for Fortune 1000 companies and the Milliman 100 Pension Funding Index reaching 95.2%.
Scope of DB Coverage: Approximately 75 million Americans participate in DB plans, with about 15 million in the private sector across 23,000 distinct plans; roughly two-thirds of these plans are active (accruing benefits) rather than frozen.
Regional Strength: Despite narratives of decline, DB plans remain thriving in corporate America, the UK public sector, Canada, the Netherlands, and Japan.
Ontario Teachers' Scale: The Ontario Teachers' Pension Plan manages a $140 billion pool for 300,000 participants and is currently fully funded.
UPS Plan Health: UPS manages a $27 billion plan with a young demographic; liability payouts are projected to peak in 2033–2034, allowing a long investment horizon.

Volatility Drivers: The primary risk to corporate pension solvency is the combination of declining asset values and declining interest rates (as seen in 2008), rather than the reverse scenario.
Accounting Pressures: Financial reporting volatility creates pressure on CFOs and CEOs to fund minimum thresholds to avoid punitive PBGC premiums and balance sheet hits.
Tax Incentives: Private sector employees cannot make tax-deferred contributions to DB plans, whereas DC contributions are tax-deferred; this tax inefficiency incentivizes employers to switch to DC models to share costs with employees.
Hybrid Models: About 40% of private sector DB plans are hybrid, offering variable benefits tied to market performance while maintaining a minimum guarantee.
Inter-generational Fairness: There is a risk that current workers must disproportionately fund benefits for retirees if longevity increases without plan design adjustments; Ontario Teachers addressed this by introducing conditional inflation protection and flexible contribution rates (currently 12% employee match).

Return Targets: UPS targets an 8.75% annual absolute return; Ontario Teachers aims for superior returns via heavy allocation to alternatives to reduce reliance on contribution rates.
Asset Allocation Mixes:
- Ontario Teachers: Maintains a high allocation to alternatives ($17B private equity, $12B infrastructure, $23B real estate) and invests 100% of real estate and infrastructure directly rather than through third parties.
- UPS: Allocates 43% to public equity, 30% to bonds, and ~25% to alternatives (including liquid alternatives and opportunistic strategies) to achieve risk-efficient absolute returns.
Direct Investment Governance: Ontario Teachers operates a "Canadian model" where the professional board, separate from sponsors, directs investment; this requires high governance standards and competitive compensation to attract direct investment talent.
De-risking Trade-offs: Transferring risk to insurers (annuities) or using Liability-Driven Investment (LDI) strategies increases administrative and management costs by approximately 15% compared to self-managing assets.
Societal Capital Formation: DB funds act as informed sources of capital for early-stage ventures (e.g., KKR) and infrastructure that public markets and hedge funds may not initially support.

Longevity Risk: Individuals in DC plans often underestimate longevity, leading to under-savings; DB plans mitigate this through "longevity pooling" over large populations.
Aging Workforce: Ontario Teachers' ratio of workers to retirees has shifted from 10:1 to 1.8:1 due to the education boom of the Baby Boomer generation, necessitating plan design flexibility.
Employee Valuation: A "Well-Being Index" survey indicates employees value DB plans significantly less than health insurance or 401(k)s, partly because younger workers prioritize portability over lifetime income.
Inflation Vulnerability: Without explicit cost-of-living adjustments, rising inflation poses a significant threat to the real value of DB benefits, a risk highlighted by potential government debt monetization strategies.
Future Flexibility: Panelists anticipate a "barbell" retirement system where DB plans serve those seeking security for long tenures, while DC plans dominate for those with fluid career paths.

PBGC Incentives: Current PBGC regulations may inadvertently encourage employers to exit DB plans; the cost of buying an annuity for a lump sum is estimated to be 15% higher in present value than the lump sum payout provided to employees.
Moral Hazard: While theoretical moral hazard exists regarding the federal insurance safety net (PBGC), practical instances are limited to bankruptcies where companies exhaust legal protections.
Policy Recommendations: Panelists suggest that regulatory changes should facilitate easier annuity purchases within DC plans and allow for cost-sharing in DB plans to improve tax efficiency and retention.