David Finn explores how multinational companies manage their pension risks

Multinational companies are exposed to a series of financial risks from their DB pension plans around the world. In an era when financial resources are limited and with a focus on immediate results, there is pressure to proactively control pension cost and volatility. Historically, a decentralised approach was taken where pension management was left to local country businesses without much engagement from the parent company. Increasingly, global HQs are now adopting a range of globally consistent monitoring and management techniques.

Drivers for change

Many global companies are seeking to manage risk across all aspects of their organisations through centralised systems. There are significant, additional external factors which have led companies to develop a strong global pension risk management framework:

- The pain caused by recent market conditions and its impact on pension plan financing mean that multinational companies have developed a better understanding of the global pension risks they face and are resolving to take actions to mitigate against future issues.

- Recent low interest rates around the world (in some cases negative) are driving pension liabilities to record highs while long term future returns on assets are widely expected to be modest.

- Changes to accounting standards mean that there is increased volatility in pension disclosures and less justification for companies to invest in return-seeking assets.

- Increasing life expectancy has seen changes to assumptions for global plans but the pace of change and assumptions vary significantly highlighting the inconsistencies of the historical approach of managing pension risk by country.

What are companies doing?

Where multinational companies are responsible for pension plan financing in a number of countries, it makes sense to consider risk on a global basis incorporating local constraints into the strategy. Global pension frameworks help scarce management resource address the challenges of complex pension arrangements in multiple countries. The steps typically involved are to:

- Understand the sources and levels of pension risk so that the level of tolerance to volatility and their impact on business metrics can be established.

- Develop a long-term management strategy including a funding policy and agreement of the solutions to be adopted.

- Set priority actions and countries in which to implement them. Companies then monitor the strategy’s success and refine as necessary.

Multinational companies’ pension risk management solutions tend to fall into three categories:

Contain – redesign or ceasing provision of DB pensions

Hedge – adopt investment strategies where assets will behave in a similar way to liabilities for example, liability driven investment (LDI).

Shrink – actions to reduce DB obligations through insurance products such as annuities and via lump sum offer initiatives. Increasing transactions in the US and the development of the Canadian annuity market is prompting speculation that this will become a global solution.

The future

In general, companies will continue to demand more pension-related information from their plans, develop their understanding of DB pension risk and proactively find solutions as opportunities arise in different countries. More sophisticated companies, where management resource and expertise is available, may further centralise the management of global pension plans.

Some companies may consider global asset pools where local trustees and fiduciaries decide on invest-ment strategies and then invest in central funds established by the parent company. This is likely to be most viable where assets are very substantial although some financial service providers are developing prod-ucts for medium-sized multinational companies. This concept could evolve further resulting in the reinsurance of pension plans to the multinational’s captive insurer combining DB pension assets and liabilities from different companies.

By considering the aggregate global position multinational companies are able to make optimal allocation of limited risk budgets and use local opportunities that fit their overall desired position.

David Finn is senior consultant, international consulting group, Towers Watson

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