The cataclysmic economic impact of the COVID-19 pandemic has been well documented globally, with disruptions triggering record unemployment in India. With a surge of new cases upon us and new lockdowns announced, the economic impact of the pandemic is still being realized. Apart from changing our approach to managing issues of public health, the pandemic has also reshaped how employees approach their personal finances and savings. India does not have a universal social security system, so the responsibility rests on individuals. Increase in participation of private pension plans would improve adequacy of the Indian pension system.

 

But for employers with defined benefit plans, market volatility and the proposed regulatory changes hold the potential to be particularly disruptive and there are a host of added considerations. From an employer sponsored plans perspective, with the rules for the new labor codes likely to be notified in the next few months, one would expect a material increase in the Gratuity liability for organizations in India. Organizations must consider how these shifts fit into their retirement benefits packages and evaluate respective costs in both the near- and long-term, making accommodations to ensure their plans remain adequately funded in a marketplace that is significantly changing. 

Unprecedented market volatility

Any organization overseeing a defined benefits pension plan today faces mounting risks and fast-changing realities marked by market volatility, fluctuating interest rates, uncertain liabilities, new regulations and immense pressure to reduce expenses and contributions.

 

To stay ahead of these realities and succeed in balancing assets and liabilities in the long-term, organizations must adopt an agile strategy and implement processes that can dynamically respond to long term market conditions – while mitigating risk exposure and staying ahead of emerging opportunities. At Mercer, we take a scientific and holistic approach to helping clients effectively manage the investments of a defined benefit plan. Our forecasting model is stochastic, predicting based on thousands of points in time and variables to provide a more comprehensive, accurate vantage point. 

Liability-side analysis

By applying actuarial principles, we are able to project an organization’s defined benefit obligations over a pre-decided time period. This time period will be for the next 10 years. We predict the yearly payout totals during this period, taking into account a number of factors: the remaining service life of employees, assumed salary increases, employee turnover, and anticipated mortalities. The forecast also gains a clearer view into the organization’s liability landscape by comparing the pension plan’s liabilities to its assets, looking at service costs, interest costs, actuarial gains or losses and, of course, the benefits paid out. 

Asset-side analysis

The next component of our study looks at the define benefit plan’s assets, formulating assumptions based on the investments including asset classes, volatility on asset classes and return correlation between asset classes. Using the upheld risk-analysis Monte-Carlo simulation method, we are able to explain the impact of risk, identify uncertainty and project asset values under different asset-allocations. By running this test over the pre-decided time period, we estimate the gap between the asset and the organization’s defined benefit obligation. After considering the organization’s funding policy under different asset-allocations, we can then project the funding requirement over time.

 

One of the benefits of this analysis is that it assesses optimality of the existing asset-allocation, taking into account the projected funding and funding volatility. Furthermore, it assesses optimality of potential asset -allocations based on projected funding and funding volatility. In the end, we help our clients arrive at an asset-allocation that minimizes long-term funding and optimizes funding volatility. 

Actionable outcomes

When our comprehensive, scientific liability-asset study is conducted, we can aid clients in selecting an asset-allocation that optimizes long-term returns and provides a predictable stream of funding to the defined benefit plan. Not only does this represent potential cost savings to the organization, it aids decision-making on determining the targeted funding ratio and drafting or editing an investment policy. The end result is a more balanced view of assets against liabilities coupled with enhanced governance measures. 

Looking ahead

Growth in assets relative to liabilities is the key function for helping defined benefit pension plans meet their final obligations and funding objectives. But the seismic changes amid ongoing pandemic disruptions, economic rebound, interest rate fluctuations, new pension age regulations and other forces will continue to disrupt how organizations in India fund their plans and seize emerging opportunities.

 

Now more than ever, employers with defined benefit plans must conduct a comprehensive analysis of their liabilities and assets. When we work with a client to help them manage their defined benefit plans, we offer advice and innovation solutions driven by an integrated interdisciplinary team of dedicated specialists.

 

With each organization’s study being customized based on the factors that impact them, our scientific approach allows decision-makers to make informed choices in renewing or expanding their defined benefit plans. With a strategy tailored to meet their liability profile and fulfill their risk appetite, organizations are in a better position to optimize long-term returns while reducing their contributions in the long run.

Preeti Chandrashekhar, FIAI
India Business Leader — Health and Wealth Mercer India

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