David Hagee Executive Vice President, Chief Investment Officer
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Key Highlights
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Pension plans serve as a cornerstone of retirement security, playing an indispensable role in providing income stability for retirees in their later years. However, the evolving economic landscape, shifting demographics, and inherent uncertainties of financial market dynamics pose significant challenges to the sustainability of U.S. pension systems.
A favorable confluence of factors — strong equity market performance, funding levels of many pension plans approaching 100%, and an easing interest rate environment — may allow pension plan providers the opportunity to strategically align their plan portfolios against future liabilities, thereby mitigating risk and possibly reducing the burden on corporate earnings.
Commerce Trust examines the current state of U.S. pensions and discusses strategies for mitigating the risks associated with these complex benefit offerings.
The complex pension landscape
U.S. pension systems are grappling with multiple challenges, driven by evolving demographics, economic volatility, and macroeconomic headwinds.
Aging populations, characterized by increased life expectancy and declining birth rates, are placing unprecedented strain on pension systems, particularly public defined benefit (DB) plans. The growing dependency ratio, where fewer workers support a larger retiree population, necessitates a critical re-evaluation of pension funding models.
Compounding these demographic pressures is the persistent issue of underfunding. Inadequate contributions, poor investment returns, and instances of financial mismanagement have left many DB plans with significant funding shortfalls. Public pension systems, in particular, often face budgetary constraints, raising concerns about their long-term solvency.
Furthermore, the inherent volatility of financial markets poses a significant threat to the stability of pension funds. Market downturns, such as the 2008 financial crisis and the more recent inflationary pressures, have severely impacted fund performance, eroding accumulated savings and jeopardizing retirement security.
The recent combination of elevated inflation and interest rates further exacerbates these challenges. High inflation erodes the purchasing power of fixed retirement incomes, diminishing their value over time. Conversely, low-interest rates constrain the investment returns of pension funds, making it difficult to generate sufficient returns to cover future liabilities.
These interconnected factors necessitate a comprehensive and multifaceted approach to address the challenges facing pension systems. Policymakers and pension fund managers must proactively adapt to these evolving realities to ensure the long-term sustainability and adequacy of retirement income for future generations.
Mitigating risks, ensuring security
Addressing the multifaceted challenges facing pension systems requires a practical and comprehensive approach among policymakers, employers, and participants.
Portfolio diversification: Implementing robust portfolio diversification strategies is crucial. By strategically allocating assets across a wide range of asset classes, sectors, and geographies, pension funds can mitigate exposure to market volatility and enhance overall risk-adjusted returns.
Gradual retirement age adjustments: Increasing retirement ages gradually can help address the growing longevity of the population. Aligning retirement ages with increased life expectancy can extend contribution periods, reduce the burden on pension systems, and help ensure the long-term sustainability of retirement benefits.
Immunization techniques: Employing sophisticated immunization techniques is essential to mitigate interest rate risk. By strategically matching the duration of assets with the timing of future liabilities, pension funds can safeguard against adverse interest rate movements and enhance the stability of their financial position.
Advanced analytics and modeling: Leveraging the power of advanced analytics is paramount for optimizing investment decisions. Asset-liability studies, sophisticated asset allocation models, and scenario analysis can provide valuable insights into potential risks and opportunities, enabling pension fund managers to make informed decisions that enhance portfolio performance and safeguard the long-term financial well-being of retirees.
Pensions play a critical role in ensuring the financial security and well-being of many retirees. Current market conditions provide a unique chance for pension plan providers to strategically realign their portfolios, helping to minimize risk and better ensure the long-term financial health of both the pension plans and their sponsors.
Commerce Trust provides institutional investment management and consulting services to nonprofit organizations, endowments and foundations, public and private pension funds, healthcare systems and corporations. With our comprehensive fiduciary approach and team-based service approach, we are well-positioned to understand new opportunities in an increasingly complex world so your organization can meet its long-term goals.
Learn more about how Commerce Trust can partner with your organization for its institutional investment management needs.
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Understanding pensions According to the Department of Labor, there were more than 801,000 pension plans with nearly 152 million total participants in the U.S. for plan year 2022.1 To understand the current landscape of U.S. corporate, multi-employer or union, and governmental pensions, it is crucial to differentiate between the two primary types of pension plans. Defined benefit (DB) plans. In a DB plan, the employer assumes the primary responsibility for providing a specified level of retirement income to employees. This benefit is typically calculated based on factors such as years of service and salary history. The employer bears the investment risk associated with managing the plan's assets. Defined contribution (DC) plans. Both the employer and the employee contribute to individual retirement accounts under a DC plan. The level of retirement income is linked to the amount contributed and the investment performance of the individual's account. The employee assumes the investment risk, while enjoying greater flexibility and portability in managing their retirement savings.
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For more than seven decades, Commerce Trust, a division of Commerce Bank, has served a diverse group of institutional clients through a variety of investment, financial and advisory services.
Non-depository investments offered in connection with Commerce Bank and its affiliates are not guaranteed, are not FDIC insured, and may lose value.
Information provided is effective as of December 30, 2024, is subject to change, and is presented for the purpose of general education, information, or illustration only, not to be considered as the opinion of Commerce Trust or Commerce Bank regarding any individual investment, investment account or market behavior. Neither Commerce nor any of its affiliates have made any recommendation or given any advice as to the terms, beneficial interests or profitability of any investment or market activity which may be referenced here, and this information may not be relied upon as such. Investors are always fully responsible for any investment transaction you choose to enter into, and you shall not rely only on the information presented from Commerce as a basis for investment decisions.
Commerce Trust is not a registered municipal advisor under Section 15B of the Securities Exchange Act and does not offer advice or recommendations concerning bond proceeds or other municipal advice subject to this section.
Commerce Trust does not provide legal advice to its customers.
Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.
