LAPP downside protection strategy saves almost $1.9 billion

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Businessman Protecting Coins With Umbrella © Andriy Popov / 123RF Stock PhotosThe volatility caused by the coronavirus pandemic made the first quarter of 2020 rough for many Canadian defined benefit pension plans.

In early June, the Local Authorities Pension Plan Corp., which is mandated to invest with the Alberta Investment Management Corp., said it began the year with $50.6 billion in assets under management and ended the first quarter with $47.2 billion. And, while an approximately 6.5 per cent reduction to the size of the fund is a hard hit, the results would have been much worse if it wasn’t for a downside protection strategy the LAPP initiated that reversed about four per cent of losses and saved the fund almost $1.9 billion.

The LAPP Corp. only became the legal trustee and administrator of the pension plan on March 1, 2019. Until then, the president of the Alberta Treasury Board and the province’s minister of finance was the plan’s legal trustee and administrator.

Following the change, the new sponsor board was given a two-year period to work on articulating its risk appetite and developing a new funding policy, says Chris Brown, the LAPP’s president and chief executive officer.

“As we worked on the work plan with that board it became clear that it was going to take some time, as you would expect, because that work would be quite foundational to then an asset-liability study for the plan and perhaps modifications of our investment policy. It also became clear that, in the context of where we were in 2019 — a decade or more into a long-standing bull market [with] the plan in very good health from a financial perspective — the risk to us, as we saw it, was something dramatic changing, which would then, potentially at least, take some options off the table for the sponsor board to consider as we looked at implementing that new funding policy.”

The LAPP’s goal was to provide time for the board to do that work without worry about the impact of a material market event on the plan’s assets limiting its options, so it decided to implement a downside protection strategy, Brown notes. “As we map out the funding policy for the plan — and potentially the future design of the plan, the future membership of the plan, because the sponsor board also has authority over the admission of new employers and members into the plan — we wanted to ensure that they had the ability to take the plan in whatever direction was open to them by virtue of the legislation, without being restricted by a severe market event.”

The global financial crisis of 2008/09 dramatically impacted the funding of the plan, he adds. “It put the plan in a significant underfunded position, like it did most defined benefit plans, and it took the plan basically a decade to begin to get back to full funding and to start bringing down those contribution rates that had to escalate quite dramatically after the financial crisis.”

To prevent another situation like the global financial crisis, the LAPP examined a number of options and worked with the AIMCo to implement the downside protection strategy at the beginning of 2020, just shortly before the market crashed due to the coronavirus. “We didn’t have a crystal ball, but some might say fortune favours the bold,” says Brown. “I think we say fortune favours the prepared.”

While the LAPP was about 119 per cent funded at the end of 2019, it was still 109.6 per cent funded at the end of the first quarter of 2020. “As we look forward, we are already considering whether we want this strategy, which is time-limited, to continue and what is the rationale for doing something like that?”

The original rationale was to ensure stability while other decisions were ongoing, he adds, but looking forward, it may make sense to continue to pursue the downside protection strategy. “It provides an opportunity to think about funding from a risk management perspective, which is an ongoing process for us, as it is for most plans.”

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