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Special Report: How to Ensure a Smooth Pension Risk Transfer

Without thoughtful preparation, offloading liabilities can be a costly and time-consuming endeavor. 

By Sarah Min


For employers, the number of reasons they should consider offloading some or all of their pension liabilities from their balance sheets seems to be growing every year. On average, beneficiaries are expected to live longer than they have in the past; generating returns to cover liabilities is becoming more challenging in a low interest rate environment; and premiums for the Pension Benefit Guaranty Corporation (PBGC) keep rising. 

Already, many plan sponsors are expected to power through deals this year. After the pandemic dampened deal flow for the first part of last year, the market is expected to continue its “steady upward trend,” according to Willis Towers Watson. 

Pension risk transfers (PRTs) can be straightforward for plan sponsors. But without careful preparation, offloading liabilities can be costly and overlong endeavors for employers. To make these deals attractive to insurers from the start, plan sponsors should get a couple things in their house in order.

Here are five things investors should consider before moving forward:

Understand Your Transaction 

Asset owners planning pension risk transfers will want to figure out what’s feasible for their plan. Should they move forward with a buyout or a buy-in (closing the plan after transferring the liabilities to an insurer or maintaining administrative control of the plan)? Do they have the resources to fund a full plan termination? Or should they start with lift-outs (annuitizing just a subset of the plan participants)? Should they offer participants a lump sum to lower the number of beneficiaries in a plan?

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A full plan termination would take more than a full year to complete. Plan sponsors need time to immunize and fully de-risk investment portfolios, as well as file forms with regulators such as the PBGC and the IRS. At the same time, insurers have to calculate the cost of future payouts to all beneficiaries under the plan, including retirees and current workers.

On the other hand, retiree lift-outs, which only siphon off a portion of pensioners, are fairly easy for employers to execute and can be completed in a matter of months or weeks, according to Legal & General Retirement America (LGRA). The speed can be attractive to some plan sponsors. In the third quarter of last year, nearly two-thirds of the pension risk transfer market was driven by retiree lift-outs, given that employers wanted to offload at least a portion of their liabilities quickly. 

Ready Your Data 

Asset owners who want a fair price from insurers will want to pass on as much information on their defined benefit (DB) plans as possible. The insurers that are underwriting liabilities will want a robust understanding of life expectancy for the underlying population, whether it skews female or male, blue collar or white collar, and so on. 

Readying the data gets more complicated if the transaction involves a lift-out of a specific demographic. Plan sponsors planning to hand over liabilities for older workers, for example, will have to develop more granular data, instead of handing over historic mortality tables for the total DB plan. Any incomplete or inaccurate data will only delay the transfer. 

“The more you get it into subgroups, the more you need to understand what’s there,” said Kevin McLaughlin, head of liability risk management at Insight Investment. 

Some Fiduciary Concerns  

As fiduciaries, employers are also required to do their due diligence and to choose the safest available annuity provider, as determined by the Department of Labor (DOL). Plan sponsors should seek insurers with well-diversified investment portfolios, as well as review the insurers’ capital, surplus, and lines of business, as outlined by the DOL 95-1. 

Employers should also seek additional protections for their liabilities. Like the PBGC, many state governments can also guarantee pension liabilities. Employers can also seek annuity contracts with greater protections, such as through separate account structures, which are often used for larger deals. 

In the event of a lift-out or buyout, versus a full termination, plan sponsors also have the fiduciary duty to review the impact any PRT will have on the remaining participants, according to McLaughlin. One way to ensure that the residual plan participants are not disadvantaged by the restructuring of the DB plan is to make sure the funded status is no worse after the transaction, which usually requires the employer to top off any shortfall. 

Risk Management 

Insurers also price transfers based on the quality of the assets with the DB portfolio. They typically prefer portfolios with more liquid assets, such as corporate bonds, Treasurys, and cash, versus more complex instruments. Asset owners should move early if they’re planning on starting a pension risk transfer to make it an easy process. 

“The more time you have to do a risk transfer in one to three years, to start working on the portfolios and removing any of these more complicated or esoteric features that are unlikely to transfer to an insurance,” the better, McLaughlin said. 

Communicate with Your Members 

Ultimately, any news of the pension risk transfer will be most significant to the plan participants or retirees who fall under it. Plan sponsors should start communicating with beneficiaries as early as possible about what their options are, such as how they will be transferring payroll and other administrative records. 

Said McLaughlin, “You have to let everybody know what the plan is.” 

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Home > News > Pensions > Special Report: The Risk Factor in Pension Transfers
Pensions

Special Report: The Risk Factor in Pension Transfers

Plans often do piecemeal deals, to reduce the chances of everything going down the tubes.

By Larry Light


A corporate pension risk transfer (PRT) in an innately risky undertaking. First are the risks of sitting tight and not doing a PRT. Such as: Will low interest rates continue and make the effort to meet liabilities harder? What if the stock market craters and stays low for a prolonged period? Can a plan meet its obligations in coming decades if the number of beneficiaries is unclear?

But then there are the fresh risks of taking the leap and making a transfer. Like: Is bridging the gap to full funding, which an insurer requires to do a deal, too grave a sacrifice? Diverting precious company capital to boost the funding level could deprive the business of the fuel it needs to grow.

Questions along these lines occupy plan sponsors as they contemplate removing liabilities that can thwart them over the long term. No wonder doing a PRT is a fraught experience. “It’s time-consuming and expensive,” said Anthony Parish, CIO at Alphastar Capital Management, a PRT adviser.

The process of finding an insurance company to take over a defined benefit (DB) plan’s liabilities—and the assets that are focused on paying them over time—involves bidding by insurers for the job. If little chance exists that a plan can achieve 100% funding, insurers will take a pass.

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That’s why plans often don’t tend to unload all obligations all at once. The standard progression is to first close a plan to new hires and to freeze the ability of existing participants to accrue more pension credits—based on pay and years of service—for their future time at the company.

This gives sponsors a better handle on the size of their liabilities. One more way to lighten a sponsor’s load is to offer participants a lump sum, which they take in exchange for forfeiting all rights to pension payments.

Then we get to the PRT. From there, the common practice is to say goodbye to groups of beneficiaries bit by bit. Delivering an entire plan to an insurer—and thus terminating all future obligations—is an enormously complicated task and can take anywhere from 12 to 18 months to perform.

The piecemeal approach is quicker and easier, although certainly a hassle, too. Often the first to be loaded on the PRT conveyor belt are those with the smallest benefits. Sponsors “might choose everyone who gets below $500 a month, because they are expensive to carry,” noted Ari Jacobs, global retirement solutions leader at Aon, which advises plan sponsors.

The Pension Benefit Guaranty Corporation (PBGC), a federal agency that oversees DB plans for 34 million US workers, charges the same amount in premiums to insure a plan for a small benefit as it does for a large payout, Jacobs pointed out.

The easiest group to transfer? Retirees who are currently drawing pension payments, said Mark Paracer, research outfit LIMRA’s assistant research director. Insurers “know what benefits they will be receiving,” as opposed to existing employees whose payments might be tougher to quantify, he explained.

Insurers like to say, with some justification, that they are simply better at administering plans. In the case of PRTs, that means large group annuities. After all, the carriers have offered annuities for many, many years, and know best how to judge beneficiaries in actuarial terms. Also, they have better scale when investing the plan assets. Insurers, said Alexandra Hyten, head of Prudential Financial’s PRT effort, “are more efficient holders” of plan assets and liabilities.

One bonus for insurers: They don’t need to pay the increasingly higher premiums that corporate plans are charged by the PBGC. The premiums now sits at $86 per participant, which is quite an increase from the $35 the agency charged 10 years before.

Burdens like that are why a good number of sponsors happily part company with their DB plans.

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