Understanding PRT: Key Steps Leading to Successful PRT

As firms move on from the first step of cleaning up their data, they must next think about the financial and accounting implications that come with pension risk transfer.

In the final session of the ISS Media 2022 Understanding PRT virtual conference, experts discussed how to execute a pension risk transfer transaction, providing detailed steps and a timeline on how plan sponsors can remove the risk from their balance sheets.

Data cleanup takes the top spot on the checklist and is an underappreciated part of the process, said Kate Pizzi, partner, senior consultant, Fiducient Advisors. There is growing scrutiny from the U.S. Department of Labor and the Pension Benefit Guaranty Corporation regarding PRT transactions, and data cleanup will help to reduce the cost and risk involved in termination.

“This important first step is essential to making sure the rest of the process goes as smoothly as possible. If you don’t get the benefit payment information right at the front end, that can derail the whole process,” Pizzi warned. “Even before you are thinking about potentially terminating the plan or another risk transfer activity, focus on that data.”

Pizzi said there are a few important data elements that should be reviewed, as they can be key factors in lowering costs and reducing risk.

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“One step that is definitely worthwhile would be finding missing participants. The PBGC has a facility to help you out if, in fact, you can’t find missing participants. If you don’t know how to locate your participants, it’s going to be very difficult to transfer that risk over to an annuity provider on behalf of that participant,” Pizzi said. “If in fact you do have an annuity provider that is willing to take that risk, you are likely going to have to pay up in order for them to take those additional risks.”

Another point that can sometimes be overlooked is required minimum distribution dates, Pizzi said. Some beneficiaries can be past key dates and require distributions either before, during or after a PRT transaction.

“Another element that is overlooked but important is doing recurring death audits,” Pizzi noted.

She cited the example of a retiree who is already in receipt of their benefit. If there is a contingent spousal annuity tied to that payment, but the spouse has since passed away and the plan’s data does not reflect this, the plan is likely paying more for that annuity transfer than necessary. For very large plans, this is even more essential.

Offering another perspective, Glenn O’Brien, managing director, head of U.S. market, Prudential, said the data standard for an annuity transaction has one of the highest thresholds associated with pension plan management. This is because of the irrevocable nature of PRT transactions.

“Once the assets leave the ERISA jurisdiction, they come to the insurance company framework, and the owner of the assets and liabilities is the insurance company,” O’Brien said. “For the insurer, it is critical to have the ability to assess and underwrite the transaction correctly.”

O’Brien said the issue of missing participants and their associated data is particularly important.

“If we have very high-quality data, it gives us just a very high threshold of confidence that we’re going to be able to track and find somebody into the future,” he explained.

As firms move on from cleaning data, they must then think about the financial and accounting implications that come with PRT, said Brent Hartman, a CAPTRUST investment strategist who moderated the panel. In some cases, plan sponsors may actually be worried their firm won’t be able to take the balance sheet hit from terminating a pension plan.

“The first and foremost consideration, from this point of view, is figuring out how you preserve the economic situation that you find yourself in now,” O’Brien said. “For people who want to reduce risk who are worried about the balance sheet hit from any sort of settlement, a buy-in is a really good solution.”

A buy-in can be thought of as an asset class decision, as opposed to the purchase of an annuity, O’Brien explained. A buy-in can also be thought about as creating a simple asset class that has longevity protection.

“It’s cash-flow matched and guaranteed to sit as an asset of the plan, until more money is put into the plan or a sponsor does something active,” he said. “It doesn’t have to be all or nothing. You can take steps to start incrementally making your way into reducing risking.”

Pizzi noted that, in light of regulations implemented by the American Rescue Plan Act in early 2021, there has been a reduced cash strain on some plan sponsors that are not as well funded. This includes reducing minimum required contributions, which can allow some sponsors more flexibility, meaning their end game may not have to be termination. Sponsors can instead possibly focus on finding opportunities to reduce their PBGC premium.

Another point to note is that a lot of employers absorb pension plans through an acquisition, said Michael Devlin, BCG Pension Risk Consultants principal. He has spent time with people who did not grow up in a world where pension plans were common, noting that it is important to help such employers make informed decisions. This will involve going through their revenue expectations to help them understand what impact there will be to their profit and loss statements.

Offering a legal perspective on the funding status of plans and preparing for a PRT strategy, George Schein, Nationwide Advanced Consulting Group technical director, emphasized how small plans that aren’t as well funded may want to pursue PRT, simply to get the plan off their books and to reduce PBGC expenses. However, they may face difficulty moving down this road, for example, because they may not be permitted to offer a lump-sum window if they are not at least 80% funded.

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Retiring Your Pension Plan: How to Handle Different Choices

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Tags: ERISA, ISS Media 2022 Understanding PRT, Kate Pizzi, PRT

Defined benefit plan sponsors have available several options to reduce their pension plan risk or obligations, with different associated costs, according to industry experts who spoke at ISS Media’s Understanding PRT conference.

Pension plan sponsors can de-risk the costs of maintaining a DB plan by transferring some, most or all the plan’s liabilities to an insurer. Managing pension risk encompasses a variety of solutions—from asset allocation strategies to group annuity transactions, says Bill Tremko, president and CEO, USI Consulting Group. These options are placed along a “de-risking spectrum,” of solutions for plan sponsors, he says.

“A de-risking spectrum [is] where we measure the amount of risk that is retained by the plan sponsor, and where the most risk is retained or traditionally where we’ve looked at de-risking plans is through traditional asset allocation, or a plan design,” Tremko says. “Your investment policy statement can be tweaked under a traditional asset allocation model to take out some risk.”

Risk Transfer Roadmap

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Pension plan sponsors initiate risk transfers to reduce longevity risk, investment risk and interest rate risks. Often the first step in managing risk is liability-driven investing, according to Tremko. “LDI is basically a fixed income portfolio with a duration matched to the liability,” he explains. “Regardless of whether interest rates move up or down, you’re maintaining your funding status,” with the approach.

But this may not be ideal for plan sponsors with pensions that are underfunded, he says.

“Some plan sponsors could look at that and say, ‘well, my plan is underfunded so I really don’t want to maintain my funding status, I want some opportunity to grow my way out of that underfunding,’ so a full LDI strategy might not be appropriate if they have that attitude but nevertheless, it’s a way to transfer some risks through that liability matching,” he says.

Further down the PRT spectrum are options for plan sponsors to pursue partial buyouts or lump sum payouts to beneficiaries, “where you’re actually cashing out liabilities either in lump sums or through the purchase of annuities and totally getting it off your balance sheet and out of a plan,” Tremko explains.

Buy-in/Buy-out out?

Plan sponsors can benefit from each of the options but must understand the features and differences, explains Elizabeth Walsh, vice president at MetLife U.S. Pensions group. Both an annuity buy-in and annuity buy-out involve the plan sponsor purchasing a group annuity contract.

A buy-in is a group annuity contract under which the insurer agrees to cover the benefit payment obligation for a covered group of participants and beneficiaries for the rest of their lives, while the plan sponsor retains the administration, recordkeeping and fiduciary obligations for the plan. A buy-out allows the plan sponsor to ‘lift out’ segments of participants and transfer all obligations to an insurer.

In a buy-out, the plan sponsor can also terminate the plan by completely transferring all the obligations of the plan to the insurer, Walsh explains. “One of the main differences here is that the buy-ins count as an asset of the plan,” says Walsh. “It’s a liability-matching asset of the plan. It’s in contrast with a buyout because the liabilities remain in the plan.”

Opting for a buy-in also doesn’t eliminate fees paid to the Pension Benefit Guaranty Corporation.

The associated costs for each also vary. “Another important difference is a buy in doesn’t figure in settlement,” says Walsh.

“Unlike the lump sum window where you don’t know what the take rate is going to be and hence you can’t calculate in advance the exact settlement effect, a plan sponsor can control the population for a buy-out,” says Tremko. “They can pick and choose who they’re going to [transfer to the] carrier. You’ve got control over the settlement effects, so that’s one of the virtues of the buy-out.”

Cost Considerations

Plan sponsors must closely consider the costs against the benefits of extra security and fees provided by an insurance company using a separate or general account for the pension obligation assets. Separate accounts can offer a greater layer of security and are “increasingly being used on the large and jumbo deals and typically will cost a little more,” says Mark Paracer, assistant research director and head of PRT sales studies at the Secure Retirement Institute.

Separate accounts hold the assets separately from the insurer’s general account, and for smaller transactions, “the cost of running a separate account could be prohibitive,” says Paracer. Some insurers may offer a commingled separate account that combines the assets of several plans to lower the costs of the account, he explains.

“This is an area where an adviser or a consultant can come in, help the plan sponsors to evaluate insurers and to tell you the best structure of the contracts given each company’s unique situation,” Paracer says.

Tremko cautions plan sponsors against trying to time the right PRT option for a favorable outlook on future interest rates. “You know the old adage about timing the stock market? You could expand that to a similar issue with trying to time interest rates,” he says. “And typically you’re not working with an economist when you’re going to purchase these contracts.”

He notes that plan sponsors must pay close attention to long-term rates, and that “it doesn’t really matter what the Fed[eral Reserve Board of Governors] does with short-term rates.”

Plans sponsors shopping for the best deal in the interest rate aisle may believe long-term rates are going to creep up over time and think “why don’t we just delay right now and pay less in the future for the same annuity contract?” Tremko adds.

But rather than being affixed to the interest rate movement-only, while important, plan sponsors must also note how assets are expected to be invested in the future. For example, if a plan sponsor has a large traditional bond portfolio, “when interest rates rise, the plan premiums will be reduced, but your assets [are] also going down, so have you really gained much ground in terms of waiting?” Tremko asks.

While the plan sponsor might be waiting, there are likely large portions of the plans’ assets in equities, and therefore the plan sponsor must also plan for what that will do to the value of those assets.

Ultimately, trying to find the right timing continues to leave the plan open to risks, when “the whole point of having this conversation about de-risking is how to get rid of some of those risks,” Tremko says. “The waiting game keeps all the risks with the plan sponsor and at the end of the day, because you’d typically have your fixed income allocated against your retirees as an example, you will not gain much [by timing] unless you’re in an LDI model.”

Related Stories:

Understanding PRT: Administrative and Fiduciary Considerations

Retiring Your Pension Plan: How to Handle Different Choices

Tags: ISS Media 2022 Understanding PRT, PRT