ResearchOctober 11, 2019

Limiting vs. Eliminating Pension Risks

Defined benefit plan sponsors should consider multiple de-risking Strategies.

Reported by Michael Katz

Defined benefit pension plan sponsors should consider the pros and cons of limiting – rather than eliminating – pension risks over time, according to MassMutual.

A recent white paper from the life insurance firm says companies looking to mitigate the financial risks that come with defined benefit plan sponsorship can use a variety of strategies to manage pension risks, such as freezing plans to new entrants, hibernating plans, re-allocating investment assets or shifting pension obligations via a pension risk transfer.

“There are several different risk strategies for employers to contemplate when managing pension risks over both the short and long term,” Neil Drzewiecki, MassMutual’s head of pension risk transfer, said in a release that was issued with the white paper. “More employers are concluding that transferring those risks to a life insurer is in the best interests of the company and its employees.”

Drzewiecki said employers that sponsor defined benefit plans are increasingly recognizing the value of pension risk transfer annuities. The white paper points out that pension buy-out transactions are the only way to eliminate pension obligations under current law, and that they have grown nearly seven-fold to $26.4 billion in 2018 from $3.84 billion in 2013, according to the LIMRA Secure Retirement Institute.

However, the surge in pension risk transfer has led to rising premiums paid by employers to the Pension Benefit Guarantee Corp. (PBGC), which is passing on higher costs to guarantee pension payments, according to the white paper. PBGC premiums for single-employer plans have more than doubled in the past 10 years, rising to $80 per participant in 2019, and they’re expected to continue to rise over the next decade.

“The latest federal budget proposal calls for PBGC premiums for collectively bargained retirement plans to rise by $18 billion over the next 10 years,” said the white paper. “Whether those figures become reality or not, it’s unlikely that premiums will decline anytime soon.”

Among the several short-term and long-term strategies for managing pension risks cited by the white paper are hibernating risks, hedging risks, and purchasing annuities.

Hibernating risks closes a plan to any new entrants and stops accruals for participants in order to limit the financial risks of the plan while allowing the sponsor to continue to manage the plan. Although this protects against the risk of benefit increases, plans are still exposed to many other risks, especially interest-rate risk.

“Hibernation may not be a panacea for every pension plan or pension risk management objective,” said the paper. “Once in hibernation, the pension must continue to be managed to some degree and therefore continues to incur costs, including investment management expenses.”

Hedging risks can help lower risk and create less volatility. MassMutual says the fixed income assets that a plan invests in can be selected in a way to match the liability’s sensitivity to interest rate movements to offset changes in the plan’s liabilities. When interest rates decrease, the asset portfolio will increase in value in an amount close to the increase in liabilities.

Annuities are becoming increasingly embraced by Americans as a vehicle to accomplish their financial goals, according to the white paper. According to MassMutual, sales of group annuities have nearly doubled in two years, climbing to $26 billion in 2018 from $13.7 billion in 2016.

“The growing popularity of PRTs is good news for both plan sponsors and participants,” Drzewiecki said. “When a plan participant receives a notice in the mail that his or her pension benefit will be paid by a financially secure, experienced life insurer with great service, it’s good news.”