The Markets September 7, 2017

DB Plan Sponsors Foresee More Robust PRT Activity

Fifteen percent say recommendations from their consultant or independent fiduciary is an important consideration when selecting an annuity provider.
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Nearly nine in ten defined benefit (DB) plan sponsors (87%) believe the level of 2017 pension risk transfer (PRT) activity will be at least as, or even more, robust than in 2016, according to MetLife’s 2017 Pension Risk Transfer Poll.

Nearly all plan sponsors (92%) are aware that, although the length of time it takes to complete a PRT transaction will vary by plan, the entire process typically takes six to 18 months. To ensure that they are ready to act, more than six in 10 plan sponsors (61%) have taken preparatory steps for an eventual PRT transaction, up from 45% in 2015. The percentage of plan sponsors that have taken preparatory steps rises to 79% among plan sponsors that are likely to engage in PRT to an insurer in the next two years.

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The most common preparatory steps taken include an evaluation of the financial impact of a pension risk transfer (71%); discussions with key stakeholders (67%); data review/cleanup (64%); and, exploration of the PRT solutions available in the marketplace (59%). Among those planning for a buyout or buyout in combination with a lump sum, one in five (20%) has already secured an illustrative bid from an insurer. According to MetLife, securing an illustrative bid is a strong indicator of intent to transact in the near future.

The top catalysts driving sponsors to consider transferring pension obligations to an insurer are Pension Benefit Guaranty Corporation (PBGC) actions (64%)—this includes PBGC premium increases (58%) and a change in the PBGC premium methodology to the risk-based formula (29%); interest rates (50%); and, the impact of changes to mortality tables proposed by the U.S. Internal Revenue Service (IRS) in 2016 for use starting in plan years beginning on or after January 1, 2018 (34%). Other notable factors for initiating PRT include the regulatory environment (29%) and funded status reaching a pre-determined level (26%).

NEXT: Implementing PRT Transactions

When asked about the type of PRT activity plan sponsors will most likely use to achieve their de-risking goals, nearly 57% say they will use an annuity buyout, including 43% who plan to use a combination of a lump sum and annuity buyout. Interest in annuity buyouts rose from 46% in MetLife’s 2015 Pension Risk Transfer Poll, which included 37% who planned to secure a buyout in combination with a lump sum offer.

Nearly half of plan sponsors (47%) say financial strength is the most important consideration when selecting an insurer for an annuity buyout transaction, followed by the cost of the annuity transaction (33%) and recommendations from their consultant or independent fiduciary (15%).

More than two-thirds of plan sponsors (69%) are aware that it is possible to split an annuity buyout transaction among two or more insurers. The highest level of awareness is among sponsors with $1 billion or more in  DB plan assets (75%). While there is a high level of awareness about split deals, only one in five plan sponsors (21%) say that if and when they are ready to complete an annuity buyout, they would be likely to split the transaction among two or more insurers.

Four in 10 plan sponsors (44%) say they would be unlikely to split the transaction, primarily for reasons of perceived complexity, believing it would cause administrative burdens and that it would be easier to manage a single transfer.

The majority of plan sponsors intend to tranche their annuity buyouts by participant population. Retirees are identified as the most common population for which sponsors are considering purchasing annuities (53%), followed by terminated-vested participants (47%). Only one in five (22%) say they would secure a buyout for all participants.

When their company is ready to complete an annuity buyout, more than half of plan sponsors (51%) say they would be more likely to select an insurer that allows the premium for the annuity to be paid with assets-in-kind (AIK)—an emerging trend. MetLife explains that with an AIK transfer, a relatively new approach used in the U.S. since 2012, the premium for the annuity is paid by transferring ownership of some or all of the plan’s eligible assets to the insurance company, as opposed to liquidating plan assets for cash. An AIK transfer is possible when assets held by a DB plan are generally consistent with those the insurer would deem suitable for its portfolio, pursuant to regulatory requirements and internal risk management practices.

The full survey report may be downloaded from here.

The Markets September 7, 2017

IDL Investing Concept Makes Certain DB Plans More Desirable

For two types of DB plans, investment-driven liabilities (IDL) is almost risk free for plan sponsors, and at the same time, provides more meaningful benefits to participants, John Lowell, with October Three, contends.
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For traditional defined benefit (DB) plans, liability-driven investing (LDI) is used to align the movement of investments with the movement in liability. John Lowell, an Atlanta-based partner with October Three, says this does a good job if done properly.

However, for two types of DB plans, investment-driven liabilities (IDL) is almost risk free for plan sponsors, and at the same time, provides more meaningful benefits to participants, he contends.

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Lowell explains there are two types of plans for which IDL is workable; variable annuity plans and market-return cash balance plans. “In a variable annuity plan, participants have a benefit a lot like with a traditional plan, but what makes it different is the plan establishes what’s called a hurdle rate,” he says. ”Assume the hurdle rate is 6%, in a given year. If assets go up by more than 6%, then plan participants get an increase in benefits related to returns over 6%. Similarly if returns are less than 6% benefits go down in relation to how much returns went below 6%, to the extent allowed by law.”

According to Lowell, essentially what happens for either of these plan types, and what makes IDL fundamentally different from LDI, is rather than locking in a low rate of return, and taking a plan that’s underfunded and making sure it stays that way because it can’t catch up, plan sponsors can generate assets to create a higher rate of return and to the extent they do, will generate higher benefits. With IDL, the plan and participants share risks. “Designed properly, they will wind up with a plan that will become well-funded, and once it is, it is almost risk free for plan sponsors, at the same time providing more meaningful benefits to participants,” he says.

Lowell further explains that with an IDL strategy, unlike an LDI strategy, there is no glidepath or funded status trigger to dictate a change in asset allocation to lock it in; there is nothing to lock in. As an example, he says, “Suppose you are a participant in a cash balance plan. The plan sponsor tells you you’re going to get the same return as the return on trust assets except that for technical reasons, the sponsor will guarantee you have no loss of principal and will cap your upside at a certain percentage. The cumulative rate or return cannot exceed a percentage specified. It depends on how the plan is designed, and that can be changed over time.”

“With IDL, I as a plan sponsor know that growth in liabilities is going to track the growth in assets,” he adds. “I will never get into a situation, if I do things properly, where the plan is not going to 100% funded.”

Lowell says October Three has found that given how pension finance works, using LDI also locks in massive costs, i.e. PBGC premiums, which make companies say they don’t want to offer DB plans anymore. On the other hand, in driving liabilities, plan sponsors are driving downside risks as well as upside rewards. They are almost able to lock in costs, then the whole idea of offering a DB plan as the primary retirement savings vehicle is no longer problematic.

“The sad thing is, not a whole lot of plan sponsors have gone down this road. But, I have not heard of a single plan sponsor that has gone down this road that say they hate it, whereas those with a traditional DB plan want out of it,” Lowell says. “IDL is attractive to unions. What they like is that risk is shared by all rather than only being on the employer, as with a traditional DB plan.”

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