Pension Risk Transfer

U.S. single premium pension buy-out sales surpassed $8.2 billion in this year’s second quarter, more than doubling those in the second quarter of 2017, according to the LIMRA Secure Retirement Institute (LIMRA SRI)’s quarterly U.S. Group Annuity Risk Transfer Survey. LIMRA SRI projects the pension risk transfer (PRT) market will exceed $23 billion by year-end.
In fact, the PRT market has been steadily growing for a decade and presents an opportunity for plan advisers to add a valuable service for defined benefit (DB) plan sponsor clients.

As Michael Devlin, a principal at BCG Pension Risk Consultants, in Braintree, Massachusetts, says, pension plan risk includes the liability, or benefit, owed to each participant, and DB plan sponsors hold all of the market, interest-rate, longevity and regulatory risk associated with liabilities.

A pension risk transfer permanently removes that liability from the plan sponsor’s balance sheet and fulfills the employer’s obligation to participants, Devlin says. To conduct a PRT, plan sponsors have two options: offer lump-sum benefit payments or buy a group annuity to cover liabilities. Lump sums may be offered to terminated, vested participants only—not to retirees in pay status. Annuitization can be utilized for both retirees and terminated, vested participants.

When offering lump-sum payments, plan sponsors also have to enable the recipients to accelerate the start date of their monthly benefit, Devlin says. With monthly annuity payments, offering them before the participant turns 65 will reduce the total amount he gets paid. Devlin says most participants do not ask for this; they either take a lump sum or not.

For plan sponsors, once the participants take a lump sum or are transferred to an insurance company’s annuity, the liability associated with them is gone, as are all other DB-plan-related risks the sponsor has borne. In addition, some costs are eliminated, such as Pension Benefit Guaranty Corporation (PBGC) per-participant premiums and some actuarial administration costs.

The difference between offering lump sums and transferring participants’ liabilities to a group annuity is that, with an annuity transfer, the DB plan sponsor does not need to amend its plan document or get participants’ authorization, Devlin says. “Of course, it is good practice to let [participants] know the transfer is coming, what company will be handling their benefits, and to tell them to keep all correspondence from that insurance company.”

The Adviser’s Role

Both Devlin and David Hinderstein, president of Strategic Retirement Group Inc., in White Plains, New York, question whether advisers with DB plan clients are serving them well if they neglect to discuss PRT with them.

According to Hinderstein, with pension risk transfers, an adviser would play two different parts: the quarterback, to help build a strategy and to manage the de-risking of the plan, and investment adviser, to ensure that assets and liabilities still match.

“Typical DB plans use an actuary, custodian and investment adviser,” Hinderstein says. “The plan sponsor doesn’t have anyone to coordinate [PRT] efforts. As consultants, we coordinate all efforts—benchmarking insurance providers, [explaining] assets and liabilities, developing goals and objectives to de-risk, and facilitating actions.” He adds that advisers do not need to be investment advisers; they can focus on helping plan sponsors build a de-risking strategy.

Daniel R. Casella, executive director of consulting, also at Strategic Retirement Group, says de-risking strategies are not limited to just frozen plans wanting to terminate. They also help plans that are open and active make liabilities smaller.

Hinderstein notes that vetting annuity providers is a fiduciary duty. In 2007, the Department of Labor (DOL) issued two rules under the Pension Protection Act (PPA) relating to choosing an annuity provider for distributions from DB and defined contribution (DC) plans. One was an interim final rule amending Interpretative Bulletin (IB) 95-1 to limit the bulletin’s application to only the selection of annuity providers for distributions from DB plans.

Hinderstein says helping DB plan sponsors with PRT is like helping them manage their balance sheet, where the plan is purely a line item—an adviser needs the sophistication to understand balance sheet management in order to help sponsors with PRT. He would recommend that any adviser spend time with various providers that specialize in DB plans, or else partner with an adviser who does.

Hinderstein also says analyzing participant demographics is important to help sponsors decide whether to do lump sum distributions, an annuity transfer or both. How many retirees already receive monthly payments? How many terminated, vested vs. active participants are there? This also helps with building a strategy for when to offer a lump sum or purchase an annuity.

According to Devlin, the cost of a PRT is something else advisers need to go over with DB plan clients. As a simple example, he says, the present value of lump-sum payments may be $50,000, but purchasing an annuity to cover that liability may cost $65,000. “There is a spread in what it costs to offer a lump sum and how an annuity provider prices an annuity,” he says. Plan sponsors need to consider what they can afford.

Investment Strategy

When pension plan sponsors implement any kind of PRT, Devlin says, it usually requires restructuring investments. Advisers can help plan sponsors with reallocation. “There should be a good, thorough review,” he says. “For example, the risk transfer could have altered the duration of the plan. If a plan sponsor is using a liability-driven investing [LDI] strategy, where they are in their glide path may have changed, so they may want to change the glide path.”

When determining how much a plan’s liability will grow year over year, the sponsor must consider PBGC holding costs, and trustee and custodian costs. “Now the plan needs a 6% return just to break even. An LDI portfolio doesn’t provide much investment return; it drags down on equity. In a bad market, a 4% loss and liability growth of 4% increases a plan’s liability by 8%,” Devlin points out.

Casella says plan sponsors looking to get returns by increasing equity exposure can save on cost by increasing their use of indexing and by reducing the volatility of liability going toward a fixed-income portfolio.
He also notes there are four different measures to calculate funded liability, and many plan sponsors are unaware of where they fall in each. Such discussions give sponsors confidence that there is a strategy.

The Value Advisers Add

From a human resources (HR) perspective, helping a sponsor slash, from 1,000 to 800, the number of participants it is responsible for eliminates required mailings, funding notices and other administrative costs, Devlin says. “It’s hard to put a number on [it], but it helps plan sponsors save money.” If, for example, a PRT reduces $20 million on the balance sheet to $15 million, it has eliminated $5 million of exposure.

According to Casella, advising about PRT is especially helpful to sponsors of frozen plans. These sponsors still have an obligation to pay benefits to participants and their beneficiaries; they are also paying actuaries, custodians and the PBGC. When such expense is involved, “it is not financially sound to keep the plan,” he says.

Devlin concludes, “It’s not to say that every DB plan sponsor should be implementing PRTs, but an adviser should make sure they review and explore the idea. For some companies, it’s a no-brainer. For some, it’s a good business decision, and, for others, it could confirm that they should keep doing what they’re doing.”

Art by Davor Gromilović