PRT Insights Can be Significant Value-Add

There are any number of ways for an adviser to use knowledge of DB plan issues to demonstrate value to existing and prospective clients, says Wayne Daniel, head of U.S. Pensions at MetLife. Obviously, DB plan insights will be valuable for advisers actually serving DB plans, he says, whether as a discretionary investment manager or in a more hands-off advisory capacity. But even for those advisers with a heavy DC focus, it will almost certainly be a positive to gain more knowledge about the difficulties facing pension plan sponsors, he says.

“It’s pretty straightforward—the more knowledgeable about innovation and the evolution of the wider retirement planning industry that the adviser brings to the table, the more they can benefit their clients,” Daniel tells PLANADVISER. “Even if the adviser is serving a DC client, or a client with both DC and DB [plans], the knowledge can be a big differentiator.”

Daniel says this is especially true as the advisory marketplace becomes increasingly competitive, due in part to merging business models and new “robo-adviser” technologies. In such an environment it will be increasingly important for advisers to be able to demonstrate that they are keeping on top of the latest industry developments, Daniel adds, both on the DB and DC sides of the industry.

Indeed, data from Cerulli Associates suggests fewer than 1,500 of the more than 16,500 firms in the registered independent adviser (RIA) channel manage 90% of the assets as of the start of 2013. Schwab Advisor Services published similar findings in a recent independent adviser outlook survey, which shows a strong majority (71%) of RIAs believe there will be increased competition for new assets in the next five years. Schwab says the number of RIAs believing their strongest competition will come from other RIAs falls significantly looking beyond 2018, with greater competition in the longterm expected mostly from the development of national RIAs and online investment advisers.

And besides, there is significant overlap of concern between DB and DC plans, Daniel explains. For example, the principles of liability-driven investing (LDI) are clearly important for pension plans looking to reduce funded status volatility and better align assets with projected benefit payment schedules. But DC plan participants, too, are increasingly demanding LDI approaches within their investment options (see “Is LDI Feasible for DC Participants?”). Like pension plans, their attention is shifting slowly from securing maximum investment returns to limiting volatility and ensuring steady income will be available post-retirement.

“Pension plan issues may not be something that is directly relevant for every particular client an adviser serves—but advisers need to be able to demonstrate they understand new products and strategies, and they need to explain why they are relevant or not relevant,” Daniel adds. “Even if the client doesn’t have a DB plan, you don’t want to be clueless if they start asking questions.”

One area in particular where advisers can demonstrate they are keeping tabs on DB industry development is in the area of pension risk transfer (PRT), Daniel explains. Plan sponsors have a whole spectrum of options for offloading pension risk, including the strategy of a pension “buy-in.”

While buy-ins are a relatively new pension risk transfer strategy in the U.S.—with the first significant buy-in deal coming in mid-2011—most plan sponsors have heard of so-called pension “buyouts.” As Daniel explains, buyouts involve a plan sponsor transferring all or part of the pension plan’s benefit liability directly onto an insurer’s balance sheet. The insurer accepts all or part of the pension plan’s assets as a premium payment for taking on the longevity, inflation and investment risk associated with operating the pension plan.

Despite the naming convention, buy-in risk transfers are actually similar to buyouts in many respects, Daniel says. “Exactly as for a buyout, the pension plan makes a single premium payment to the insurer to enact the buy-in, and the payment can either be 100% lump sum cash or it can be assets in kind,” he explains. “And the single premium payment covers the future benefit payments for either a selected group or all of the plan participants. In turn, the insurer issues a group annuity contract to the plan. So far the process is exactly the same as for a buy-in or a buyout.”

Where the buy-in differs is that, rather than taking over the benefits payment schedule of the employer, the insurance company instead makes a monthly bulk payment back to the pension plan to cover either current or future cash flow needs, Daniel says. Cash payments to the employer represent the monthly benefit amount covered under the buy-in contract.

“So one of the big differences, then, there is no direct relationship between MetLife and the plan participant under the buy-in arrangement,” he says. “The pension plan continues to make the pension payments, and then the insurer makes payments to the pension plan to ensure the necessary cash will be there to pay benefits that are claimed.”

Daniel says another and perhaps more informative name for “buy-ins,” under which MetLife originally marketed this type of service, is “pension cash-flow guarantee.” As this name implies, the benefit for plan sponsors is ensuring the plan will have enough cash on hand at a given point to meet projected benefits obligations.

“So you see a pension buy-in is really part of the risk transfer spectrum,” Daniel adds. “You can actually think of the full buyout—when all of the liabilities and all of the assets are transferred to the insurer—as being on one end of the spectrum, and then aggressive LDI is on the other end. Under this analogy the buy-in concept would fit somewhere right in the middle.” LDI, or liability-driven investing, is an asset allocation strategy that tries to match plan assets with liabilities.

Daniel says MetLife has been a leader in bringing this type of service to U.S. pension plan sponsors—adding that the firm secured what he believes was the largest buy-in contract to-date in the U.S. earlier this year, valued at $92 million. He says the firm is currently working to increase acceptance of buy-in strategies among U.S. plan sponsors, and to give current and potential clients a better sense of how buy-in strategies work.

One of the chief objectives, he says, is to help plan sponsors (as well as the advisers guiding them) realize that different pension risk transfer options can work together over time to smoothly de-risk a pension plan.

“When the plan sponsor is beginning to think about a risk transfer, this is generally coming only after the sponsor first reviewed the liabilities within the plan and accurately projected the benefits schedules. Perhaps they have already implemented an LDI portfolio,” Daniel explains. “Once the assets are appropriately aligned, we start to see a reduction in the volatility of the plan’s funded status. It then becomes easier for the plan to start targeting for either a buy-in or a buy-out, whether for the whole plan or for a section of the participants.”

He points to the UK market to demonstrate the idea. “In the UK, employers moved to mark-to-market accounting faster and further than the U.S. for the most part,” he explains. “And so, plans in the UK and their corporate sponsors actually have for a while been forced to recognize the true economic cost of holding the defined benefit promises that they’ve made. And also in the UK, we saw a significant increase in the regulatory cost of operating a defined benefit plan, such as increases in the pension protection fund levies, and the regulator mandates fairly aggressive rates of improvement in future longevity tables.”

All of this has more quickly added to the cost and pressure for UK pension plans, he explains, which is why in the UK, plan sponsors saw a need to de-risk earlier and there was recognition that for many plans de-risking was going to have to happen in several stages.

“For those that were not fully funded or ready to move to full buyout, a buy-in was a very appropriate solution,” he explains. “So buy-ins became a fairly typical route from LDI to the full offloading of pension liabilities. In fact, we’ve seen in some previous years that, in terms of the total number and value of transactions in the UK de-risking market, buy-ins have exceeded buyouts in recent years. It’s a major feature of that market.”

Daniel says similar pressures are emerging in the U.S. as significant increases in PBGC premiums take effect (see “PBGC Premium Hikes Shake Up Buyout Landscape”). He says the pending adoption of new Society of Actuaries mortality tables accounting for improved longevity among U.S. retirees could cause projected liabilities to jump as much as 8% for the typical pension plan immediately upon implementation.

“It’s clear the costs associated with managing the risks within pension plans are going up, year in and year out, and plan sponsors are seeing that,” Daniel continues. “Their advisers are pointing it out, and while we do expect to see more buy-ins in the future in the U.S., I think that a lot of plan sponsors will still go straight to buy-outs, more so than in the UK. We’re hoping to change that.”