A new issue brief from the Pension Committee of the American Academy of Actuaries explores the perspectives of different stakeholders involved in pension risk transfer (PRT) transactions, suggesting careful consideration of differing viewpoints along the way can dramatically improve the PRT experience.
“Pension risk transfers can have significant implications for the financial security and responsibilities of different plan stakeholders,” notes Ellen Kleinstuber, chairperson of the Pension Committee. For example, employers generally come into the process with two fundamental motivations: They want to address longevity and investment risk, and they want to act before increasing Pension Benefit Guaranty Corporation (PBGC) premiums adds even more to the cost of running a pension plan.
Employees, on the other hand, generally want PBGC coverage for their pension plan assets, and the resulting loss of PBGC insurance coverage following a PRT buyout can be concerning—especially if the plan sponsor and providers fail to effectively communicate the need for change and exactly how and why the PRT process will unfold. Furthermore, during partial buyouts, changes in plan funding levels following a risk transfer transaction can negatively affect the benefit security of participants remaining in the plan post-transaction.
These two parties in semi-conflict will then inevitably interact with at least a small handful of service providers who will help get the transfer deal in place—likely to include advisers, legal resources and sales/service professionals from the insurer offering a bid for the PRT business. According to the Pension Committee, it is important for plan sponsors to remember that service providers are looking to make as profitable a deal as possible in all this, so they should be ready to do some tough negotiating on terms.
With such challenges in mind, the issue brief “does not offer a judgment about whether PRT transactions, on balance, enhance or detract from a retirement system. It instead seeks to provide a factual basis upon which such determinations may reasonably be made.”
NEXT: Factors considered in PRT transactions
According to the analysis, plan sponsors (i.e., the initiating party in a PRT transaction) cite a variety of factors in deciding whether and when to de-risk.
“Some plan sponsors may be waiting until interest rates rise to carry out risk transfer activities. Many others compare the cost of settling today to the economic liability (balance sheet liabilities at low interest rates plus the present value of administrative expenses, investment management fees, and PBGC premiums) and conclude de-risking makes economic sense now,” the issue brief explains. “With the announcement by the IRS that updated mortality projections reflecting the RP-2014 mortality tables are not required to be used to determine minimum required lump sums paid during 2017, plan sponsors now have certainty as to the required calculations for lump sums offered during 2017.”
The issue brief suggests plan sponsors will likely assume that the reported increase in life expectancy will be reflected in minimum required lump sums at some point after 2017, potentially driving them toward PRT in 2018 or 2019.
“However, plan sponsors will also need to consider other factors, such as potential changes in the interest rates used to calculate lump sums,” the issue brief warns. “The insurance industry may not have the capacity to absorb increased demand for pension settlements. If a plan sponsor waits until interest rates rise, many plan sponsors may seek to place significant blocks of annuities with insurers at the same time, diminishing or even eliminating capacity, or causing insurers to be less competitive with bids.”
From the insurer’s perspective, another challenge to consider is that participants in poorer health are more likely to elect lump sums that may be tied into the risk-transfer effort. This in turn can impact pricing presented to the sponsor later in the process.
“Offering a lump sum opportunity to terminated participants with deferred benefits shortly before purchasing annuities for the participants who do not elect lump sums can increase the price of the annuities, as insurers will reflect the expected greater longevity of the remaining group in their pricing,” the issue brief explains.
The analysis concludes that life and annuity insurance companies are in the business of managing long-term risks, and many of them do so very effectively, so participants should not be by definition opposed to buyouts.
“However, rigorous steps need to be taken to fully evaluate the insurance company being considered in the selection process so that the ERISA protections under a qualified pension plan are replaced with the required protections under the insurer’s annuity contract,” the analysis concludes.
The full PRT issue brief can be downloaded here.