Corporate DB Sponsors Slow to Transfer Liabilities

Some defined benefit (DB) plan sponsors are reluctant to transfer liabilities to an insurer, saying it is too expensive, particularly compared with the accounting liability, Mercer says.

However, Mercer points out that accounting liability does not include all costs associated with maintaining the plan. Since October 2013, the cost of maintaining a DB plan continues to be approximately the same as the cost of transferring liabilities to an insurer for the sample plan modeled for Mercer’s U.S. Pension Buyout Index. The current environment allows plan sponsors who have evaluated a risk transfer to execute under favorable conditions, the consultant says.

During March, the index showed the average cost of purchasing annuities from an insurer increased slightly from 108.4% to 108.6% of the accounting liability. The economic cost of maintaining the liability remained level, at 108.7% of the balance sheet liability.

The index tracks the relationship between the accounting liability for retirees of a hypothetical DB plan and two cost measures—the estimated cost of transferring the pension liabilities to an insurance company (i.e., a buyout) and the approximate total economic cost of retaining the obligations on the balance sheet.

Mercer notes that research from the Society of Actuaries revealing people are living longer than expected may result in actuaries soon updating plan mortality assumptions, which would increase plan liabilities. While no start date has been established yet for when these new life expectancies are to be used, Mercer expects the Internal Revenue Service may require plans to use the new tables to assess funding from 2016 onward, while auditors may expect plan sponsors to reflect the new tables even earlier than that for accounting purposes. The increase to plan liabilities is expected to be greater than any increase seen in annuity prices, which Mercer believes will be another compelling reason for plan sponsors to purchase annuities and transfer the risk.

In addition, the annual per participant premiums for the Pension Benefit Guaranty Corporation (PBGC) were recently increased significantly, from $49 per participant in 2014 to $64 per participant in 2016, and increasing with inflation thereafter, according to the index. This increase of more than 30% is a contributing factor to the increasing costs to plan sponsors of maintaining their DB plan and is a large factor in many plan sponsors’ decisions to transfer liability (see "PBGC Premium Hikes Shake Up Buyout Landscape").

Mercer notes that the current economic environment, combined with the increase in PBGC premiums and adoption of the new mortality tables on the horizon, makes 2014 an attractive time for DB plan sponsors to consider an annuity buyout as an effective risk management tool.

According to Mercer, DB plan sponsors considering a buyout in the future should review their plan’s investment strategy and consider increasing their allocation to liability hedging assets, either immediately, given recent improvements in funded status, or over time as the funded status improves. This can reduce the likelihood of the funded status decreasing again, leading to unexpected additional cash being required to purchase annuities at a later stage.