High interest rates have made it a good time for some defined benefit plan sponsors to transfer pension risk, but a liquidity pinch may be delaying or altogether shutting off the window, according to experts who spoke at PLANADVISER’s virtual DB Summit last week.
The interest rate hikes, which the Federal Reserve started about a year ago to try and tame inflation, have brought present liability down for many plans, said Gloria Griesinger, assistant treasurer for global pension investments and M&A support at Cummins Inc. If sponsors were invested conservatively enough not to be hit too badly by market downturns, they may be in a good position to transfer their participant obligations to an insurer, she said.
“In some cases, if your assets were invested properly—faster than then your assets went down—you’re in a good position to do a risk transfer,” Griesinger said during the webinar called Factors in DB Plan Decisionmaking.
Total risk transfers hit a record in 2022, according to LIMRA, an insurance industry association. Total U.S. single premium buy-out sales hit $48.3 billion last year, up 42% from 2021, according to the Windsor, Connecticut-based association.
Many defined benefit plan sponsors, however, are in a tough spot if they are looking to do a transfer, as they do not have enough liquidity to fund the transaction, according to Griesinger.
“You can’t do it if you don’t have liquidity,” she said. “And if you’ve been aggressively investing, sometimes in doing more less-liquid private market assets, those have been really hit because of the turmoil in the markets.”
It has been much more difficult, Griesinger said, to get good valuations on those investments to sell them into the secondary market without taking a loss.
“There’s a glut right now,” she said. “There’s great value if you’re a buyer, but there’s a lot of difficulty if you’re a seller, and you’d have to be willing to take those haircuts in order to come up with the cash so you can do the risk transfer.”
As recently as March 7, the Fed signaled further aggressive rate hikes this year, with job gains outpacing expectations as of Friday—which would suggest more tightening. Over the weekend, however, the collapse of Silicon Valley Bank has some experts predicting a slowdown of hikes to ease stress in the markets.
SVB’s woes were due in part to holding long-term bonds locked in at lower returns that have since lost their value due to rising interest rates, according to ratings agency Moody’s. On Sunday, the Department of the Treasury said it was “fully protecting” all depositors in the bank through a protective fund fed into by other banks called the Deposit Insurance Fund—not via taxpayers.
The SVB circumstances are likely to continue volatility in the markets that will have plan sponsors considering their specific situation when it comes to pension risk transfers. Up to now, many DB plan holders have been considering transfers such as insurance annuity lift-outs or lump-sum-window payouts, Jeff Witt, a principal at Groom Law Group, said during Wednesday’s summit.
“What we’re seeing, even on an administrative and plan design side, is that companies are addressing risk transfer to minimize volatility and move their financial statements from a benefit program that may not be their core business,” Witt said.
For open defined benefit plans, some companies have decided to stop admitting participants and to freeze the plan for when they can find a good time to transfer. At that point, Dewitt says, financial management becomes critical, as plan sponsors need to act in a timely way, but one that also takes into account a long, 12 to 24 month window for a plan to terminate.
“You need to have everything ready so that when you get to a friendly financial environment, you are receptive to taking these actions, and you’re able to do it in the right way,” he said.
A crucial part of being prepared, according to Griesinger, is having clean data on the participant pool and assets. “If the data is not clean, you can’t do it, or it’s going to take more time or a [hit] on the pricing,” she said. “The insurance companies are not going to want to take on the risks of your data, or they’ll just walk away.”
Witt added that when a participant hits age 65, they get a notice from the Social Security Administration advising them that they are entitled to a benefit from the plan, often called a “pot of gold.” That, in turn, will trigger retirees coming to the company asking for their benefits—a trend, he notes, that is likely to increase as more Baby Boomers reach retirement age.
“For a lot of my clients, especially if you’ve had plans that have gone through acquisitions, or you did an acquisition … there may not be a clean trail,” Witt said.
All pension plans will have some data issues, he noted, but fiduciaries and companies can work to ensure their data is in the best shape possible.
Pros and Cons
Overall, Griesinger noted that it is hard to argue for maintaining a defined benefit plan these days. It is a difficult proposition when considering the multiple parties needed, both internally and externally, to design and administer the plan, as well as dealing with regulatory oversight and potential audits from the DOL and IRs, she said.
“That’s a burden, and it’s a burden that so many companies, because of cutbacks and slowing things down, just are not prepared to handle,” she said. “If you’re a company that prides itself on rotating people through positions, and you don’t have that expertise to figure out [long-term complications], … why have a DB plan?”
Witt, who agreed with Griesinger, did not some positives to DB plans. He said that sponsors can offer a plan without paying as much upfront as you’re not funding it dollar for dollar as in a profit-sharing contribution, but paying it out at a later date. It can also ensure that participants have a steady income in retirement, something that, thought he DC world is trying hard to implement, is often not taken or wanted by participants, particularly when they are younger.
“When your employees are in their 20s 30s and 40s, they really don’t appreciate the defined benefit plan,” he said. “But once they start getting to their late 40s and 50s and start seeing retirement on the horizon, all of a sudden, that carries tremendous value … all of a sudden, at that point, they realize the value of that pension of saying, ‘Hey, I’m going get $1,000, or $2,000 a month for the rest of my life when I retire?’ That’s a big benefit.”
In the end, though, both experts see retirement income being solved within various options in DC plans..
“Thanks to new tools and evolutions, there are options we can now have in DC plans that will provide for lifetime income,” Griesinger said, noting in-plan annuity options may be chosen by plan participants or offered as a default option. “We can do things to help lower-earning employees prepare for retirement, and if you take that and you couple it with the fact that there’s a lot of portability in DCs, … there’s a lot of things that we are—and I do believe Congress is—trying to do to look out for plan participants to have a secure retirement.”