While combined pre‑funding and risk transfer actions have typically been economically positive, primarily due to the substantial increase in Pension Benefit Guaranty Corporation (PBGC) premiums and other defined benefit (DB) maintenance costs, many plan sponsors have stayed on the sidelines or managed pension risk tentatively, Mercer notes in a report.
However, Mercer says, pension sponsors are growing tired of market and regulatory volatility and are contemplating bolder action. Potential tax changes that will drive accelerated pre‑funding make a tipping point imminent. “We have seen many iterations of de‑risking actions over the past decade, and we see full plan terminations as the next wave, as many frozen plan sponsors convert from gradual steps to a Big Bang,” Mercer concludes.
The private defined benefit (DB) pension market of approximately $3 trillion dwarfs the total bulk buyouts executed to date, Mercer notes.
“Over the next five to 10 years, we expect to see a shakeout of the corporate pension market with substantial outflows to insurance and household balance sheets in the form of annuities written by insurers and participants taking their DB benefit as a cash option,” the report says. The company also anticipates a number of factors will align in 2017 to accelerate pension changes and upend the relative inertia of recent years.
“We see an imminent tipping point on pension pre‑funding that will, in turn, drive (or be driven by) pension risk transfer opportunities. While many will stick with their ‘hurry up and wait’ mentality in hopes of a more bullish market, we see an increasing number of plan sponsors jumping to the endgame. For frozen plans in particular, voluntary funding to terminate now, seen as a bold move in the past, may now be a very smart one,” Mercer says.NEXT: Factors driving the change
According to the report, key factors driving accelerated pension activity include:
- Increasing PBGC premiums – These have been the primary rationale for pre‑funding, potentially with partial or full (i.e. plan termination) risk-transfer actions. Both the per‑participant and variable rate premiums have increased fourfold, Mercer notes.
- The prospect of reducing corporate taxes makes pension pre‑funding even more compelling. The changing corporate tax outlook with the new administration may, at face value, deteriorate tax deduction benefits of pension pre‑funding. However, as pension funding is inevitable for many in the near‑term, more will opt for taking a higher deduction sooner rather than later by accelerating pre‑funding. For example, should corporate taxes reduce next year, plan sponsors will be provided a window of opportunity to pre‑fund in 2017, availing of the higher corporate tax deductions.
- The potential flood of repatriated cash for global sponsors will be looking for a home if and when related tax levies are eased or eliminated under the new administration. For many, the search for investment opportunities by free cash flow is already difficult. When combined with other incentives described above, pension funding emerges as an attractive opportunity for this newfound cash—supporting further de‑risking or outright exit.
- Pension sponsors are suffering from volatility fatigue having ridden the funding rollercoaster for several decades. “Our experience is that most sponsors are tired of second guessing rate moves, and more of them feel they should not be in the business of making these calls. Beyond the interest rate psychology, pension sponsors are jaded by pension volatility in general; including market, longevity and regulatory unpredictability. With geopolitical and economic tail risks in the daily news, more are thinking now may be a good time to right‑size their risk budgets to their core business and get out of the pension business entirely,” Mercer says.
- A more selective insurance market with potential first mover advantage saw many insurers become more selective in 2016 in the liabilities they take on with particular reticence related to deferred and/or complex benefits for active or vested terminated employees. Careful consideration is now warranted to packaging and sequencing buyout activity with an eye to insurer appetite and how that evolves. “Given the other factors outlined above, we anticipate a much higher demand for plan terminations, resulting in further pressure on the insurance market, particularly for deferred benefits. We anticipate those that start to prepare now will have a pricing and execution certainty advantage given the potential triggering events on the horizon,” the report says.
- The never ending regulatory roundabout extends well beyond the PBGC headwinds. Recent years have seen increases in longevity assumptions for various purposes, only to be dialed back over the past year, causing confusion and distraction. This is just one example of the byzantine oversight of U.S. pensions that keeps service providers busy and pension sponsors distracted from their core business.