Although in 2015 we didn’t see the same number of large companies offering lump-sum windows or transferring some pension liabilities to insurers as we saw in previous years, there is still a steady movement of pension risk transfer activity in the defined benefit (DB) plan space.
At least one large firm this year, Kimberly-Clark, entered into purchase agreements with The Prudential Insurance Company of America and Massachusetts Mutual Life Insurance Company for group annuity contracts to transfer payment responsibility for retirement pension benefits estimated at approximately $2.5 billion owed to some 21,000 Kimberly-Clark retirees in the U.S.
At the same time, more small and medium-sized companies are seeking pension buy-outs, LIMRA sales data shows. In August, Lincoln Electric Company entered into an agreement to purchase a group annuity contract from The Principal Financial Group to settle $425 million of its outstanding U.S. pension obligations.
News of such actions is spread out because transferring pension risk doesn’t happen overnight. Firms prepare with investing strategies or by “cleaning up” their plans before actually making a move. Nearly half of large defined benefit (DB) plan sponsors (45%) have taken proactive steps to prepare for an eventual pension risk transfer, according to MetLife’s 2015 Pension Risk Transfer Poll.
For example, plan sponsors looking to enact a pension risk transfer transaction, but lacking sufficient cash, might consider “hibernating” their portfolio until a more favorable risk transfer opportunity arises. “Hibernation” means getting a liability driven investing program in place for a frozen pension plan, and then letting the natural process of paying out benefits shrink the plan, and thus shrink the overall pension risk and the size of a future transfer premium.
The fastest-executed transactions take five or six months from start to finish, but most take significantly longer. Plan sponsors must clean up the census and benefits calculation data and find the right consulting and advisory partners and the right insurer to actually take on the risk. When selecting an insurer, the insurer’s financials are just a starting point; plan sponsors need to assess how its retirees are going to be treated, educated and communicated with for years to come.NEXT: Concerns not slowing pension risk transfer activity
DB plan participants are concerned that pension risk transfers will mean their benefits will not be as well protected as Employee Retirement Income Security Act (ERISA)-covered benefits, for example in the case of a personal bankruptcy or the bankruptcy of the insurer taking on the liabilities. This was the claim in a case against Verizon, which made the decision in 2012 to transfer obligations for 41,000 of its DB participants accounts. They also claimed they were blindsided by the transaction—not given sufficient notice or time to object. But, the 5th U.S. Circuit Court of Appeals eventually blessed the Verizon deal, ruling that the decisions to amend the plan and transfer certain assets to an annuity contract were settlor, not fiduciary, functions.
Participants are not the only ones concerned; this year, the states of New York and Connecticut have passed laws to protect pensioners whose benefits are divested from the protections of ERISA and the insurance of the Pension Benefit Guaranty Corporation (PBGC). Many say one factor leading DB plan sponsors to decide to transfer pension risk is rising PBGC premiums, and this is making the agency nervous because as more companies transfer risk, premiums paid to the PBGC will be less, potentially diminishing its financial stability and ability to protect those with accounts still in employer-sponsored plans. The agency has begun requesting pension risk transfer information in premium filings.
Lump-sum transfers cause some concerns as well—fears that those who take a lump-sum payment of benefits will not reinvest the money or will not know how to manage their investments. In July, the Internal Revenue Service (IRS) announced that DB plan sponsors may no longer offer a lump-sum window to participants who have begun receiving installments.
Despite these concerns, DB plan sponsors and providers see pension risk transfer as an effective option for ensuring retirees will receive the benefits they’ve accrued, as well as protect the finances of the sponsoring company. Insurance companies can invest for, and administer, retiree liabilities more efficiently than most plan sponsors, owing to their greater size. Plus, insurers’ efficiency is shared with plan sponsors in the pricing of risk transfer deals, says Caitlin Long, head of the pension solutions group at Morgan Stanley in New York City. “This is why both the sponsors and insurance companies have felt that the transactions were good deals.”
PBGC recently released a study of DB plans with more than 1,000 participants and found 534 had some kind of risk transfer activity in the years 2009 to 2013. According to LIMRA data, group pension buyout sales were $8.5 billion in 2014, compared with $3.8 billion in 2013. The pension risk transfer train shows no signs of slowing down.