Risk Capture

In the U.S., interest in pension risk transfer (PRT) is growing among defined benefit (DB) plans. Over the past several years, some large plan sponsors have forged the way—General Motors, Verizon and Kimberley-Clark, to name a few—offering lump-sum windows to certain terminated, vested participants and transferring the liabilities for retirees to an insurance company.

Nearly half of large defined benefit plan sponsors (45%) have taken proactive steps to prepare for an eventual pension risk transfer, according to MetLife’s 2015 Pension Risk Transfer Poll. The Pension Benefit Guaranty Corporation (PBGC) recently released a study of 3,590 DB plans with more than 1,000 participants and found 534 had some kind of risk transfer activity between 2009 and 2013. Small and medium-sized plan sponsors are seeking pension buyouts as well, data from LIMRA show.

Pension risk transfers are not limited to plans that have been closed or frozen. An active plan can offer lump sums to terminated vested participants and transfer liabilities for retiree payments.

The interest in understanding risk transfer options comes as defined benefit plan sponsors encounter additional challenges. Advisers to these plans know that their sponsors are faced with a barrage of new accounting and funding requirements, and market performance and revised mortality tables have led to a decrease in funded status for many. More recently, plan sponsors have been faced with higher PBGC premiums. Many clients have already frozen or closed their plan to try to decrease its impact on the balance sheet.

For advisers whose plan sponsor clients have a defined benefit plan, now is the time to educate themselves about pension risk transfer and to partner with an insurance provider on administration, says Wayne Daniel, senior vice president and head of U.S. pensions for MetLife in New York City. “They can demonstrate to their clients that they are looking out for clients’ best interest and [thereby] add value,” he says.

Is Pension Risk Transfer Suitable?
Russ Proctor, director of institutional markets at Pacific Life Insurance Co. in Newport Beach, California, says the adviser needs to determine whether a client is able to deal with the volatility and risk of the pension plan or would be better suited to offloading it. For example, he says, General Motors’ pension liability was about four times the size of its market capitalization when it performed a large de-risking deal in 2012; many believed that the liability had become too big in relation to the company.

In addition, if a client’s plan is closed or frozen, that is a flag that something needs to be done, Proctor says. “The plan sponsor didn’t freeze [the plan] for the purpose of keeping it frozen; it wanted to move the plan off its balance sheet at some point. Pension risk transfer fits in almost all of those situations,” he says.

One thing advisers can do when helping clients consider a pension risk transfer is provide an expense analysis to compare the cost of maintaining the plan with the cost of solutions, Proctor says. Mercer performs a monthly analysis to show plan sponsors how much they could save by purchasing an annuity. For example, the Mercer U.S. Pension Buyout Index, November 2015, showed that during that month, the average cost of purchasing annuities from an insurer was 105.2% of the accounting liability. In the same period, the economic cost of maintaining the liability was 105.6% of the accounting liability.

Advisers and sponsors should also consider the funded status of the plan, Proctor says. If the plan is poorly funded, it limits the solutions available to the sponsor. The funded status must be good in order to offer a lump-sum payment window and/or to purchase an annuity from an insurer. So, according to Proctor, the first step for an adviser may be to help the plan sponsor with a liability-driven investing (LDI) portfolio strategy or glide path strategy to get the plan better funded. Once the decision to transfer pension risk has been made, the end goal is that all of the liability will either be paid to participants as lump sums or transferred to an annuity provider, Proctor says.

Richard Taube, vice president of institutional markets at Pacific Life, also in Newport Beach, points out that the process to complete pension risk transfer takes six to 18 months once a decision has been made to terminate the plan, but it could take years from the time a plan is frozen. Getting the investment portfolio in shape and ensuring clean plan data can take up to a year alone, he says.

Advising Clients Along the Way
“A good plan adviser is able to take the sponsor and pension plan all the way through, from freezing the plan to reviewing benefits calculations and the plan data, to considering de-risking options,” Daniel says. Advisers also need to review benefits calculations to make sure they are correct and make sure data representing participants and retirees is accurate, he says, adding that advisers can help plan sponsors determine the best time to approach the insurance market to get the best premium.

Proctor explains that, with an annuity buy-in, liabilities are insured with an annuity but remain assets of the plan. Implementing a buy-in does not result in plan sponsor settlement accounting or reduce funded status, but it could be a useful first step to an annuity buyout.

Moreover, he says, insured LDI has been available from the insurance industry for about four years. This can help stabilize the plan’s funded status and provide liquidity for payments—another helpful step before pension risk transfer. He explains that traditional LDI attempts to make plan assets match liabilities, which change with interest rate changes.

For example, for generally accepted accounting principles (GAAP) account purposes, the pension liability is often discounted using a rate based on the Citigroup Pension Discount Curve (CPDC), which, in turn, is based on AA corporate bonds. With traditional LDI, using bonds, derivatives and other investments, the plan sponsor tries to match the movement of that yield curve, but there is no guarantee the match will be exact; the CPDC changes each month. With insured LDI, an investment contract is valued each month by recalculating the contract value according to the present value of the plan’s projected benefit payments using that month’s CPDC. Thus, there will be no tracking error between the contract value and liability based on the projected benefits provided by the plan sponsor, thereby yielding a perfect match between assets and liabilities.

Advisers can suggest, “Here are some solutions available to help with moving the plan off [your] books” and can help the plan sponsor calculate which solution is best, Proctor says.

With so many moving parts to pension risk transfer, advisers should create a plan to help the sponsor understand the entire process and ensure it has the right people available to help, Proctor says. Besides the plan sponsor, adviser and insurer, the sponsor’s actuary and/or accountant will play a role in the overall process, Taube observes.

Interpretive Bulletin 95-1
Proctor says many advisers help with selecting an insurer, for instance. He notes that the Department of Labor (DOL) has provided some guidance for this in Interpretive Bulletin (IB) 95-1. Advisers can help with gathering data about insurers to see which meet the plan sponsor’s criteria, selecting five or so to bid on the deal and then choosing the right one. He points out that selection of the annuity provider is a fiduciary function; advisers may either take on that role themselves or hire an independent fiduciary to do so.

In IB 95-1, the DOL takes the position that the plan fiduciary implementing a termination need not hire outside experts, to the extent the fiduciary has the requisite expertise. When the fiduciary is potentially conflicted with respect to a transaction, the department favors hiring an independent fiduciary to make or advise on the decision.

IB-95-1 also says the fiduciary must select the “safest available” annuity, unless the participants’ interests would clearly be served otherwise. It gives only two examples of annuities it considers acceptable though not the “safest available”: 1) where the safest annuity provider is unable to process claims, and 2) where the safest annuity is only “marginally” safer and disproportionately more expensive, the participants benefiting from the price difference in the form of enhanced annuities.

Moreover, IB 95-1 states that, in selecting the annuity, the fiduciary may not rely solely on ratings by insurance atings services. Rather, it must evaluate the soundness of the annuity on the basis of at least six factors: 1) quality and diversification of the annuity provider’s investment portfolio; 2) size of the insurer relative to the proposed contract; 3) the level of the insurer’s capital and surplus; 4) the annuity provider’s exposure to liability from its other lines of business; 5) structure of the annuity contract and guarantees supporting the annuities, such as the use of separate accounts; and 6) availability of additional protection through state guarantee agencies. In addition to safety and soundness of the annuity, the fiduciary must also take into account the ability of the provider to process claims.

Getting Education and Experience
Daniel says general awareness of pension risk transfer is growing among advisers. In the past, MetLife had “de-risking 101” conversations with them, but they have become more informed from press coverage and industry conferences.

For an adviser less experienced with pension risk transfer, talking to insurers that are active in the market will improve his knowledge, Daniel suggests. “Advisers need to understand the requirements insurers have; they ask for very specific data about each participant and have very specific questions about plan information before undertaking a pension risk transfer,” he says.

Proctor says there are many resources available for advisers to learn more about PRT. Providers and publications offer webinars about the topic, and industry conferences, especially those run by actuaries or accountants, frequently discuss it. Pacific Life sponsored a research paper written by employees of Ernst & Young that offers a framework for evaluating pension de-risking strategies.

“It’s a complicated field, and, with [the] fiduciary issues, it is hard for a new adviser to just jump in and do it on his own,” Proctor notes. “But we have seen an instance where a new adviser partnered with an experienced adviser familiar with the process,” he says.

Even advisers mostly focused on the defined contribution (DC) plan market can get in on pension risk transfer deals. “We are seeing more DC-focused advisers who want to help their clients with their pain points get involved with their clients’ DB plans,” Proctor says. Pacific Life finds that increasing PBGC premiums are the most common driver of pension risk transfer conversations.

“The U.S. pension risk transfer market is currently quite active and buoyant, and we expect that to continue through 2016,” Daniel concludes.

Where Advisers Play a Role In the
Pension Risk Transfer Process

Advisers can help by:

• Identifying who in the company’s internal team will manage the pension risk transfer process;
• Retaining players such as specialty consultants—­actuaries, investment bankers and/or legal counsel, etc.—to help guide the plan sponsor through the process;
• Reviewing a financial analysis for the plan and implementing a new investment strategy, if needed, to improve the plan’s funded status;
• Reviewing and cleansing participant data;
• Conducting insurer due diligence;
• Developing and issuing a request for proposals (RFP) from insurers;
• Evaluating RFP responses, including quotes, submitted by the insurers;
• Selecting the annuity provider; and
• Communicating to plan participants, retirees, etc.

Source: MetLife

Key Takeaways:

• Determine whether the pension liability is too large.
• Partner with an insurance provider, actuary and accountant.
• Offer lump-sum payments and/or purchase an annuity.