Special Report: How to Ensure a Smooth Pension Risk Transfer - Chief Investment Officer

For employers, the number of reasons they should consider offloading some or all of their pension liabilities from their balance sheets seems to be growing every year. On average, beneficiaries are expected to live longer than they have in the past; generating returns to cover liabilities is becoming more challenging in a low interest rate environment; and premiums for the Pension Benefit Guaranty Corporation (PBGC) keep rising.

Already, many plan sponsors are expected to power through deals this year. After the pandemic dampened deal flow for the first part of last year, the market is expected to continue its “steady upward trend,” according to Willis Towers Watson.

Pension risk transfers (PRTs) can be straightforward for plan sponsors. But without careful preparation, offloading liabilities can be costly and overlong endeavors for employers. To make these deals attractive to insurers from the start, plan sponsors should get a couple things in their house in order.

Here are five things investors should consider before moving forward:

Understand Your Transaction

Asset owners planning pension risk transfers will want to figure out what’s feasible for their plan. Should they move forward with a buyout or a buy-in (closing the plan after transferring the liabilities to an insurer or maintaining administrative control of the plan)? Do they have the resources to fund a full plan termination? Or should they start with lift-outs (annuitizing just a subset of the plan participants)? Should they offer participants a lump sum to lower the number of beneficiaries in a plan?

A full plan termination would take more than a full year to complete. Plan sponsors need time to immunize and fully de-risk investment portfolios, as well as file forms with regulators such as the PBGC and the IRS. At the same time, insurers have to calculate the cost of future payouts to all beneficiaries under the plan, including retirees and current workers.

On the other hand, retiree lift-outs, which only siphon off a portion of pensioners, are fairly easy for employers to execute and can be completed in a matter of months or weeks, according to Legal & General Retirement America (LGRA). The speed can be attractive to some plan sponsors. In the third quarter of last year, nearly two-thirds of the pension risk transfer market was driven by retiree lift-outs, given that employers wanted to offload at least a portion of their liabilities quickly.

Ready Your Data

Asset owners who want a fair price from insurers will want to pass on as much information on their defined benefit (DB) plans as possible. The insurers that are underwriting liabilities will want a robust understanding of life expectancy for the underlying population, whether it skews female or male, blue collar or white collar, and so on.

Readying the data gets more complicated if the transaction involves a lift-out of a specific demographic. Plan sponsors planning to hand over liabilities for older workers, for example, will have to develop more granular data, instead of handing over historic mortality tables for the total DB plan. Any incomplete or inaccurate data will only delay the transfer.

“The more you get it into subgroups, the more you need to understand what’s there,” said Kevin McLaughlin, head of liability risk management at Insight Investment.

Some Fiduciary Concerns

As fiduciaries, employers are also required to do their due diligence and to choose the safest available annuity provider, as determined by the Department of Labor (DOL). Plan sponsors should seek insurers with well-diversified investment portfolios, as well as review the insurers’ capital, surplus, and lines of business, as outlined by the DOL 95-1.

Employers should also seek additional protections for their liabilities. Like the PBGC, many state governments can also guarantee pension liabilities. Employers can also seek annuity contracts with greater protections, such as through separate account structures, which are often used for larger deals.

In the event of a lift-out or buyout, versus a full termination, plan sponsors also have the fiduciary duty to review the impact any PRT will have on the remaining participants, according to McLaughlin. One way to ensure that the residual plan participants are not disadvantaged by the restructuring of the DB plan is to make sure the funded status is no worse after the transaction, which usually requires the employer to top off any shortfall.

Risk Management

Insurers also price transfers based on the quality of the assets with the DB portfolio. They typically prefer portfolios with more liquid assets, such as corporate bonds, Treasurys, and cash, versus more complex instruments. Asset owners should move early if they’re planning on starting a pension risk transfer to make it an easy process.

“The more time you have to do a risk transfer in one to three years, to start working on the portfolios and removing any of these more complicated or esoteric features that are unlikely to transfer to an insurance,” the better, McLaughlin said.

Communicate with Your Members

Ultimately, any news of the pension risk transfer will be most significant to the plan participants or retirees who fall under it. Plan sponsors should start communicating with beneficiaries as early as possible about what their options are, such as how they will be transferring payroll and other administrative records.

Said McLaughlin, “You have to let everybody know what the plan is.”