Without the support of a broader de-risking plan, partial buyouts can be an expensive way to only marginally reduce pension risk—and possibly even increase it, argued NISA Investment Advisors in its latest white paper.
“Plan sponsors eyeing a partial buyout… should ask whether de-risking by asset allocation instead can actually get them where they want to be with much less labor and effort.”According to NISA, anything less than a full buyout often leaves a pension plan with a significant amount of risk. Factors such as the allocation of the remaining assets and the demographics of the remaining participants—younger pensioners being both riskier and more likely to stay behind in a partial buyout—can add up to leave a plan in a worse position than it was to begin with.
NISA found that insurers in partial buyouts tend only to be interested in the retiree portion of liabilities—those currently being paid out to former employees who have stopped working. According to the report, a partial buyout of that nature might mean the plan is left with liablities that are smaller, but also more volatile.
“Without a holistic, plan-wide de-risking approach, a partial buyout can lead to the undesirable outcome of paying a premium to achieve a reduction in pension risk that could have been reached by a simple change in asset allocation,” the paper warned.
According to NISA, “while the size of the liability will decrease after a transaction, the risk reduction may be underwhelming.”
Sponsors should not commit to partial buyouts unless they plan to reduce overall risk in the pension fund as much as possible, NISA said. Instead, the firm supported liability-driven investing, with the report concluding that “a lion’s share of pension risk can be eliminated by simply changing asset allocation.”
“Plan sponsors eyeing a partial buyout… should ask whether derisking by asset allocation instead can actually get them where they want to be with much less labor and effort,” the report continued.
But those in the pension risk transfer business disagreed with NISA’s assessment. Phil Waldeck, head of Prudential Retirement’s Pensions & Structured Solutions business, said that some of the largest and most sophisticated pensions on both sides of the Atlantic have seen value in partial buyouts.
“Companies benefit from a range of solutions to manage risk,” Waldeck said. “As companies’ tolerance for volatile pension outcomes decreases, more companies are electing to achieve greater certainty by transferring pension risk.”
Most recently, the UK pension fund of industrial giant ICI completed a £5 billion ($7.6 billion) derisking project involving several partial buyouts over a three-year period.
For those that do elect to transfer risk, NISA advised mitigating the risk leftover by shifting asset allocation to match the remaining liabilities. By combining the two strategies, the report concluded, pensions might actually achieve the best results.