A corporate pension risk transfer (PRT) in an innately risky undertaking. First are the risks of sitting tight and not doing a PRT. Such as: Will low interest rates continue and make the effort to meet liabilities harder? What if the stock market craters and stays low for a prolonged period? Can a plan meet its obligations in coming decades if the number of beneficiaries is unclear?
But then there are the fresh risks of taking the leap and making a transfer. Like: Is bridging the gap to full funding, which an insurer requires to do a deal, too grave a sacrifice? Diverting precious company capital to boost the funding level could deprive the business of the fuel it needs to grow.
Questions along these lines occupy plan sponsors as they contemplate removing liabilities that can thwart them over the long term. No wonder doing a PRT is a fraught experience. “It’s time-consuming and expensive,” said Anthony Parish, CIO at Alphastar Capital Management, a PRT adviser.
The process of finding an insurance company to take over a defined benefit (DB) plan’s liabilities—and the assets that are focused on paying them over time—involves bidding by insurers for the job. If little chance exists that a plan can achieve 100% funding, insurers will take a pass.
That’s why plans often don’t tend to unload all obligations all at once. The standard progression is to first close a plan to new hires and to freeze the ability of existing participants to accrue more pension credits—based on pay and years of service—for their future time at the company.
This gives sponsors a better handle on the size of their liabilities. One more way to lighten a sponsor’s load is to offer participants a lump sum, which they take in exchange for forfeiting all rights to pension payments.
Then we get to the PRT. From there, the common practice is to say goodbye to groups of beneficiaries bit by bit. Delivering an entire plan to an insurer—and thus terminating all future obligations—is an enormously complicated task and can take anywhere from 12 to 18 months to perform.
The piecemeal approach is quicker and easier, although certainly a hassle, too. Often the first to be loaded on the PRT conveyor belt are those with the smallest benefits. Sponsors “might choose everyone who gets below $500 a month, because they are expensive to carry,” noted Ari Jacobs, global retirement solutions leader at Aon, which advises plan sponsors.
The Pension Benefit Guaranty Corporation (PBGC), a federal agency that oversees DB plans for 34 million US workers, charges the same amount in premiums to insure a plan for a small benefit as it does for a large payout, Jacobs pointed out.
The easiest group to transfer? Retirees who are currently drawing pension payments, said Mark Paracer, research outfit LIMRA’s assistant research director. Insurers “know what benefits they will be receiving,” as opposed to existing employees whose payments might be tougher to quantify, he explained.
Insurers like to say, with some justification, that they are simply better at administering plans. In the case of PRTs, that means large group annuities. After all, the carriers have offered annuities for many, many years, and know best how to judge beneficiaries in actuarial terms. Also, they have better scale when investing the plan assets. Insurers, said Alexandra Hyten, head of Prudential Financial’s PRT effort, “are more efficient holders” of plan assets and liabilities.
One bonus for insurers: They don’t need to pay the increasingly higher premiums that corporate plans are charged by the PBGC. The premiums now sits at $86 per participant, which is quite an increase from the $35 the agency charged 10 years before.
Burdens like that are why a good number of sponsors happily part company with their DB plans.