The Pension-Risk Transfer Game

aiCIO spoke with Scott Gaul, head of distribution for pension risk transfer at Prudential, about the current state of de-risking.
Reported by Bhakti Patel
Scott Gaul, Prudential’s head of distribution for pension risk transfer
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Few topics have dominated the corporate pension discussion of the past few years as pension-risk transfer has. In light of this—and in light of the fact that Prudential has come to dominate the American market for transferring pension liabilities—aiCIO recently spoke with Scott Gaul, head of distribution for pension risk transfer at Prudential, about the current state of de-risking.

aiCIO: It’s been about a year since the GM and Verizon mega-deals. Bring us up to date.

Gaul: This year, we’ve had hundreds of conversations with plan sponsors trying to help them understand what happened at GM and Verizon—what they did, how they did it, and whether it’s an option for their plan.

On a larger level, we’ve seen corporate funding status improve dramatically in 2013. A year ago, the average plan was in the mid- to high 70s. With interest rates rising and equity markets growing steadily, we saw a good run up late in the summer. What this means for us at Prudential is more conversations—our activity picked up as funding statuses improved.

The other trend that we’ve seen from a year ago is that most of our dialogues have shifted from “Why should I transfer risk?” to “How do I do it, and what are the risks?”

aiCIO: But why haven’t more plans followed GM and Verizon? Is it just that it takes a long time to go from idea to execution?

Gaul: These transactions take time. Prior to GM and Verizon, the unknown question was, “Is there capacity to get a large transaction done at a price that can benefit the company and its shareholders?”. With those transactions, the answer has become more clearly accepted as “yes.”

Many companies are preparing: Doing cost/benefit analysis, looking at product structures, hiring strategic advisors and talking to their boards. With funded statuses now in the 90 percent range, we expect activity to further accelerate into 2014 and 2015.

aiCIO: How long is it from preparation to execution? What is the timeframe?

Gaul: The GM transaction was probably as complex as you could get. From the point when they got serious with the insurance carriers, we were able to close within a year. There was a lot of work in the preparation phase that I can’t speak to—that’s in the sponsor’s hands—but if you can get all parties completely engaged on it, you can transact quicker.

aiCIO: One criticism we’ve heard from some CIOs is that GM and Verizon paid too much for this based on the possibility that interest rates might go up.

Gaul: I think first and foremost companies are trying to get a handle on what it costs them to hold the plan, and what it costs them to get rid of it.

GM and Verizon didn’t transact the whole plan. They ultimately focused on 25% of the pension obligation. Companies who want to wait for rates to go up and funding status to improve could take some of their fixed income assets where rates are locked in and transact on 25-50% of the plan to begin the de-risking process.

aiCIO: How does the relatively low level of interest rates factor into the decision?

Gaul: If you asked plan sponsors if they could immediately freeze the pension and annuitize, most companies would. So, it’s not the interest rate, per se, that informs the decision—it’s the funding status, and making an interest rate bet is one way to close the funding gap.

For a frozen plan at 105% funded, the risk becomes asymmetrical. They could take more risk to get to 110%, but if they went way over that, it’s hard to monetize that surplus. They have all the downside, and the upside is limited because they can’t get the cash out of the pension plan.

aiCIO: Is there a middle ground between the buyout option and LDI?

Gaul: Prudential is a very large LDI manager also, so most of our dialogues aren’t pension-risk transfer only. They are pension-risk transfer plus how do you manage the remaining assets.

LDI is embedded in a buyout. We think both of those solutions have a place, and then the dialogue becomes about the company’s goal. If it’s to clean up the balance sheet, then transferring those remaining risks may be appropriate. It’s not one or the other; both solutions play a role.

aiCIO: Is there a capacity issue in the marketplace?

Gaul: With a $3 trillion US pension market, all that money can’t move to an annuity buyout; it just can’t happen. In the short run, there seems to be plenty of capacity, especially when you consider that the average year prior to GM and Verizon there was $1 billion or $2 billion in total risk transfer. Based on research I’ve seen, over the next five years you could potentially move $100 billion dollars’ worth of liability in this space.