Factors Still Ripe for Choosing Pension Risk Transfer

Mercer has seen that roughly half of defined benefit (DB) plans considering risk transfers have done a lump-sum window for terminated, vested participants in last two years or have one underway for 2015, according to Matt McDaniel, principal and business leader for Mercer’s Philadelphia retirement practice.

The trend now is annuity buyouts for retirees, he told attendees of a Mercer webcast.

Lump-sum economics are different from buyout economics, McDaniel notes, and the reason some plan sponsors are considering lump sums in 2015 is if they look ahead, the situation could get worse. He explains that lump-sum calculations for participants are higher with interest rates low, so plan sponsors may think they should wait until interest rates rise. However, it is anticipated the Internal Revenue Service (IRS) will update mortality tables for lump-sum calculations just like the Society of Actuaries updated mortality tables for accounting purposes—Mercer is hearing from some sources that updated IRS tables could be fast tracked to be effective 2016, McDaniel says—which will make lump-sum calculations even higher.

“Interest rates would have to rise significantly for lump sums to be reduced to below 2015 levels,” he notes. “So there could be a cost to waiting.” He adds that increased Pension Benefit Guaranty Corporation (PBGC) premiums also add to the cost of holding liabilities.

Sean Brennan, a partner in Mercer’s Buyout Strategy group in New York, notes that the Mercer U.S. Buyout Index finds the average premium for purchasing an annuity to cover DB liabilities decreased from 9% of the total liability as of November 30 to 5.3% as of December 31. This is primarily due to the adoption of new Society of Actuaries mortality tables; plan sponsor accounting liabilities now look more like what insurers have been basing their pricing on. Mercer thinks this will drive more plan sponsors to considering annuity buyouts for the DB plans, Brennan says.

Richard McEvoy, a partner in Mercer’s financial strategy group in New York, says low interest rates and volatile markets are hindering some pension risk transfer action, but many plan sponsors are tired of trying to second guess interest rate and market movements.

Some plan sponsors have accounting concerns; they have the view that investors will punish de-risking activity. But, according to McEvoy, there is no evidence that this is happening. “There is a one-time charge to absorb, but in the long-term, accounting is better.”

Some DB plans have increasing plan deficits, in part, because of new mortality assumptions, which result in higher cash costs for pension buyouts. But, McEvoy notes that increasing PBGC rates are making pre-funding DB plans through an annuity purchase compelling. “Plan sponsors will save up to 3% a year on variable rate premiums,” he says.

Mercer recommends creating a strategic plan, monitoring preparedness for risk transfer in an ongoing way so the plan sponsor will be ready to execute, and evaluating DB plan participant security. He notes that the Mercer Pension Risk Exchange is a solution that helps plan sponsors with these steps. It includes ongoing price monitoring to be able to execute a risk transfer when the time is right, as well as investment advice to coordinate with de-risking activity.

Looking at DB risk transfer deals over the years, Brennan notes that traditionally the annuity selected was backed by the insurer’s general account, now it is becoming more popular to choose an annuity backed by a pool of assets dedicated to obligations in a separate account—if the separate account assets become insufficient, they are backed by the general account. However, increased focus on participant security has created an emerging trend of using an annuity that is split between insurers, or splitting liabilities by groups of participants and using multiple annuities This strategy was used for the recently announced Kimberly-Clark pension risk transfer transaction. “It can enhance guarantee protection for participants,” Brennan says.