Pension Risk Transfer Appetite Is Unabated

Legal & General Retirement America’s Pension Risk Transfer Monitor shows the U.S. pension risk transfer (PRT) market has remained very active throughout the first three quarters of 2019.

Relative to the same period in 2018, this year has seen a 12% increase in total deal count. According to the report, the total premium paid only increased by 1%, largely due to an “outlier transaction” in the second quarter of 2018, when FedEx entered into a $6 billion PRT transaction. Excluding the FedEx transaction, the total premium increase is nearly 53%.

The analysis shows plan terminations accounted for just under $4 billion of sales in the first half of this year, nearly surpassing total plan termination sales in 2018.

Legal & General Retirement America projects that this year’s final deal volume will approach, but not reach, the record level set in 2012. Looking back, 2013 saw far less PRT activity than 2012, but each year since 2013, the PRT transaction total has increased or remained essentially flat, as was the case between 2015 and 2016.

The research points to a variety of causes for the trend of increased PRT transactions. Insurance premiums paid to the Pension Benefit Guaranty Corporation (PBGC) continue to increase, and at the same time, the Internal Revenue Service (IRS) is instituting updated mortality tables, which reflect a longevity measurement more in sync with insurance carrier assumptions.

Employers that sponsor defined benefit (DB) plans are increasingly recognizing the value of PRT annuities as they look to accomplish multiple goals, says Neil Drzewiecki, head of pension risk transfer for MassMutual. He says annuities help employers shift pension risks off their balance sheets, reduce their long-term financial liabilities and costs, and maintain long-term financial security and service for plan participants.

As detailed in a new MassMutual white paper on the topic, PRT effectively represents the only way to eliminate pension obligations under current law. This is another core reason why pension buy-out transactions have steadily gained traction during the past several years, growing from $3.84 billion in 2013 to $26.4 billion in 2018. The paper notes PBGC premiums for single-employer plans have more than doubled in the past 10 years, rising to $80 per participant in 2019.

“There are several different risk strategies for employers to contemplate when managing pension risks over both the short- and long-term,” Drzewiecki says. “More employers are concluding that transferring those risks to a life insurer is in the best interests of the company and its employees.”

He points to several short-term and long-term strategies for managing pension risks. First is to address “hibernating risks.” When plans are in “hibernation,” they have been closed to any new entrants and have stopped accruals for participants. While hibernating a DB plan protects against the risk of benefit increases, such plans are still exposed to many other risks, especially interest-rate risk, Drzewiecki says.

Next, in order to manage market risk, some plan sponsors elect to reallocate investments according to a funded stats-based schedule to hedge the exposure of their plan’s liabilities. With this approach, plan investments are increasingly allocated toward fixed income as the plan’s funded status improves. Doing so helps diminish the risk-reward tradeoff associated with equities, while fixed-income assets helps provide a hedging effect as interest rates rise or fall.

Another consideration for plans is whether/how to hedge equity market risk. Often, hedging reduces investment risks but does not eliminate them entirely. According to MassMutual, while it’s impossible to hedge every risk, hedging can help lower risk and create less volatility in some cases.

MassMutual’s analysis concludes that, as the management of pensions becomes more complex, employers are concluding that they and their employees would be better served by shifting defined benefit obligations, liabilities and risks to life insurers, which focus on risk management as their primary purpose. Insurers are also well-equipped to offer administrative services to large groups of plan participants.

“Many companies have considerable experience administering annuities for pension plans that have previously purchased annuities as well as other insurance-oriented lines of business that are similar to pensions,” the white paper concludes. “Life insurers, with their experience managing tail risks that can extend decades, are professional risk managers and are, therefore, best equipped to handle such risks.”