COVID-19 Has Put Some PRTs Behind Schedule

DB plan sponsors are weighing their options for pension risk transfers and trying to balance what’s best not just for their finances, but for those of their participants.

Just as the effects of the COVID-19 pandemic have stalled implementation of certain plan decisions by defined contribution (DC) plan sponsors, they may have defined benefit (DB) plan sponsors rethinking the timing of pension risk transfers (PRTs). 

According to Milliman, a PRT is currently more expensive. The latest results of the Milliman Pension Buyout Index (MPBI) found that, during March, the projected cost to transfer pension risk to an insurer increased from 105.2% to 105.7% of a plan’s total liabilities. This means the estimated retiree PRT cost for the month is now 5.7% more than those plans’ retiree accumulated benefit obligation (ABO). March’s increase is the result of discount rates increasing 80 basis points (bps), compared to a 71-basis-point rise for annuity purchase rates, so the relative cost of annuities climbed slightly, Milliman says.

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 “Plan sponsors are currently monitoring where interest rates are,” notes Mary Leong, a consulting actuary at Milliman and co-author of the study.

She explains that the decline in interest rates affects not only annuity pricing, but a plan’s funded status as well. “It increases how much they’re going to need to contribute to go forward with a pension risk transfer,” she says.

Plan funded status, which compares the assets of the plan to its future liabilities—or projected benefit obligation (PBO)—plays a large factor in the timing of a PRT. Plan sponsors want their plans to be well-funded to lessen the amount they will have to contribute to transfer PBOs to insurers. Lower interest rates result in a higher PBO valuation, but plans’ funded status has also been hit by the market decline caused by the COVID-19 pandemic.

DB plan sponsors may need to take action to get back on track to implement a PRT.

There are different strategies plan sponsors can take, Leong says. For example, sponsors can talk with their consulting actuary about whether they must increase contributions to make up for the loss in funded status, or whether they should change their timing and delay the PRT until the plan can recoup some of its losses, she says. “Trying to get back on track is a combination of markets coming back, interest rates coming back, and making contributions or finding some other way to fund that shortfall or loss,” Leong adds.

Linda K. Stone, a senior pension fellow at the American Academy of Actuaries, says when deciding whether a PRT is a good deal or not, sponsors are looking at the value of the liabilities, compared with the price of transferring that liability to an insurance company. For some plan sponsors that are looking for cash in any way they can to run their businesses, they may still consider making contributions to their DB plans to implement a PRT.

Some plan sponsors may be concerned with the economic cost of maintaining their DB plan. Stone says many are making small annuity purchases—or implementing a partial PRT—to lessen Pension Benefit Guaranty Corporation (PBGC) variable premium costs. Plan sponsors may implement a lump-sum payment window to terminated, vested participants or only transfer liabilities of retirees to insurers. “When you think about what you’re paying administrators to maintain those records, and what you’re paying for fixed and variable premiums per person, that’s why they have been transferring these smaller amounts,” she says.

Stone notes that as the industry studies the long-term effects of the pandemic post-COVID-19, it will be interesting to understand on what basis employers are making decisions. “Looking at the pension plans and the fallout from COVID, what we’ve seen is plan sponsors take different actions than they would have beforehand, since their business situation has changed so much,” she says.

She paints two scenarios common to those plan sponsors facing difficult plan decisions in this environment. On one hand, handling the process of a PRT transaction can be tough to navigate for plan participants. When questioning whether to implement a lump-sum window or purchase an annuity for their pension obligations, sponsors have to consider administrative issues, which can include requiring spousal consent or notarization of documents, even when social distancing is being practiced.

On the other hand, as more individuals are laid off and looking for cash to pay bills, a lump-sum window is a way to provide money to those individuals, Stone notes. “If people need food on the table and rent, this can be a valuable source of funds, she says.

Leong shares a similar idea, but notes that during these unprecedented times, as most employers are putting their worker’s needs first, retirement plan decisions are going on the back burner. “Every plan sponsor has a unique situation, and in this environment, there’s a lot of other factors outside the plan that each business is considering,” she says.

QDIAs the Best Place for Participant Assets During Downturns

QDIAs keep DC plan participants on a path for growth, but the current market volatility plants seeds of new ideas about their construction going forward.

Most defined contribution (DC) plan participants invested in a qualified default investment alternative (QDIA) refrained from trading in the first quarter, despite the tremendous decline in the market and subsequent volatility, David Blanchett, head of retirement research at Morningstar Investment Management, told attendees of the “Managing Through the Crisis: The State of QDIAs” webinar sponsored by the Defined Contribution Institutional Investment Association (DCIIA), The Retirement Advisor University, the SPARK [Society of Professional Asset Managers and Recordkeepers] Institute and The Plan Sponsor University.

Only 2% of those invested in a managed account made a trade and only 2.1% of those invested in a target-date fund (TDF) made a trade, Blanchett said. By comparison, 17% of participants who self-direct their investments made a change, and 22.7% of those invested in more than one TDF vintage made a change, he noted.

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“You don’t want them trading because this hurts them in terms of long-term performance,” Blanchett said.

Speaking to PLANSPONSOR, Doug McIntosh, vice president of investments at Prudential Retirement, says participants have so far fared better during the COVID-19 crisis than in the Great Recession of 2008 because of the increased use of TDFs as the QDIA. In 2008, 60% of plans used TDFs as the QDIA; today, that number has risen to 97%, he says.

In addition, “today, TDFs have generally taken down risk for those closest to retirement,” McIntosh says.

“The glide paths have gotten more conservative,” he adds. “As well, there are a broader set of asset classes being utilized, such as TIPS [Treasury inflation-protected securities] and private real estate, to minimize equity volatility and inflation.”

During the webinar, Liana Magner, partner, U.S. defined contribution and financial wellness leader, Mercer, said the scaled back equity exposure in TDFs has made a difference: In 2008, they suffered a 14% decline, whereas in the first quarter of 2020, they went down by 10.4%. “This is mostly because they have less exposure to growth,” she said. “Long-term bonds have helped as well.”

However, McIntosh says he believes TDFs need to become even more conservative, noting that some 2025 TDFs lost 20% to 25% of their value in the first quarter of 2020. “If I am only five years out from retirement, that is a concern,” he says.

Magner said the key question is how the COVID-19 crisis will affect the TDF marketplace. “Will they take on more downside protection?” she asked. “Will there be more focus on retirement income? Will there be more use of custom funds? It will take some time for the investment managers to become more strategic, but we do expect a reinvention phase.”

The Setting Every Community Up for Retirement Enhancement (SECURE) Act encourages plans to offer guaranteed income solutions, McIntosh notes. He says he believes that should be part of the QDIA.

Sharon Scanlon, senior vice president, head of CX, Individual Life & Annuity Ops and Retirement Plan Services, Lincoln Financial Group, told webinar attendees that investors in her company’s products also refrained from trading during the first quarter.

Moving Away From TDFs

Joe DeNoyior, president of HUB |Washington Financial Group said, “One of the most important challenges plan sponsors face is determining the appropriate QDIA for their workforce.” He explained that the 2008 crisis showed that not all TDFs are created equal—some can mitigate volatility, some are tactical—and TDFs have become more sophisticated. “We think sponsors should expand their due diligence. Plan sponsors need to scrutinize their default options looking at their demographics and taking a view through participants’ eyes,” he said.

DeNoyior noted that in the past five years, more of HUB | Washington Financial Group’s clients have been considering managed accounts. DeNoyior expects more sponsors will adopt them, particularly as the expanded use of automatic enrollment and automatic escalation has resulted in higher balances.

“They can provide for different risk tolerance and tend to have stickier assets,” he said. “Once the dust settles from this crisis, we think plan sponsors will be more inclined to use managed accounts as the QDIA, or at least offer it in their plan.”

McIntosh says he expects managed accounts, as well as TDFs, will increasingly pair actively managed fixed income with low-cost passive asset management.

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