Risk Transfer Floodgates Hold, For Now

In his role as vice president of liability-driven investing (LDI) strategies for PGIM Fixed Income, Tom McCartan is responsible for the development of custom LDI solutions for Prudential’s many pension plan clients.

Prior to joining PGIM, McCartan was based in the United Kingdom, where he spent several years at Redington, a London-based investment consultant for U.K.-domiciled defined benefit (DB) pension plans. Prior to Redington he worked as an actuarial analyst with Mercer in Belfast.

According to McCartan, now focusing on private pension plans here in the U.S., there are some striking differences between the European and American scenes when it comes to pension plan management. The more long-term and strategic approach typically embodied by private pension plans in the U.K. has allowed those plans to be early adopters of LDI and other forms of de-risking. Plans in the U.S. are playing catch-up.

“From my perspective, liability awareness and hedging are creeping across to the U.S., and that’s encouraging,” McCartan says. “The U.K. market offers a learning opportunity for how to do LDI and de-risking effectively.”

In terms of what is driving U.S. pension plans to think more about the LDI approach and de-risking, McCartan points to a variety of factors. Perhaps foremost is the influence of the Financial Accounting Standards Board’s Statement No. 158, published in September 2006.

“That accounting rule change was incredibly important in taking the pension liability form a disclosure footnote into an actual balance sheet item for U.S. companies,” McCartan says. “The risk carried by the pension plan became much more noticeable and notable for the wider company and to investors. This is what has driven the increased attention on LDI here in the U.S.”

Risk transfer heats up, but road blocks remain

In his ongoing conversations with U.S. pension plans, McCartan says, the twin topics of risk transfers and liability-driven investing come up constantly.

“We like to link the strategies together and talk about them as two approaches to a similar end,” McCartan says. “De-risking on balance sheet is LDI, and de-risking off balance sheet is a pension risk transfer [PRT] transaction.”

McCartan ensures clients understand there are pros and cons to both approaches, and that different parts of the plan population will have different opportunities for moving off the balance sheet efficiently. For example, retirees can transfer efficiently to an insurer, meaning the insurer will take on retirees’ liabilities with only a small premium added to the projected benefit obligation (PBO) amount. As McCartan explains, this low premium is possible because there is only one factor of uncertainty for this population, and that’s mortality.

“For just risk-transferring retirees, this is a competitive segment of the market, with probably 20 providers bidding for this business,” McCartan says. “The non-retired group is a different matter, especially when there are lump sums available and different options for drawing benefits. The insurers have to price for pension holder issues, so you can easily see a 30% premium over the PBO price for getting these folks off the books.”

PRT deal candidates for 2019 and beyond

As McCartan recalls, for several years now the pension risk transfer market has hovered around $20 billion per year in total liability transfers. He expects the same for 2019, which by the end of this year would mean that only about three-quarters of 1% of the $3 trillion of corporate pension liabilities will have been transferred to insurers.

“We haven’t seen a mega transaction since 2012, so we’re watching out for that,” McCartan adds. “Another market segment we are closely engaged with is plans with small average balances. Plans in this segment often make great candidates for risk transfers. Despite this small annual benefits, the sponsor is paying Pension Benefit Guaranty Corporation premiums of $80 per person per year. The PBGC premiums are a big part of the PRT math for small-balance plans, and transfers can thus be very attractive.”

Hard PRT numbers show room for massive growth

While 2018 was a robust year for pension risk transfer, plan sponsors plan to increase their PRT efforts in 2019, according to a recent poll of defined benefit (DB) plan sponsors by MetLife. In fact, according to the 2019 Pension Risk Transfer Poll, among DB plan sponsors with de-risking goals, 76% intend to completely divest all of their company’s liabilities at some point in the future.

“The poll findings indicate a trend in increased risk transfer activity as we anticipate plan sponsors will want to proactively deal with the cost and volatility of their plans,” says Wayne Daniel, senior vice president and head of U.S. pensions at MetLife. “As a result, many will begin to look more closely at the $3 trillion of DB plan liabilities that have not yet been de-risked and begin to evaluate how they can address this.”

The MetLife data suggests that among the 67% of DB sponsors considering a risk transfer in the next two years, 77% have evaluated the financial impact of such a transfer, 74% have held discussions with key stakeholders, 65% reviewed and cleaned up their data, 59% have explored the solutions in the marketplace and/or quantified the cost of a pension risk transfer. The majority, 79%, say they are more likely to consider an annuity buyout now that they have witnessed several large corporations taking this action. Sixty-seven percent say they will conduct an annuity buyout to de-risk, up from 57% in 2017 and 46% since 2015.

Data shared by LIMRA Secure Retirement Institute supports the same conclusion. According to the data, in 2018, single premium buy-out product sales peaked at $26 billion, more than 14% higher than 2017. Total single premium product sales (including buy-ins) exceeded $11.3 billion in the fourth quarter 2018. For the year, total single premium product sales were $27.3 billion.

“A big driver of the 2018 buy-out sales was a combination of mid- to large-PRT deals,” says Eugene Noble, research analyst, LIMRA Secure Retirement Institute. “We also saw two new insurance companies enter the PRT market.”

Total assets of buy-out products were $135.5 billion in 2018, according to LIMRA SRI, more than 18% higher than the prior year.