Administration April 18, 2019

Risk Transfer Floodgates Hold, For Now

Even with the documented acceleration of de-risking activity, Tom McCartan at PGIM Fixed Income notes that less than 1% of U.S. private pension plan assets and liabilities have been formally transferred to insurers.
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Art by Davor Gromilovic

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.

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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.

Benefits April 16, 2019

Employer-Provided Student Loan Repayment Programs Have Pros and Cons

Employers wanting to offer student loan repayment benefits to employees have a multitude of selections to sift through. Which ones should they consider implementing?
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Art by Mar Hernández

From student loan refinancing and forgiveness programs, to employer-sponsored repayment approaches, employers wanting to offer student loan repayment benefits to employees have a multitude of selections to sift through. Which ones should they consider implementing?

 

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One type of student loan debt repayment program offered by some defined contribution (DC) plan sponsors is a match of contributions to an employee’s student loan debt repayment that goes into the employee’s DC plan account. Ross Riskin, assistant professor of Taxation and CFP program director at The American College of Financial Services, says, “That way, the employee gets to add to both their student loan payments and retirement savings.”

 

This type of student debt repayment program was approved in an IRS Private Letter Ruling issued in August of 2018 for employer Abbott. Because participants receiving a student loan repayment non-elective contribution can still make deferrals to the 401(k) plan and receipt of the contribution is not dependent on whether the employee makes deferrals to the plan, the IRS ruled the benefit will not violate the “contingent benefit” prohibition of the Income Tax Regulations.

 

Despite this, plan sponsors are still wary on offering these types of programs, due to fear of noncompliance, says Jeff Holdvogt, partner at McDermott Will & Emery. IRS Private Letter rulings apply to the plan sponsor requesting the ruling, and not to retirement plans overall.

 

“Plan sponsors are inherently conservative about these types of issues, no one want to make a plan design and a couple of years later, have the IRS come back and say ‘what you did was inappropriate and illegal.’ Until there’s either legislation that changes tax law or more guidance and applicability from the IRS, there is going to be some uncertainty out there on these issues,” he says.

 

This strategy differs a bit in the nonprofit space. According to Randy Lupi, regional vice president at AXA Advisors, K-12 employers don’t often contribute to a 403(b), usually because the match will be added to the state 401(a) pension plan.

 

Other types of student debt assistance programs

 

Another type of student debt assistance some employers are providing is a match of the amount employees pay toward their student loans—paying down the debt more rapidly. This method holds two potential cons: Some companies may hold restrictions on the number of contributions an employer could provide, and, unlike the first method, these employer matches are taxable, says Holdvogt. 

 

“While it can be an attractive option, it is a taxable benefit to the employee because there’s no specific tax provision that would make it tax-free to the individual. So, part of the issue is employers are trying to provide a student loan benefit in a tax-incentivized way,” he says.

 

In an article, “Evaluating the Effectiveness of Employer-Provided Student Loan Repayment Assistance Programs,” Riskin notes that income-driven repayment plans—which allow for loan payments to better align with a borrower’s ability to pay rather than a traditional amortized loan—are offered to federal student loan borrowers. In addition, numerous forgiveness programs are also available for federal student loan borrowers, such as the Teacher Loan Forgiveness Program and the Public Service Loan Forgiveness Program (PSLF).

 

He says employers’ match of employees’ student loan debt payments are intended to reduce the principal balance on these loans, but it is possible that the loan servicers may not apply the additional monthly payment this way, and that could hurt employees’ qualification for income-driven repayment plans or loan forgiveness programs. “For example, if the required monthly payment due for Mike on his federal student loans is $100, and the employer were to make a payment of $141 without instructing the excess payment to be applied directly to principal, the additional $41 would apply to the next month’s payment. When Mike goes to pay the remaining $59 the next month to remain current in his repayment status, the $59 would not be considered a qualifying payment for the aforementioned repayment programs. Employers should make sure their plans are set up to ensure these instructions are accurately communicated to the applicable loan servicers,” the article states.

 

In addition, it is also possible that when a borrower makes an additional payment with the help of his employer, he will be placed in “paid ahead status.” Payments made while in paid ahead status to satisfy the monthly loan obligation are not counted as qualifying payments for income-driven repayment plans or in accordance with public service loan forgiveness rules.

 

For the Teacher Loan Forgiveness Program and the Public Service Loan Forgiveness Program, Lupi says employers should be attempting to connect with employees on the requirements for the programs, whether it’s through group educational campaigns or communications means.

 

“What type of loan counts for public service? What type of repayment benefit counts? Who is the sponsor of the federal program? Whether they file their taxes separately or jointly with a spouse, that makes a difference with adjusted gross income,” Lupi says.

 

Because workers confuse public service repayment programs to teacher loan forgiveness and other initiatives, it’s important for plan sponsors to educate workers on their eligibility and qualification status, and how they can take advantage of these opportunities, says Lupi. Teacher loan forgiveness programs, for one, often require teachers to work in a specific school district or have a specific title status. The Public Service Loan Forgiveness Program requires participants to work as a full-time employee and add their loan repayments to an income-driven repayment plan prior to consideration, he adds.  

 

Working with a financial adviser or someone well-versed in financial services or partnering with insurance and retirement companies to add educational sessions can help increase overall comprehension, as most can provide a thorough analysis catered to ensuring participants are enrolled correctly and that their loans qualify, Lupi suggests.

 

Employers may also simply offer the benefit of providing employees with access to organizations that work with them to help them refinance or consolidate their student loans, according to Holdvogt.

 

Despite the varying opportunities, Holdvogt recognizes the swift revolution surrounding student loan debt programs in the retirement industry, more so now than in the past years. In February, a group of senators introduced the Employer Participation in Repayment Act, permitting employers to contribute up to $5,250 tax-free in their employees’ student loans.  

 

“This is a rapidly changing area, and these types of benefits have only started to come into existence in the past couple of years,” he says. “There’s been a lot of interest from plan sponsor groups and a lot of action on this issue, and I expect a lot of changes in the next couple of years—whether that’s guidance or legislative action.”

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