Pension Risk Transfer Market Keeps Setting Records

The U.S. pension risk transfer market showed no sign of slowing in the third quarter of 2022, as market activity continues to reach new levels.

The year’s first quarter saw $5.3 billion in sales split about evenly between single premium buy-ins and buyouts, according to data from financial industry research organization LIMRA. That mark was 40% higher than 2021’s first quarter and the highest first-quarter result on record.

There were no buy-in contracts sold in Q2, but single premium buyout sales totaled $12.3 billion, an increase of 148% from 2021. That brought the combined buy-in and buyout total for the first half of the year to $17.6 billion, far surpassing the previous first-half sales record of $9.7 billion, set in 2018.

The momentum continued quartering Q3. Stamford, Connecticut-based Legal & General Retirement America’s November 2022 Pension Risk Transfer Monitor reported it was one of the busiest quarters on record.

“At an estimated $27 billion, not only was it the largest Q3 on record, but it was also the second largest quarter ever for the market, exceeded only by 2012’s Q4, which was near $36 billion and included both the GM and Verizon transactions,” noted Sheena McEwen, vice president and head of distribution at LGRA, in the report.

Given the year-to-date results, it’s likely that full-year 2022 will be one of the best, McEwen’s report added.

“In our half-year monitor, we reported that the first and second quarters of this year were also record-breakers, so it’s no surprise that 2022 will be the largest year ever for the U.S. PRT market at an estimated $55 billion in total market volume. This is significantly larger than 2021’s record of $38.1 billion.”

Market Drivers

Sources cited several factors driving PRT activity higher. George Palms, the president of LGRA, points to many corporate pension funds’ improved funded status. In its October 2022 Pension Solutions Monitor report, Legal & General Investment Management estimated that the average funding ratio for U.S. corporate pension plans rose to 100.7% that month from 95.6% in September.

“As funded status improves, that gives the plan sponsor more optionality in terms of engaging in a PRT transaction and taking risk off the table,” Palms explains.

The market conditions in 2021 and 2022 have put many corporate funds in a good position to consider offloading some of their volatility risk, according to Mary Leong, a principal and consulting actuary with Milliman in Houston.

“We saw negative returns in assets, but we also saw rising interest rates,” Leong says.  Liabilities will decrease when interest rates go up, and plan sponsors were still actually seeing improvements in their funded status because that liability decrease was greater than the negative return on their assets.”

Ari Jacobs, a senior partner and global retirement solutions leader with Aon in Norwalk, Connecticut, said additional market conditions helped increase activity.

“These (PRTs) have become more available and common in the market, and there are more insurers entering this market,” Jacobs explains. “There are more plan sponsors who have done this, so that allows other pension plans—that may have had reasons where they weren’t prepared or willing to do it—to move forward with understanding the market, understanding the insurers and understanding what they need to do to implement one of these.”

Aon’s U.S. Pension Risk Transfer 2022 Mid-Year Update highlighted several other trends influencing 2022’s results. First, there were more plan terminations this year: “There was a 50%+ increase in the number of annuity purchases resulting from plan terminations in the first half compared to 2021. We see an elevated number of plan terminations for the rest of this year and into early next year.”

Plan sponsors executing repeated PRT transactions was another highlighted trend; the Aon update reported that, “Smaller plan sponsors also take this approach to settle liabilities over time.”

Although buy-ins accounted for only $2.7 billion of deals, all executed in the first quarter, Aon reported that a “few plan sponsors have shown interest in a buy-in solution for later this year.” Leong also cited growing interest in buy-ins, which she said have not been prevalent in the U.S. but are more widely used in Canada and the U.K.

Plan sponsors may be starting to entertain the idea of a buy-in contract that later converts to a buyout contract, she maintained. This step effectively locks in a price on a contract, rather than waiting until the end of a plan termination to lock in that premium price. It’s not a new concept, Leong adds, and it may be making its way into the U.S. market.

“Plan sponsors may be wanting to lock in their funded status once they reach that threshold where they say, ‘We’re ready to terminate,’” Leong explains. “They can start with that buy-in contract, lock in that price and not have to necessarily worry about what that price is going to be when they ultimately terminate the plan over the 12-month period or longer that it takes to get through all the filings and the lump-sum window.”

“Termination is a pretty lengthy process,” Leong says. “So I think some plan sponsors are looking to the buy-in to set that cost up front. It’s a known cost, and they can then proceed with the rest of the termination and later convert that contract to a buyout.”

Favorable PRT deal-pricing also spurred activity. Through July 31, the Milliman Pension Buyout Index, which tracks retiree buyout costs from eight participating insurers, dropped to its lowest level since the index’s inception in 2010.

“Plan sponsors looking to de-risk a portion of their pension plan may see the competitive retiree buyout cost as an opportunity to shed pension liability at or below the value they are holding on their books,” Long explains. “In a year where we have seen interest rates rise, seeing the annuity purchase rates move relatively in tandem with accounting discount rates may have provided plan sponsors with the incentive to capitalize on the Fed’s rate hikes,. ”

The year has also seen multiple large transactions. LGRA’s McEwen pointed out that this year’s projected total deal volume of $55 billion has been “driven by the jumbo transactions that continue to come to market, the largest being IBM’s $16 billion lift-out in Q3. But even without that mega-deal, we’d still be looking at a record year, as we expect at least eight other deals around $1 billion to have closed over the year.”

Leong agrees that 2022 is likely to end on a strong note. In a September article for Milliman, she noted that, historically, “65 to 75% of PRT transactions occur in the second half of the year, but so far in 2022, Q1 and Q2 have both broken records for PRT activity, with $5.3 billion and $12.5 billion in sales, respectively. This is already 47% of the record $38.1 billion total in 2021. And it does not look like the momentum is expected to slow down.”

Looking ahead

Palms projects that the high level of PRT activity will continue in 2023, supported by secular trends that he believes are driving deals. The first trend is that provided plans’ funded status remains healthy; sponsors will have the option to de-risk their plans through PRTs.

Also, higher Pension Benefit Guaranty Corporation premiums will give sponsors an incentive to “take out the lower benefit tranches of their plan to try and reduce costs,” Palms says. “That can be a positive way for a sponsor to get their initial experience in doing a PRT transaction.”

Finally, a younger cohort of incoming chief financial officers, many of whom might lack experience with defined benefit plans, could question the value of their company’s plan. As that cohort takes leadership positions, they may view pensions as “historical vestiges” and decide they want the company to focus more on its core business, Palms adds.

Jacobs believes an increase in insurers participating in the PRT market will help sustain its growth. The participant count is approaching two dozen, says Jacobs, and the entrants are “very thoughtful about what segments of the market they work in.” Some insurers are focusing on plan size or plan liabilities; others are focusing on particular industries. At the same time, current participants are not pulling back or leaving the market, he adds: “We are still seeing a bullish sentiment from the insurance industry overall in this market.”

Palms also mentions that reinsurers’ growing presence as another important trend.

“I think the other development that may in the medium term be even more significant is reinsurers being utilized and getting involved in the market and providing additional balance sheet capacity to insurers,” says Palms. “It gives the reinsurer the ability to participate in the liability flow without being a direct writer in the market. We’ve seen a number of reinsurers enter this year, and I expect that’s going to continue in the years ahead.”

There are still ample assets in private-sector DB plans to ensure PRT-market growth, Jacobs notes. According to the Investment Company Institute, those plans held $3.2 trillion in assets at the end of the Q2. Many of those plans’ liabilities are easier to price and still desirable by insurance companies, Jacobs maintains. Although many organizations have de-risked those “easier” liabilities already and are left with more complex liabilities, he believes the insurance market is ready to handle the additional complexity.