While buy-ins are a relatively new pension risk transfer strategy in the U.S.—with the first significant buy-in deal coming in mid-2011—most plan sponsors have heard of so-called pension “buyouts.” As Daniel explains, buyouts involve a plan sponsor transferring all or part of the pension plan’s benefit liability directly onto an insurer’s balance sheet. The insurer accepts all or part of the pension plan’s assets as a premium payment for taking on the longevity, inflation and investment risk associated with operating the pension plan.
Insurers can make a profit in the operation because they can function more efficiently than many employer-sponsored pension funds, and they are also not generally required to pay things like Pension Benefit Guaranty Corporation (PBGC) premiums or other expenses. The benefit for plan sponsors and the sponsoring company is the relinquishing of longevity and investment risk, as well as the partial or complete elimination of administration costs associated with the pension plan.
Despite the naming convention, buy-in risk transfers are actually similar to buyouts in many respects, Daniel says. “Exactly as for a buyout, the pension plan makes a single premium payment to the insurer to enact the buy-in, and the payment can either be 100% lump sum cash or it can be assets in kind,” he explains. “And the single premium payment covers the future benefit payments for either a selected group or all of the plan participants. In turn, the insurer issues a group annuity contract to the plan. So far the process is exactly the same as for a buy-in or a buyout.”
Where the buy-in differs is that, rather than taking over the benefits payment schedule of the employer, the insurance company instead makes a monthly bulk payment back to the pension plan to cover either current or future cash flow needs, Daniel says. Cash payments to the employer represent the monthly benefit amount covered under the buy-in contract.
“So one of the big differences, then, there is no direct relationship between MetLife and the plan participant under the buy-in arrangement,” he says. “The pension plan continues to make the pension payments, and then the insurer makes payments to the pension plan to ensure the necessary cash will be there to pay benefits that are claimed.”
Daniel says another and perhaps more informative name for “buy-ins,” under which MetLife originally marketed this type of service, is “pension cash-flow guaranty.” As this name implies, the benefit for plan sponsors is ensuring the plan will have enough cash on hand at a given point to meet projected benefits obligations.
“So you see a pension buy-in is really part of the risk transfer spectrum,” Daniel adds. “You can actually think of the full buyout—when all of the liabilities and all of the assets are transferred to the insurer—as being on one end of the spectrum, and then aggressive LDI is on the other end. Under this analogy the buy-in concept would fit somewhere right in the middle.” LDI, or liability-driven investing, is an asset allocation strategy that tries to match plan assets with liabilities.
Daniel says MetLife has been a leader in bringing this type of service to U.S. pension plan sponsors—adding that the firm secured what he believes was the largest buy-in contract to-date in the U.S. earlier this year, valued at $92 million. He says the firm is currently working to increase acceptance of buy-in strategies among U.S. plan sponsors, and to give current and potential clients a better sense of how buy-in strategies work.
One of the chief objectives, he says, is to help plan sponsors realize that different pension risk transfer options can work together over time to smoothly de-risk a pension plan.
“When the plan sponsor is beginning to think about a risk transfer, this is generally coming only after the sponsor first reviewed the liabilities within the plan and accurately projected the benefits schedules. Perhaps they have already implemented an LDI portfolio,” Daniel explains. “Once the assets are appropriately aligned, we start to see a reduction in the volatility of the plan’s funded status. It then becomes easier for the plan to start targeting for either a buy-in or a buy-out, whether for the whole plan or for a section of the participants.”
He points to the UK market to demonstrate the idea. “In the UK employers moved to mark-to-market accounting faster and further than the U.S. for the most part,” he explains. “And so, plans in the UK and their corporate sponsors actually have for a while been forced to recognize the true economic cost of holding the defined benefit promises that they’ve made. And also in the UK, we saw a significant increase in the regulatory cost of operating a defined benefit plan, such as increases in the pension protection fund levies, and the regulator mandates fairly aggressive rates of improvement in future longevity tables.”
All of this has more quickly added to the cost and pressure for UK pension plans, he explains, which is why in the UK, plan sponsors saw a need to de-risk earlier and there was recognition that for many plans de-risking was going to have to happen in several stages.
“For those that were not fully funded or ready to move to full buyout, a buy-in was a very appropriate solution,” he explains. “So buy-ins became a fairly typical route from LDI to the full offloading of pension liabilities. In fact, we’ve seen in some previous years that, in terms of the total number and value of transactions in the UK de-risking market, buy-ins have exceeded buyouts in recent years. It’s a major feature of that market.”
Daniel says similar pressures are emerging in the U.S. as significant increases in PBGC premiums take effect (see “PBGC Premium Hikes Shake Up Buyout Landscape”). He says the pending adoption of new Society of Actuaries mortality tables accounting for improved longevity among U.S. retirees could cause projected liabilities to jump as much as 8% for the typical pension plan immediately upon implementation.
“It’s clear the costs associated with managing the risks within pension plans are going up, year in and year out, and plan sponsors are seeing that,” Daniel continues. “Their advisers are pointing it out, and while we do expect to see more buy-ins in the future in the U.S., I think that a lot of plan sponsors will still go straight to buy-outs, more so than in the UK. We’re hoping to change that.”