On July 7, the British Telecom (BT) pension plan trustee announced longevity insurance and reinsurance arrangements have been entered into to provide long-term protection and income to the plan in the event that members live longer than currently expected. To facilitate the transaction and maximize the plan’s access to the global insurance and reinsurance market, the trustee has set up a wholly owned insurance company and transferred longevity risk to this insurer, which has in turn reinsured this longevity risk with The Prudential Insurance Company of America.
Amy Kessler, a senior vice president and head of Longevity Reinsurance within Prudential Retirement’s Pension Risk Transfer business, tells PLANSPONSOR that since the BT transaction, more U.S. clients with foreign subsidiaries that are struggling with de-risking their UK, Canadian or Dutch pension plans are inquiring about their options abroad.
Kessler notes defined benefit plan sponsors have liability risk because they do not know how long people will live, and they have asset risk because they do not know how the market will perform. In the 2000s, more plan sponsors started turning to liability-driven investing (LDI) strategies, in which they add long-duration bonds and other fixed-income investments, to try to match liabilities to assets. While U.S. plan sponsors were turning to LDI, those in the UK were moving on to pension risk buy-ins or buy-outs. Beginning in 2011, U.S. plan sponsors began following the UK’s lead.
The transaction BT announced is different and newer, however. Kessler explains that in the UK, many pension plans that began using LDI years ago now have 70% to 80% of their portfolios invested in fixed-income with longer durations to match liabilities, and because they are so heavily invested in fixed income, they are no longer expected to “outrun” life expectancies. If life expectancies continue to increase, the pension plans will have to come up with cash to continue paying annuitants. Rather than retain that risk, the largest plans in the UK are buying longevity insurance to lock in a future cash flow that will help pay benefits after annuitants reach their life expectancy. “That gives the pension funds a fixed and known future liability cash flow,” Kessler says. There have been many such transactions in the UK, and Prudential expects the first longevity insurance deal in Canada in the not-too-distant future, she adds.
However, this solution has not yet migrated to the United States. Kessler says this is in part because of the asset mix of U.S. defined benefit plan portfolios, and the U.S. market has just begun to adopt up-to-date longevity expectations. A key deterrent has been the mortality tables used by U.S. plans, but new mortality tables look more like what insurance companies use. In addition, once U.S. defined benefit plans get to 70% to 80% of assets in longer duration fixed-income investments, longevity insurance will be a viable solution for longevity risk. “It’s a turning point in the U.S. market—a time for plan sponsors to take a look at the new solution as well as revisit the other two,” Kessler says.
Kessler explains that a buy-out covers all asset and liability risk associated with the annuitants for whom the buy-out transaction is made. An annuity is purchased by the plan to settle certain pension liabilities. It is a full settlement, so the portion of liabilities annuitized leaves the plan sponsor’s balance sheet and goes on the balance sheet of the insurance company. Kessler says this is a holistic, bundled solution similar to what GM and Verizon entered into with Prudential. “From that moment forward, Prudential pays participants directly,” she explains. She adds that a buy-out is a solution available in the U.S., UK, Canada and the Netherlands.
A buy-in is similar in that it is an insurance product that covers all asset and liability risk for annuitants covered, but the key difference, Kessler explains, is a buy-in is a contract between the insurance company and the pension plan, which is held in the plan, rather than a settlement of the liability. The first U.S. pension risk transfer transaction was a buy-in Hickory Springs Manufacturing in Hickory, North Carolina, entered into with Prudential. Prudential knows the amount of the payout obligation the plan has each month and matches that liability. Prudential is responsible for all of asset and liability risk, and pays the benefits into the pension plan, while the plan cuts the checks to annuitants. Kessler says buy-ins are the most frequently used pension risk transfer transactions in the UK. Buy-in solutions are also available in Canada.
Prudential recommends defined benefit plan sponsors start working with actuarial consultants to prepare their data and to look at the different solutions available side-by-side to see which is best. “One of the things we think is very exciting about all the innovation that has happened in pension risk transfer space in the UK, is we can bring all those ideas to the U.S. market,” Kessler says, adding that plan sponsors should engage in dialogue with insurers about the goals for their plans and the resources available.
According to Kessler, “For the first time in a long time, U.S. pensions have a healthy funded status, and a lot of plans are in striking position to reduce risk or transfer risk. It’s a good time to think about getting risk off the table.”
She notes that in the past there have been various windows of opportunity where plans were well-funded, but at some point there’s economic difficulty again. “There’s a sense of urgency to de-risk today, to strike when the iron’s hot, because there’s likely, at some point, to be a turn in the business cycle.”
More information about pension risk transfer from Prudential is at http://pensionrisk.prudential.com.