Pension Risk Transfer: Due Diligence Considerations

April 11, 2014 ( - Ongoing market turbulence and lingering low interest rates have created formidable challenges for pension plan sponsors recently.

Aging populations, increasing human longevity and rising costs have intensified the financial pressure on many plan sponsors. As a result, organizations with significant obligations are seeking new strategies to minimize risk and create long-term sustainability for their retirement offerings.

Pension risk transfer transactions—including lump sums, buy-ins, buy-outs and longevity insurance—are increasingly viable options for de-risking. Building off the success of these products in the United Kingdom, several leading insurers have developed innovative products to address the risks faced by corporate pension plans and the risks associated with specific regulatory and design features of the U.S. market.

While pension risk transfer transactions offer significant potential benefits to plan sponsors, due diligence by the plan sponsor, with help from its advisers, is required to properly assess the cost-benefit trade-offs and whether the price is competitive and reflects plan attributes and population.

In this article, we discuss considerations for plan sponsors as they examine pension risk transfer transactions. We also highlight lessons learned by early adopters in the U.S. and in the more mature market of the UK.

Due diligence: a strategic and detailed process

The newness of these transfer products, the range of alternatives and the potential complexity of a transaction call for an extra emphasis on due diligence. The results of completed transactions have shaped more robust and formal due diligence processes, and leading practices have emerged. The objectives for plan sponsors are typically optimized transaction pricing, stronger alignment of transaction terms to plan sponsor goals and reduced risk across the board.

To get there, savvy plan sponsors focus on critical areas of the transition process:

Bid solicitation and review. Some early adopters have requested bids from multiple insurers to ensure the pricing is competitive. Others have broken a large transaction into several smaller ones to increase the pool of bidders, who can then tailor their offers to their strengths. The smaller transactions may cover different risks or different population subgroups, such as current participants and terminated participants.

Actuarial assumptions. The rigorous comparison of actuarial assumptions and actual plan performance may reveal opportunities to enhance assumptions and, in turn, improve transaction terms and pricing. For example, pension funds may be valued differently for different purposes, such as for accounting mandates, IRS funding mandates, lump-sum buy-out calculations and discount rate setting. The discount rate curve, inflation curve, base mortality rates and future mortality improvement assumptions should be also be reviewed, as well as demographic assumptions such as employment persistency, early and late retirement rates, lump sum commutation, proportions of members married and spousal age differentials.

The regulatory value of a plan will also affect transaction economics. Sponsors must consider the higher minimum funding requirements from the Pension Protection Act of 2006 and the Moving Ahead for Progress in the 21st Century Act (MAP-21) regulations of 2012. Possible changes to accounting treatments may make it harder to evaluate plans and also raise risks for plan sponsors.

Data. Insurers use data from the plan sponsor to price contracts. For optimal pricing, plan data must be accurate and complete. In our experience, a thorough data review almost always has a material impact on transaction pricing. Data items most often incomplete or incorrect include marital status, spousal data and member retirement dates. Delivering high quality data reduces risk for the insurer and allows more competitive pricing.

A plan needs to be in place for correcting data, and the party at risk from bad data needs to be identified. In the UK, where buy-in transactions are more common, plan sponsors often obtain coverage for inaccurate benefit information and for members not identified at the transition.

Sensitivity analysis. Plan sponsors may want to conduct sensitivity analyses to gauge the impact of changing economic assumptions, market changes, discount rates and inflation. Demographic assumptions, such as mortality rates and improvements, and timing scenarios, such as the impact of delaying the transaction, are also typically examined.

These analyses can yield valuable insights, and may support or undercut the rationale for the transaction. They can also reveal the contract terms and data most likely to have an impact on pricing.

Contract terms. Plan sponsors, with the help of their advisers, should review the legal and commercial terms of a contract to confirm the policy covers the intended plan members and benefits, and should establish a plan to address transition issues sensibly and fairly. Conversion terms must also be reviewed if a buy-in annuity will be converted to a buy-out annuity. Risk management options, such as collateralization, should be assessed and accounted for.

Transition arrangements. Transition arrangements help ensure the economic position of the plan stays constant as the liabilities are transitioned from the plan sponsor to the insurer. Agreeing on answers to the following questions can be critical to the success of the transition:

  • If assets will transfer from plan to insurer, what happens if the value of the assets changes during the transition period?
  • What happens if interest rates change?
  • How will employees who leave the plan and collect lump sum payments be treated and accounted for?
  • Should credit or counterparty adjustments be applied?
  • Who will develop and deliver any expected communications to plan members?


Bottom line

Pension risk transfer transactions can substantially affect income statement, balance sheet, tax, administration and reporting for plan sponsors and members. We encourage organizations and plan sponsors to embrace a thoughtful and comprehensive approach when evaluating transactions, managing transaction risks, executing transactions and accounting for them. A robust due diligence investigation is the best way to for the transfer to achieve the intended objectives.


By Adam Berk, Jennifer Haid and Uros Karadzic  

The opinions expressed in this article reflect the opinions of the authors and are not necessarily those of Ernst & Young LLP.  

Adam Berk is a partner in Ernst & Young’s (EY’s) Human Capital – Talent and Reward practice in Houston, Texas, and can be reached at  

Jennifer Haid is a manager in EY’s Insurance and Actuarial Advisory Services practice in New York, New York, and can be reached at  

Uros Karadzic is a senior manager in EY’s Human Capital – Talent and Reward practice in Toronto, Ontario, and can be reached at  

NOTE: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.   

Any opinions of the author(s) do not necessarily reflect the stance of Asset International or its affiliates.