Preparing for a Pension Risk Transfer

December 17, 2012 (PLANSPONSOR.com) – The preparation for a pension risk transfer includes many steps.

For the last several years, pension risk strategies have focused on retaining the risk via plan redesign or a dynamic investment policy, but now defined benefit plan sponsors are focused on transferring the risk, noted Sean Brennan, principal, senior consultant with Mercer Financial Strategy Group, during a webcast sponsored by Mercer. Even if plan sponsors think a risk transfer is in order later down the road, actions can be taken now to prepare and ensure that the cost will be minimal, he said.  

Plan sponsors must identify their risk management/transfer options and engage with insurers to understand pricing and capital commitment. Brennan suggested sponsors develop an in-house cost/economic liability study, identify the appropriate discount rate for calculation of pension liabilities as well as the most recent mortality assumptions.   

Sponsors should engage with insurers to ensure capacity and willingness to take on plan liabilities, according to Scott Gaul, SVP, Prudential’s Pension & Structured Solutions. He said capacity for these types of transactions is high. Not only jumbo plans, but smaller plans need solutions like this, and the capacity exists for all ends of the market.

The next consideration is insurer pricing; sponsors can provide participant data and benefit provisions and receive indicative pricing. The process to obtain a quote is straightforward, Brennan said. Having clean data and understanding plan provisions is important to insurers. Other information may be required, for example, for large plans, a mortality study of the plan’s experience. However, if the sponsor does not have or cannot provide that information, the insurer can make assumptions so as not to hold up the process, he noted.  

Brennan contended that most plan sponsors understand the cost of a buyout is approximately 110% of benefit obligations to the retired population, but they must consider other factors which may influence the cost to settle liabilities, such as the number of retirees versus non-retirees, plan characteristics, different solutions for different groups of participants, timing, assets used to settle liabilities, no steady increase factor for COLAs, cash balance plans, no liquidity in the investment portfolio, and variable forms of annuity used. 

According to Brennan, to help the likelihood of success for the pension risk transfer transaction, plan sponsors should create a commitment from senior members of the company and share as much data as possible to all parties. Organize census data, mortality experience and asset data, and create structure by defining objectives and communicating them.  

There are investment considerations prior to a risk transfer as well. Milla Krasnopolsky, principal, senior consultant with Mercer Financial Strategy Group, said plan sponsors should evaluate whether they want to do an in-kind transfer of assets or an in-cash transfer; it can have an effect on pricing. She noted that there is an asset and liability mismatch in typical pension portfolios; plans using liability driven investing (LDI) are better off prior to a pension risk transfer. When preparing for a risk transfer, investment strategy becomes a transition strategy, she said.  

A replay of the Mercer webcast can be obtained at www.mercer.com/pension-risk-transfer-replay.

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