Proper Analysis Ensures Right Pension Risk Transfer Decision

August 11, 2014 ( - If defined benefit plan sponsors start a pension risk transfer process with the wrong assumptions, information or consulting team, they may end up making the wrong decision.

During a webinar sponsored by Dietrich & Associates, Mark Unhoch, vice president and senior consultant at the firm, advised plan sponsors considering a pension risk transfer to start the planning process immediately because planning could take three to six months. He said plan sponsors should develop clear and concise goals and objectives, set parameters for their analysis for determining whether to initiate a risk transfer and which kind, and identify the deliverables and appropriate contributors to the analysis.

Plan sponsors should work with a team consisting of legal counsel, an actuary, their investment adviser or other advisers to the plan to set parameters and look at the options available.

Discussing an actual case study, Unhoch said one defined benefit plan sponsor decided to act following the announcement of increased Pension Benefit Guaranty Corporation (PBGC) premiums and updated mortality tables approved by the Society of Actuaries. The plan sponsor wanted to look at the cost of removing risks of the plan today versus the cost of managing the risks over several years, and formulate the different options available.

Pension risk transfer methods can address several risks for plan sponsors: interest rate risk, investment risk, mortality risk and regulatory risks, as well as balance sheet volatility and expense risk. Risk transfer options could include a lump-sum distribution window to certain participants, a partial or full annuity purchase, or plan termination. Andy Wilkinson, vice president and managing principal at McCready and Keene, a OneAmerica Company, explained to webinar attendees that insurance companies have experience with these risks and managing them. They do something similar to liability-driven investing, by purchasing high-quality bonds to match liabilities, and they also pool plans together and the higher assets help reduce risk and volatility.

Unhoch noted that determining future risks and expenses for a plan cannot be based on just one scenario, so for the client in the case study, Dietrich used three different sets of assumptions for discount rates, asset returns and expenses. The calculations should also take into consideration the plan sponsor’s investing approach. For example, in its calculations, Dietrich took into consideration that the client in its case study was using a dynamic derisking glide path investing approach, with triggers for changing asset allocation as the plan became better funded.

Wilkinson added that comparing the cost of maintaining a plan to the different risk transfer options also depends on various factors. He noted that most insurance companies have factored in the new mortality tables, so that shouldn’t impact the cost of purchasing an annuity, but it will impact the calculation of lump sums and plan liabilities. Bond yields and discount rates could create a lot of volatility in the amount of cash required at different times, so actuaries can help plan sponsors know when the time is right for offering a lump-sum window. These were factors that made 2013 and 2014 popular years for lump-sum windows, according to Wilkinson.

Other than the plan liabilities, PBGC premiums, new mortality tables and other expenses could make the true cost of a plan 118% or more of liabilities, Wilkinson said. A lump-sum window could reduce that cost for employers to 95%. However, he noted that it is usually the least healthy plan participants that take lump sums, and if the plan sponsor then wants to transfer risk to an insurance company, some insurance companies will charge a premium in consideration that the remaining plan beneficiaries are healthier. Right now, Wilkinson said, the cost of doing a pension buyout is fairly comparable to maintaining the plan.

The bottom line, according to Unloch, is having the right team and planning process will help a plan sponsor determine the right action to take. Actuaries can provide calculations and projections critical to determining what action to take, certified public accountants can audit all these analyses and the assumptions used, consultants may act as a liaison between the plan sponsor and other contributors as well as insurance companies, and investment advisers can help manage the plan’s assets to preserve value during the process.

The webcast, “The Value of a Well Executed Pension Risk Transfer: Priceless,” may be viewed from Dietrich’s YouTube page.