There are several options to reduce risk
Speaking at the 2012 PLANSPONSOR National Conference, Tom Toale, AVP of U.S. Pensions at MetLife, said many DB sponsors think they either have to deal with the status quo of funding volatility or freeze or terminate their plans, but there are many options to reduce risk in between those two extremes. He contended pension risk transfer should start with some form of liability-driven investing (LDI). Plan sponsors can extend the duration of their fixed-income investments, change asset allocations to hold more bonds and add principal protection products. When the plan is better funded, sponsors can consider a pension buy-in or buy-out.
You don’t have to give up your relationship with participantsStephen W. Ellis, CFO at Hickory Springs Manufacturing, the first company in the U.S. to complete a pension buy-in (see “Pru Completes Nation’s First Pension Buy-In”), told conference attendees his company wanted to keep its strong relationship with employees and retirees. He explained that a pension buy-in is different from a buy-out in that with a buy-out, the insurer takes on the liability of the pension plan and pays participants and beneficiaries, but with a buy-in, the insurer provides the cash for payments, and the plan sponsor makes the payments. Another difference is that with a buy-in, the plan sponsor can rescind the contract or switch to a buy-out agreement.
There are additional costs associated with a buy-in or buy-out
Glenn O’Brien, managing director at Prudential Retirement, and the point person for General Motor Co.'s recent buy-out deal (see “GM Transfers Some Pension Risk”), explained that with a pension buy-in or buy-out, the liability transferred has to be fully funded by the insurance product, so plan sponsors may have to use some cash to complete the transaction. DB plan sponsors should not worry that this will hurt their ability to sell the idea of pension risk transfer to the retirement plan committee or company’s board though, according to O’Brien. Risk for pension plans correlates to the risk of the business cycle, and with such a long period of volatility, plan sponsors can make the case that the buy-in or buy-out is a shareholder-friendly activity. In addition, the guarantee that assets will match liabilities is in the best interest of plan participants.
Transferring risk is safe
For those plan sponsors that worry because Pension Benefit Guaranty Corporation (PBGC) coverage of the pension plan ends with a buy-in or buy-out, Toale said insurance companies are strictly regulated by the states, and insurance commissioners will seek out other companies to cover insurance products if one company fails. O’Brien added that a pension plan’s assets will be held in a separate account and not the general account of the insurance company, so the assets will be protected from insurance company creditors.
Don’t wait until it’s too lateToale warned that DB plan sponsors that are timid to be one of the first or that think the low interest rate environment is temporary and pension funding will get better may miss their opportunity to transfer risk. He said there will eventually be capacity issues. Underwriting liabilities takes a lot of capital and, at some point in time, insurance companies will run out of capital for this business or will lack the ability to produce it quickly. O’Brien added that as larger transactions happen, bonds are being bought in significant amounts which could potentially reverse the yield curve, and sponsors could get priced out of the market. In addition, providers such as Prudential will get to a risk limit; they are only willing to take on a certain amount of risk.
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