2012 was a game-changer for the pension buy-out market in the United States, reaching $37 billion across two large deals involving General Motors and Verizon. Those deals demonstrate the need many plan sponsors have to wind down or close defined benefit (DB) schemes, as well as the trend toward a defined contribution (DC) focus. PLANSPONSOR spoke with Scott Gaul, senior vice president, head of distribution, Pension Risk Transfer at Prudential Retirement, about how sponsors are considering—and using—pension risk transfer (PRT) options with their DB plans.
PS: What is the approximate cost of a buy-out for a plan sponsor, and how large is the buy-out market?
Gaul: The cost of a buy-out or a buy-in on the retiree side is roughly 110% or 111% of the liability—not 130% or 140% as some purport. Whether a sponsor is ready to exit now or later, one of the key messages is to know your end-point number because the last thing you want to do is take this risk, get 130% funded and realize you needed less to exit. Plan sponsors are unable to capitalize on excess funding at termination.
The market last year was $37 billion. For the past decade, it’s been $1 billion to $2 billion—risk transfer strategies were once very popular, and they are regaining popularity.
PS: What are the obstacles for not doing a buy-out?
Gaul: One obstacle I speak to almost every day is cost. The second issue we hear is that interest rates are too low.
As interest rates go up, the dollar cost of that liability changes. I think everyone would buy a product in this interest rate environment if they had the money. The question becomes, “If I’m 20% short, how do I close the gap?” One way is to look for rates to rise. Others would be to put cash in the plan, take advantage of current lending rates in today’s market and borrow to fund the plan, or close the gap using assets where you’ve already locked in rates, such as fixed income.
PS: What types of options are available in the liability-driven investing (LDI) market?
Gaul: The U.K. market has been innovative in carving out various different risks. In regard to risk transfer, buy-outs are very popular. On the other hand, some sponsors have been offloading just the longevity component of the risk. That’s been very popular, largely driven by the U.K. cost of living adjustments in the benefit design.
Most of the sponsors we’re working with are looking at partial transactions, whether it’s a partial LDI strategy, a partial move to private equity to get more aggressive on the equity side, or a partial buy-out or buy-in. If you look at the General Motors and Verizon transactions, they wanted to remove 25% of the risk, so they both settled a portion of their management plan. I think the key point is it’s not a one-size-fits-all scenario. It can be phased in over time; it’s not all or nothing.
Even within one product there are many different features to consider. We’ve seen companies looking at their retired population on the salary plan to transact first. Other companies want to start this process by offloading a population that has a really small balance or a very large balance.
PS: Is there a regulatory or theoretical reason why longevity hedges, which are a common feature in the U.K. pension de-risking market, could not be a feature in the U.S.?
Gaul: Chief financial officers (CFOs) at most U.S. companies are worried about equity risk and interest-rate risk. Longevity risk is pretty far down the pecking order. In the U.K. there’s a better recognition of longevity changes.
Heard at PLANSPONSOR National Conference
Panelists speaking about pension risk transfer strategies at the PLANSPONSOR National Conference discussed 2012’s notable deals and what characteristics might make a plan a good candidate for PRT. Scott Gaul, senior vice president, head of distribution, Pension Risk Transfer at Prudential Retirement, spoke first-hand about the General Motors and Verizon pension transactions—both of which utilized the expertise of Prudential’s PRT team.
However, Gaul said, it isn’t only the big names using the PRT strategies. “We also see a lot of robust activity in sponsors at the very small end of the market as well,” he said, mentioning interest and activity from plans with $5 million or $10 million in assets. “Market trends lead us to believe there is a huge opportunity to partner with plan sponsors to de-risk their pension plans,” he said.
Gaul said the asset side of the pension plan has migrated toward how to manage or minimize volatility within a plan. “This is what the leading-edge companies are doing, looking at this equation from a corporate balance sheet point of view,” he said. “Interest rates are just one input, but it seems most plan sponsors tend to focus on this factor.”
« Expert Voices: Elaine Sarsynski