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.