THOUGHT LEADERSHIP

Pension Promises

Risk reduction strategies let plan sponsors continue promised DB payments to employees.
PS1015-Story-Portrait-MetLife.jpgWayne Daniel, Senior Vice President and Head of U.S. Pensions
Photography by Stephen Mallon

Defined benefit (DB) pension plans have long been recognized as promises employers made to their employees. Wayne Daniel, MetLife’s senior vice president and head of U.S. Pensions, spoke with PLANSPONSOR about pension risk-reduction strategies and ways insurance companies can help plan sponsors continue to honor those commitments and make sure they get carried out as promised.

PS: Wayne, what external factors are prompting plan sponsors to explore pension risk-reduction strategies?

Daniel: It’s a combination of factors—volatility in fixed-income and equity markets, sustained low interest rates, higher Pension Benefit Guaranty Corporation (PBGC) premiums, and also the new mortality tables recently published by the Society of Actuaries (SOA).

PS: What are some potential strategies?

Daniel: They can range widely. Some examples of pension risk-reduction strategies include pension design changes, such as changes to benefits or contributions, hard or soft freezes of the plan and investment policy actions. Funding strategies can include lump sums paid to plan participants to settle any and all claims that they may have under the plan, as well as pension risk transfer (PRT), in which the plan’s assets and liabilities are transferred to the insurance company in the form of an annuity buyout. So, de-risking can be accomplished via a range of alternatives that aren’t necessarily mutually exclusive.

PS: Why would a plan sponsor consider securing an annuity buyout from an insurance company?

Daniel: There are two primary reasons: Either they’re terminating their plans so they need to settle the plan liabilities, or they want to reduce the risk, expense and size of the plan.

Pension buyouts are a popular option, currently, for defined benefit plan sponsors, and will likely remain so for the foreseeable future. According to MetLife’s 2015 Pension Risk Transfer Poll, among plan sponsors who would most likely transfer pension risk with an annuity buyout to an insurer, 57% are considering doing so in the next two years. That percentage rises to 63% for plans with DB plan assets of $250 million to $499 million, and 77% for plans with DB assets of $500 million to $1 billion.

PS: What are some of the costs plan sponsors should be aware of when it comes to implementing such an annuitization approach?

Daniel: A plan sponsor should consider the total amount of cash needed to adequately fund the plan, the foregone earnings resulting from reduced investment risk, any financial impact of a change in the expected return on the assets, as well as the accelerated recognition of accrued gains or losses. Many plan sponsors have decided that the benefits of reduced pension risk more than offset these costs—or they will when the costs reach a level that the plan sponsor deems reasonable. Since each company’s financial drivers and accounting history varies, there’s no one crossover point that applies generally.

PS: What costs and benefits should plan sponsors weigh as they attempt to quantify the costs and overall financial impact of taking an annuitization approach?

Daniel: There are a number of explicit, as well as implicit, costs and benefits, which vary depending on the approach. I think it’s vital that plan sponsors quantify the cost level at which implementing a risk reduction approach makes sense for them.

For annuitization, it would include the difference between the plan’s current funded status, the existing assets and the total amount required to settle all or a portion of the plan liabilities; the impact of the accelerated recognition of a portion of a plan’s accumulated accrual gains or losses; and the effect on the funded status of the remaining plan, resulting from the settlement of a portion of liability, or partial risk transfer.

Plan sponsors should also consider the ongoing expenses and any reduction thereof; for example, the investment management fees, the PBGC premiums, the plan administration fees, all of those associated costs.

Finally, I would emphasize that the accounting measure is only one measure of the costs associated with a pension plan. To get a true picture of what the pension is costing the business, it’s important to look holistically at the economic liability. This should take account of the additional costs and the risks, which all plan sponsors have. These include costs from lower than anticipated market returns, PBGC premiums, and costs related to the updated mortality tables from the SOA.