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.
PS: What steps should sponsors take to prepare as they consider an annuitization approach to this de-risking?
Daniel: At MetLife, we recommend that plan sponsors take the following steps: quantify the costs and understand the financial impact; identify an acceptable level of costs and financial impact for the plan and the plan sponsor; obtain the necessary internal approvals for action; monitor the environment so that opportunities can be tracked and not missed; and then, finally, implement a strategy when appropriate.
We believe that these steps are necessary so that the plan sponsor can react and execute promptly when the opportunity arises.
PS: How should plan sponsors determine the acceptable cost for doing an annuitization de-risking?
Daniel: Assume the plan sponsor is investigating a partial risk transfer settlement of the retirees, and is concerned only with the difference between the accounting liabilities and the economic liabilities. If the accounting liability for the retirees is $500 million and competitive annuity bid is $525 million, then the price difference is $25 million. Is that price too high, or is it acceptable?
The acceptable cost varies by firm. A cash rich firm with a plan that is large relative to the firm may be more willing to absorb these costs than a plan that does not have available liquidity with a small legacy plan.
PS: What roles might different decision-makers play as the company contemplates a pension risk transfer?
Daniel: There are a number of different stakeholders involved in the decision-making process around a pension risk transfer. Our research shows that plan sponsors believe that the C-suite is the most important stakeholder group when deciding to transfer pension risk to an insurer, and the chief financial officer (CFO) needs to deem that the financial impacts of implementing are beneficial—or at least acceptable—to the company. The plan actuary is another important stakeholder, as any change in the investment strategy of the plan or partial settlement involving the plan may affect the expected return on assets and the funded status of the remaining plan.
The board of directors of the plan sponsor may actually wish to agree on an acceptable funding level for implementing an annuitization strategy; then they can approve a transaction in principle in advance, and, subject to achievement of that funding level and a proper due diligence, the pension de-risking can proceed.
For the investment committee, an existing policy statement may be required to be modified to reflect any changes to the overall investment strategy and/or involving the use of annuities for the plan. And, the plan’s legal counsel should review the fiduciary and regulatory aspects of the desired strategy.
So, all of these parties need an input as the plan sponsors go through the three major steps: They need to obtain agreement among all of these stakeholders, they need to decide on the insurers that may be appropriate for obtaining quotations for the annuitization, and they need to design an implementation strategy and a protocol for authorizing the execution when the conditions in the market are acceptable.
PS: How can a plan sponsor prepare for such an approach, and what are some of the steps involved in the actual implementation?
Daniel: Once a plan sponsor selects an annuity provider, the implementation of the group annuity contract involves close interaction among the plan sponsor, the advisers and the annuity provider. The steps involved relate to procuring data, data cleanup, any participant communications, final contract execution and the release of participant certificates.
PS: How can plan sponsors be confident that their participants will get the same level of ongoing service and protection from an insurance company as they did from the employer?
Daniel: Well, insurance companies are in the business of assuming risk and issuing guarantees. The employer can return to focusing on its core business, as well as providing for the financial security of their plan participants. And, most importantly, plan participants win because they gain the expertise and the protection of a company like MetLife, which has been providing these group annuity contracts for more than 90 years. Plus, a risk transfer to an insurance company where the participant’s benefits are preserved does not represent a risk transfer to the participant in any way.
The participants maintain all of their benefits—for example, spousal protection—even after a pension risk transfer. In fact, the group annuity certificates we issue to participants in a defined benefit risk transfer are actually required to follow the planned provision and benefit rules. So, nothing changes except the entity sending the participants their payment.
With a pension risk transfer to an insurance company, the plan assets and liabilities are irrevocably transferred to the insurer. Each participant has a right to an annuity payment, and that payment is enforceable against the insurer; the insurance company assumes all of the financial and administrative responsibilities of paying the benefits.
The annuity has two layers of protection—the insurer as well as the State Guarantee Association. In this way, an annuitization approach offers at least as much protection and, for many participants, perhaps greater protection, than traditional reliance on the plan sponsor and the PBGC.
« Employee Retirement Plans