For several decades, corporate America had been looking for ways to shed the increasing costs and performance risk of sponsoring traditional, defined-benefit (DB) pension plans. Freezing plans by halting the accrual of future benefits had become a popular strategy. But plan sponsors that did that were still on the hook for funding benefits that had accrued, as well as for overseeing plans for decades to come as plan participants and beneficiaries continued to draw benefits.

Five years ago, General Motors and Verizon Communications surprised much of the pension community when they undertook on a grand scale what until then had been a relatively obscure strategy for shedding pension risk: purchasing a group annuity to cover some of their DB plan’s pension liabilities. Since those two starter megadeals, the strategy’s popularity has surged.

In a typical transaction, the plan sponsor transfers to the insurer securities and cash equal in value to the benefit obligation the sponsor wishes to shed. The transfer is usually a portion of the sponsor’s total obligation, since shedding the entire obligation at one time could be prohibitively expensive. Once executed, the transaction moves the pension liability from the plan sponsor’s balance sheet to the insurer’s balance sheet, and the insurer becomes responsible for paying all future pension benefits to plan participants covered by the agreement.

Drivers of Change

What’s prompting an increasing number of DB plan sponsors to consider transferring some or all of their pension benefit obligations to an insurance company? A recent CFO Research survey, conducted in cooperation with Prudential Financial, found that, of 80 senior finance executives at U.S. companies that sponsor DB pension plans, more than 4 in 10 respondents (45%) said their firms had already completed a pension risk transfer.

17Oct_FieldNotes_Fig1Respondents who had completed a risk transfer indicated that their decision to purchase a group annuity had been driven by a broad list of factors, but a desire to manage total pension costs—including mitigating the impact of increased premiums paid to the Pension Benefit Guaranty Corporation (PBGC)—was high on their list. (See Figure 1.)

The survey also found that among DB plan sponsors who had not yet purchased a group annuity to transfer pension liabilities, nearly half (49%) said they had discussed such a transaction with an external organization, and more than one in five (21%) said they expected to execute such an agreement in the next two years.

Among the developments driving this pivot to pension risk transfers are actual and anticipated changes in the regulatory and economic environment. The desire to lock in the current value of a pension liability, rather than watch it float (and potentially rise in value), is often a key factor in the decision to transfer the risk.

For example, more than one-third (36%) of survey respondents that had not transferred risk said that recent increases in the per-participant premiums their plans paid to the PBGC, and the prospect of further increases, were making it much more likely that their companies would consider a near-term group annuity purchase.

Nearly as many survey respondents, 33%, said a recent change in actuarial mortality assumptions, and the prospect of further changes, also made it much more likely that their organizations would weigh a pension-risk transfer. Finally, more than 1 in 4 respondents (28%) said they were being pushed in that direction by the increase in interest rates from a year ago, as well as prospects for further interest rate hikes. By contrast, fewer than 1 in 10 respondents (9%) said tax reform allowing for the U.S. corporate repatriation of profits held oversees would motivate them to pursue the annuity route. (See Figure 2.)

17Oct_FieldNotes_Fig2However, more than half of survey respondents (55%) said that if Washington enacts tax reforms that lower corporate tax rates, their companies would likely use the tax savings to increase funding of their defined benefit pension plan and execute either a full or partial liability transfer via a group annuity. (To make the agreements work for insurers, plan sponsors must fully fund the benefit obligation they’re transferring to an insurance company.)

Where to Begin

More than 4 in 10 survey respondents (43%) said that if they conducted a liability transfer transaction, they would begin with a partial transfer of their pension liabilities and then follow with the purchase of additional annuities over time. Complete transfers can be challenging; most corporate pension plans today are not fully funded. (The aggregate funded status of the largest U.S. pension plans fell to 83% in August 2017.) And CFOs are not likely to tap banks or the capital markets to cover the shortfalls. Fewer than 1 in 5 survey respondents (18%) said their organizations would likely borrow or issue debt to more fully fund their plan prior to a risk transfer.

A common annuity purchase strategy is to target liabilities for retirees first, since they’re the least expensive group to annuitize, and to then focus on retirees who are receiving low monthly payments. Because PBGC premiums are charged on a per-capita basis, rather than on the amount of the benefit, significant pension risk can be mitigated by annuitizing retirees who receive small benefits.

17Oct_FieldNotes_p47Finance executives whose companies had transferred pension risk using group annuities reported outcomes in line with expectations and suggested they’ll be doing more such agreements in the future. Among the survey respondents whose companies had purchased group annuities, more than 8 in 10 (83%) said they were satisfied with all aspects of their agreements, and nearly three-quarters (72%) said they were likely to undertake more such transactions to further whittle down their pension liabilities.

In addition, among the survey respondents who had purchased a group annuity to transfer pension liabilities, more than 8 in 10 (81%) agreed that plan beneficiaries affected by the transaction were content to receive their pension payments from an insurance company. In addition, a stronger majority (86%) of respondents said they believed the arrangement offered those participants greater retirement security in the long run.

For many CFOs, it appears that group annuity purchases to transfer pension obligations are successfully meeting the risk management needs of the enterprise. At the same time, these agreements continue to faithfully fulfill the enterprise’s pension obligations. Not surprisingly, the survey found that most finance chiefs welcome the opportunity to leave their DB plan obligations behind: the performance risk that accompanies a DB pension is better off in the hands of an organization that is a specialist in managing it.

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