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Special Report: Pension risk transfer

Some see no free lunch in the risk transfer landscape

Textron’s Charles Van Vleet

While the volume of pension risk transfer transactions has accelerated over the past six years, some in the industry find there is no less risk remaining following such a transaction. There might in fact be more risk left for plan sponsors.

For the future of transferring assets, Charles Van Vleet, chief investment officer of Textron Inc., Providence, R.I., said he gets the sense that corporations are not as enthusiastic about preparing their portfolios for potential in-kind transactions.

He notes insurance companies' preference for in-kind assets to save on the cost of turning cash into bonds and enable them to "accept $99 worth of bonds vs. $100 worth of cash," he said.

"Plan sponsors get excited about 'saving 1%,'" he said. "However, they are slowly learning that building a portfolio of deliverable bonds is not cheap or easy. In fact, the cost is roughly the same 1%.

"If a plan sponsor is willing to separate the need for rates and the need for credit spread, there are much cheaper and easier ways to gain rate exposure (swaps, STRIPS, futures) and to gain credit spread," such as through equity, first-lien loans and short-duration non-investment-grade fixed income, Mr. Van Vleet said.

He noted that few buyouts have involved asset-in-kind transactions because of the size ($1 billion or more) required for such a transaction.

The other question is whether corporations want to take on the added risk of the portfolio that remains following a liability transfer. Insurance companies have only taken on liabilities of retirees, which by their very nature are the least-risky assets with the shortest duration. The corporate pension plan, on the other hand, is left with a portfolio that has a longer-duration liability with more potential risk.

"Our view has always been: We really think the term 'pension risk transfer' is almost a misnomer," said David Eichhorn, president and head of investment strategies of NISA Investment Advisors LLC, St. Louis. "The risk inherent in pension funds can be dealt with in asset allocation. You don't transfer risk to an insurance company. You send them a liability stream."

If funded status is a concern, Mr. Eichhorn said an annuity purchase from an insurance company shouldn't be seen as a risk management exercise.

"If instead I built a 10% (equities)/90% (fixed income) portfolio and ran the plan like an insurance company, really the risk is effectively de minimis."

The volatility of funded status, Mr. Eichhorn said, would be extremely small in the case of a hibernation portfolio.

"With any variant of a hibernation strategy those numbers tend to be 1% or 2% (variation in funded status) per year … by the time you get down to that, it's not equity risk. It's not cyclical. That 1% to 2% is lost in the enterprise risk equation even with the most pension levered companies."