Re: “Pension buyouts might increase risk for plan, report finds” (P&I Daily, June 26):
Citing a J.P. Morgan Asset Management report, this article suggests that purchasing a pension buyout might increase risk for the plan and its sponsor. Unless Pensions & Investments readers understand how the terms “buyout” and “risk” are used in the context of JPMAM's report, its conclusions may cause confusion.
What the report terms a buyout is actually a partial buyout, often referred to as a “carve-out,” which is a settlement of only a portion of a plan's liabilities by the purchase of an annuity contract. Observations in the JPMAM report such as “buyouts only marginally address longevity risk” don't make sense unless understood to apply only to partial buyouts. The report nowhere mentions the possibility of a buyout of all the plan's liabilities — in spite of the fact that such buyouts represent the vast majority of defined benefit group annuity purchases. In a full buyout, all of the funding risk, contribution risk and longevity risk go to zero immediately.
JPMAM's report is based on its study modeling the effect of a partial buyout on plan sponsor contribution cost for the residual plan. Its observation that “buyouts can increase risk” is based on a definition of risk that includes expected contribution costs. However, most pension and investment professionals would consider risk to be purely a measure of uncertainty. It is true that the cost of a buyout is frequently higher than the cost of maintaining a plan. That does not mean it is riskier. If we look at the example in the report in which the partial buyout is claimed to be riskier than the initial plan, we see that the worst-case scenario on the initial plan requires $530 million more (+310%) contributions than expected, and the worst-case scenario on the residual plan is $490 million more (+130%). Isn't that less risk?
The main reason that the risk numbers in JPMAM's report are so high relative to the size of the plan is because the assumed asset portfolio composition, 60% equities and alternatives, is a poor match for the long-duration liabilities. The deck is stacked even more against the post-buyout residual plan, which has even longer liabilities. A plan sponsor considering a buyout to remove risk would likely already be using an LDI investment strategy for which the downside risks would be much smaller. A comparison of the cost of a buyout (using more realistic insurance pricing assumptions) vs. the cost to maintain a plan with an LDI strategy would be of greater relevance.
Principal, Penbridge Advisors LLC