Pension buyouts expected to surge — but not yet

Pension buyouts have been in a lull so far in 2013, but insurers and consultants expect a rush by corporate defined benefit plans in the next several years.

That's because expectations of rising interest rates plus improved funding ratios for many plans will make it easier and less expensive to sell their liabilities to insurers, sources said.

Executives at annuity providers like Newark, N.J.-based Prudential Financial Inc. and Metropolitan Life Insurance Co., New York, expect a total of $2 billion to $5 billion in buyouts by the end of 2013. Year to date there's been about $1 billion in activity, but corporate plans historically ramp up their decisions on pension buyouts in the last quarter.

Glenn O'Brien, managing director and head of U.S. distribution and client management for pension risk transfer at Prudential in New York, said he expects about $2 billion in pension buyouts in 2014, possibly reaching $3 billion. ”We think $150 billion in five years could get done.”

Ed Root, vice president of U.S. pensions at MetLife, said several “super jumbo” pension plans could be in a position to do an annuity transaction in 2014, but he wouldn't name the plans. He also expects an average of $20 billion in pension buyout deals annually over the next 10 years.

So far this year, buyout activity has been average compared with the last 10 years, but far below the heady days of 2012, when high-profile pension buyouts at General Motors Co. and Verizon Communications Inc. propelled the liability annuitization market to about $37 billion for the year.

“The market won't rebound to $37 billion this year,” said Richard McEvoy, partner and leader of Mercer LLC's U.S. financial strategy group, New York. “The market hasn't taken off, and (current) interest rates have a lot to do with this, but sponsors take a while to get their act together. They're talking about it.”

“We knew, especially after Verizon and everything else, that 2013 was going to be a disappointing year,” Mr. O'Brien said. “But (executives at large plans) know they can get it done, depending on their funded status.”

Said Donald Stegall, financial adviser in the Paramus, N.J.-based Napolitano Group at Morgan Stanley: “Once the dam breaks, there's going to be a huge flood of pension buyouts.”

Sources also said many frozen DB plans that are at or near 100% funded will be in a position to offload their liabilities. They wouldn't identify any plans, but according to data from Pensions & Investments, the following companies with frozen DB plans and funded status at or above 100% could be in a position to do so (all data are as of Dec. 31):

• Prudential, whose $12.69 billion plan was 105.3% funded;


• Bank of New York Mellon Corp., New York, at $4.278 billion, 104.5% funded;


• Target Corp., Minneapolis, $3.223 billion, 101.9% funded; and


• J.C. Penney Co. Inc., Plano, Texas, $5.035 billion, 99.9% funded.

Pension executives at Prudential, BNY Mellon, Target and J.C. Penney did not return calls for comment. Several sources said plan executives, particularly those at publicly traded companies, are reluctant to say whether they're considering pension buyouts because of the regulatory requirements for disclosures to the Securities and Exchange Commission, Internal Revenue Service and Department of Labor.

Prudential's Mr. O'Brien said the insurance giant's DB plan has 75% of its assets in a liability-driven investment strategy. The plan is purposely overfunded so excess pension assets can be transferred to the company's health benefits account under IRS Code Section 420. “We could annuitize, but not at this moment,” he said.

One pension executive overseeing a frozen DB plan thinks the time isn't right. “It's early in the lifecycle,” said Brian Szames, treasurer at Cincinnati-based Macy's Inc., which has a $3.387 billion frozen plan. “I've read about GM and Verizon. It's very interesting, but we feel it's too early.”

Mr. Szames wouldn't say whether there'd be interest in a buyout in the future or elaborate on when the timing might be right to do a buyout. The Macy's plan was 95.3% funded as of Dec. 31, according to P&I data. He said funding has improved since then but wouldn't provide statistics.

Still, it's “a fair assumption” that large, fully funded, frozen DB plans are prime candidates for buyouts, said Janis Kane, director, asset allocation research, at Rocaton Investment Advisors LLC, Norwalk, Conn. “The more well-funded pension plans using (liability-driven investing) would at least consider it.”

For open and active pension plans, buyouts are discussed more in passing, added Robin Pellish, Rocaton CEO and co-founder, but “the more serious discussion is with those frozen or closed plans that are close to full funding, though not all are looking to transfer their liabilities,” looking instead to other derisking strategies.

“2014 will be a significant year for derisking,” said Matt Herrmann, St. Louis-based senior consultant and leader of the retirement risk management group at Towers Watson & Co.

And pension executives, though currently taking a wait-and-see attitude on when buyouts will be affordable, are talking about it with consultants and insurers, “We've had a lot of conversations with pension plans, basically about if not now, when should we do this,” he said. “(Low) funded status was a fairly significant deterrent when the median (funding ratio) was 75%, but we're seeing a shift back again as the equity market has improved and funding ratios have grown to 85% to 95%.”

For pension plans with more than $1 billion in assets, it might not make sense to do a buyout now because settlement accounting is a problem cost-wise. “Big plans can wait to get to 100%, 110% funding when it will be less expensive to do a buyout,” Napolitano Group's Mr. Stegall said.

Ari Jacobs, senior partner and global retirement solutions leader at Aon Hewitt, also in Norwalk, said pension buyouts take 12 to 24 months “from soup to nuts.” That includes regulatory requirements, necessary changes in asset allocation and communicating the changes to participants.

Pension executives first have to determine how to derisk — through buyouts, pension buy-ins, LDI or lump sums — or some combination.

“From an economic standpoint, lump sums are generally more cost-efficient” than pension buyouts, said Rocaton's Ms. Kane. “It's usually a natural progression from lump sums to buyouts.”