U.S. corporate executives considering a pension risk transfer need to think long and hard about the mechanics of how best to structure the deal with an insurance company: an asset-in-kind transaction, a cash transaction or some combination of both, industry experts said.
While an asset-in-kind transaction might be appealing, given its cheaper cost to execute in terms of a premium paid to insurance companies, it also will require plans to work in advance with their advisers so that assets meet the needs of insurers.
Pension plans are tax-exempt under the Employee Retirement Income Security Act of 1974, which enables corporate plans to take on more risk. But insurers operate under tighter regulatory restrictions, which requires that plans take a more cautious approach to assets that could later be under the control of an insurer.
Group annuity purchases of less than $1 billion are often cash transactions, and those over that threshold usually involve assets in kind, or a combination of assets in kind and cash. An assets-in-kind transaction allows an insurance company to accept securities, most often types of fixed-income assets but also a limited amount of other assets, directly from the pension plan. Historically, most transactions involve the pension plan liquidating securities and transferring cash to the insurer.
Lisa Longino, senior vice president, head of insurance asset management at MetLife Investment Management, said insurance companies often prefer asset-in-kind transactions for the larger deals because of the funding delay in transferring large pools of cash into securities the insurance company wants to manage.
"Largely, the plan sponsor's preference will be dictated by the comparative cost of liquidating the portfolio, (think of this as the bid-ask spread) with a potential premium benefit offered by insurance companies in their pricing. The benefits offered can vary from insurance company to insurance company," said Scott Kaplan, senior vice president, head of pension risk transfer at Prudential Financial Inc., Newark, N.J.
According to Prudential, the cost of a buyout is about 104% of the pension liabilities being transferred. The premium paid, however, can sometimes be less depending on the nature of the deal.
"Insurance company preferences will typically vary based on their view of the specific liability and how well the particular assets available for the assets-in-kind transfer fit the liability profile. Oftentimes, the insurer and sponsor can agree on subsets of the sponsor's portfolio that would be a good fit and represent the largest value," Mr. Kaplan said.
That work has its origins in liability-driven investing, which many corporations have employed in the past two decades as they have frozen benefit accruals in their defined benefit plans. LDI increases the plan's exposure to fixed income over time to match the liability duration of the plans.
Industry experts said the question on how best to execute a buyout is increasingly coming up as more corporate plans position their portfolios for an eventual transaction after blockbuster deals in 2012 brought new visibility to the PRT option.
Detroit-based General Motors Co. and New York-based Verizon Communications Inc. effectively transformed the pension risk transfer landscaper, transferring $29 billion and $7.5 billion, respectively, to Prudential's insurance unit.