Pension Risk Transfer: Derisking Trends and Considerations

Thanks to a supportive macroeconomic environment, more corporate plan sponsors are able to derisk their pension plan. As evidenced with another banner sales year for the industry, they are choosing pension risk transfer (PRT) transactions — a solution through which pension plan sponsors can move some or all of the financial obligations to an insurance company.

The recent increase in interest rates, following the low-rate environment of the last decade, paired with equity market gains, has improved pension plans’ funded statuses, setting the stage for more plan sponsors to pursue a PRT transaction. Specifically, the funded status of the 100 largest U.S. corporate defined benefit pension plans reached 103.2% at the end of September, up from 101.5% a year earlier, according to the Milliman 100 Pension Funding Index.

“The environment that we’re in today — not only with strong funded statuses but also with many plan sponsors that have aligned their assets in a way that protects that funded status — will encourage more plan sponsors to come to market,” said Ian Cahill, head of pension risk transfer at Massachusetts Mutual Life Insurance Company (MassMutual^®), during the Current Trends in PRT panel at P&I’s Managing Pension Risk Conference in October.

Financials are only part of the story, as derisking through a PRT can remove plan sponsors’ internal responsibility of administering the benefit plan and its related payments as well. Cahill expanded the conversation covering trending transaction types as well as steps to PRT transaction success.

Trending Transaction Types
There are multiple types of PRTs — a popular one being a “lift-out,” in which the liabilities of a specific covered group of employees are carved out of the larger plan and transferred to an insurance company. Lift-outs are often one of the first steps in a plan’s derisking journey, but more sponsors are getting further along in that journey and looking to pursue a full “plan termination.” In a plan termination, the sponsor transfers all of the remaining liability of the plan to an insurance company and is able to fully remove the pension plan from their balance sheet and day-to-day responsibilities.

“We’ve seen a pickup over the past couple of years in plan terminations,” Cahill said, noting that the improvement in funded status has also driven increased interest in full terminations. While plan terminations are a good solution for fully funded plans that are no longer accruing benefits, “there’s an opportunity for a plan that may not be as well funded to do a lift-out if they are derisking,” Cahill said.

Preparing for Success
Whether a lift-out or full termination, the quality of data is critical to the success of the transaction. Complete data about the plan’s covered population that will be transferred to the insurance company helps with the underwriting and pricing process as well as with the transaction itself.

Regarding pricing, insurers need to understand the scope of the work to be performed as well as the value of the liabilities. “Insurers that have been in this market for a while have been able to develop data analytics that allow them to set mortality assumptions that drive better pricing than the standard assumptions that plans are using in their accounting liability,” Cahill said. “The most accurate data allows the plan sponsor to have the best comparison of insurer pricing on selection date and helps the insurers ‘sharpen their pencils’ when calculating the premium,” he shares in Quality Data Bolsters Pension Risk Transfer Success.

Additionally, pension plans that typically tilt their asset allocation more heavily toward fixed income to protect their funded status have been able to use that allocation as a potential funding source for a PRT, he noted. This is done through asset-in-kind (AIK) funding, where a plan sponsor pays a portion (or all) of the PRT premium through transferring assets acceptable to the insurer instead of paying cash.

For plan sponsors who are interested in learning more about AIK, Cahill offers a deeper look into the process in his paper, Managing Group Annuity Buyout Costs and Risks with Assets-In-Kind.

Evaluating Insurers
When evaluating insurers, it’s essential plan sponsors consider insurer structure and culture as these factors are the underpinnings of enduring financial strength and an insurer’s commitment to serving the annuitant for the long term.

For example, MassMutual has a mutual structure, which is about collectively working together to help individuals and organizations meet their long-term financial needs. Whether to meet obligations to policyowners for an insurance claim, or to help investors meet long-term investment or risk management needs, often the timeframe extends decades into the future. Hence, MassMutual takes a long-term view when working to serve our customers, Cahill explained. With this culture and point of view, MassMutual has insurer ratings — a key indicator of enduring financial strength — that are among the highest in the industry.¹

In addition, plan sponsors should zoom in on insurer PRT expertise as the ultimate objective of a PRT transaction is to ensure the satisfaction of the pension obligations — financially and administratively — through the life of the group annuity contract. “Plan sponsors will want to understand how the annuitant will be served after the transaction as part of the decision-making process,” said Cahill.

An insurer’s ability to make the payments it has guaranteed under its group annuity contract involves a combination of its financial ability to make the payments and the insurer’s commitment and ability to sustain the administration of the group annuity contract, including completing all payments due to the annuitants — all for the long term. For a list of key questions when evaluating an insurer’s annuitant services and more, please review MassMutual’s paper, Voice of the Annuitant.

Delivering on a promise
As stated earlier, the ultimate goal is to deliver the promised payments to the annuitant. The success of a PRT implementation “really comes down to all the data and information being handed over to the insurer,” Cahill said. “Providing the cleanest data — and the most complete data — to the insurance company helps deliver a very smooth transition.”

Complete data is required to properly administer the payments, and it also helps ensure proper communications about the transaction are sent to plan participants — who are referred to as annuitants post-transfer — so they know when and from whom they should expect to receive their monthly pension payment, Cahill said.

One recommended practice for plan sponsors is to issue what Cahill termed a “goodbye letter” with information about the final payment from the employer, the transaction and the next payment to be sent from the insurance company that has taken on the pension liability. It could also contain background on the selection process and highlights of the insurer.

Around the same time, the insurance company should notify plan participants of the changes, such as who will issue subsequent pension checks, how they can validate the accuracy of their information and where and how to access their accounts.

These communications can serve to reassure participants that their payments will continue and provide a contact should they have questions. As experts in PRT, MassMutual has solidified its implementation process and is prepared to walk plan sponsors through all aspects of the process including annuitant communications, Cahill said.

In Conclusion
MassMutual believes that PRT providers are poised to respond with appropriate capacity and flexibility as more corporate pension plans seek to leverage their improved funded status by derisking given the current market conditions. “When we look at the growing number of plans that are now moving over to insurance companies, we believe that this very steady growth [in pension risk transfer] will continue as more plans become fully funded,” Cahill said. “We expect the market will continue to grow steadily for at least the next three years, and MassMutual is well prepared to serve.” ■

^{1Our most current ratings are always available at MassMutual.com/about-us/MassMutual-financial-summary
Group annuity contracts and certificates are issued by Massachusetts Mutual Life Insurance Company (MassMutual), Springfield, MA 01111-0001.}