Approximately 30% of U.S. defined benefit (DB) pension plans currently have a funded status of 95% or higher, making a full buyout or significant risk transfer transaction a “feasible option” for a growing number of plans since the start of the year, according to a recent analysis by RiskFirst, a financial technology company that works with pensions and professional investors.
DNY59 / E+ / Getty Images
Such a high funding ratio for assets over liabilities puts a pension plan within realistic reach of selling a large portion of its projected benefit obligation (PBO) to an insurer or eventually terminating the plan. This opportunity exists for pensions when the premium over current annuity pricing is less than the increasing costs to sponsors of managing the plan themselves.
RiskFirst analyzed data on 500 plans with total assets of more than $100 billion, according to an August 2 company press release. In the first half of 2018, 50% more plans than at the end of 2017 were situated in a band of funding status hovering around 100%, which likely makes selling pension assets beneficial.
Types of Plans in Study
The pension plans studied by RiskFirst ranged in size from smaller plans to those with $8 billion in assets and were relatively typical of U.S. plans as a whole, the firm stated.
“[Thirty%] is certainly a sizable number, and while risk transfer will, of course, only be the right option for some of those plans within striking distance, it wouldn’t take much of a change in sentiment to impact the appetite for bulk annuities in the current climate,” said Michael Carse, DB pensions product manager for RiskFirst.
Furthermore, if these plans could increase their long-term yields by 50 basis points (bps), or 0.5%, 40% of the DB plans examined would be within this well-funded group. If their yields increased by 75 bps, 46% of pensions would be in this funding-level band, the study found.
A group annuity risk transfer allows an employer to transfer all or a portion of its pension liability to an insurer. In doing so, an employer can remove an often-threateningly large liability from its balance sheet and reduce the volatility of the pension’s funded status.
Single-premium group, or terminal funding, annuity contracts are purchased by an employer that has decided to terminate its DB pension plan and is required by regulation to transfer participants’ accrued benefit liabilities into a life insurer’s irrevocable group annuity contract.
Reasons for Risk Transfers
Several years of low interest rates and volatile financial markets have made it difficult for many sponsors to keep DB plans fully funded. In addition, significant increases in premiums charged by the U.S. Pension Benefit Guaranty Corp. (PBGC), and adjustments in mortality tables recognizing rising longevity among pensioners have made pension risk transfers more attractive.
With market factors now presenting favorable conditions for “derisking”—including accounting reforms, a strong equities market combined with reductions in liabilities, escalating PBGC premiums, and the incentive for additional prefunding in 2018 ahead of corporate tax-rate changes—RiskFirst said there is the potential for risk transfer rates to rise “considerably.”
See ¶1030 in the Pension Plan Fix-It Handbook for more details on selecting a plan annuity provider when a pension is being terminated.
Jane Meacham is the editor of BLR’s retirement plan compliance publications. She has nearly 30 years’ experience as a writer/editor of financial services news.