When the pension plan gets in the way of the business plan….

By William F. McCloskey

The global pension risk transfer market has never been more vibrant with nearly $94bn in transactions since 2014 in the US, UK and Canada alone.¹ This market has been transformed by innovation in the insurance and reinsurance industry aimed at solving the real problems that corporate plan sponsors are facing today. These include enduring funded status volatility, ongoing financial market uncertainty, low and lower interest rates, more stringent funding requirements, more transparent accounting, a hyper-competitive business environment and dramatic increases in life expectancy for plan participants.

Longevity risk presents sponsors with a particularly daunting challenge, as it entails the possibility of making benefit payments to plan participants for longer than expected. It has an immediate impact on funded status when life expectancy increases and it is exactly the sort of risk that should be insured. Accordingly, when a company’s pension plan gets in the way of its business plan, firms are turning to pension risk transfer as a solution that allows them to refocus on their core business, and maintain a secure benefit for their retirees.As shown in Exhibit 1 (inset), the retired lifetime—or the number of years a person expects to spend in retirement—for males in the US and UK has increased substantially since 1970. The retired lifetime of an average US male has increased 35% over the past 40 years, and now US and UK males can expect to spend nearly 18 years in retirement.With such rapid change in life expectancies, pension risk management decisions made without considering longevity risk will underestimate overall risk and understate the advantages of risk transfer. Presently, insurance solutions are the most effective means of addressing longevity risk, and there are several solutions available, including:Pension buyout. With this solution, the plan pays a premium to an insurer to settle the liability. The insurer assumes all investment, benefit option and longevity risk, and the liability is removed from the sponsor’s balance sheet. Buyouts are common in the US, UK and Canada, where companies like General Motors, Verizon, Motorola and EMI have chosen this solution and $86bn of transactions have been completed since 2010.²Pension buy-in. This solution serves as a plan investment that perfectly matches the liability, providing the exact amount of income the plan requires to make benefit payments for participants’ lifetimes. This option is rarely used in the US because the liability is not settled. Pension funds in the UK that are on the path to plan termination use this solution, including firms like Philips and ICI, which have pursued a phased de-risking programme to transact when buy-in pricing is attractive. Approximately $40bn of buy-in transactions have been completed in the US, UK and Canada since 2010.³Pension hibernation with longevity risk transfer. This is the fastest growing solution in the UK where many companies seek to manage their pension risk safely on the balance sheet, leveraging the capabilities of their in-house CIO. This entails a disciplined liability driven investment strategy or an absolute return strategy for over 70% of the assets, a diversified risky asset strategy for the remaining assets (up to 30%) and a longevity hedge. The longevity transactions prevalent in the market today convert an unknown future liability into a fixed liability cash flow by locking in plan participants’ life expectances. With a fixed future obligation, large pension funds can manage assets against the known liabilities more easily. Longevity risk transfer is often used by sophisticated sponsors as the capstone to any pension hibernation strategy since no hibernation strategy is complete until longevity risk is addressed. Over $97bn of these transactions have been completed since 2007 in the UK and Canada, where British Telecom, Aviva, BMW and Bell Canada are just a few of the companies that have chosen this approach.⁴Exhibit 2 below shows the available risk transfer solutions and some of the firms that have implemented them.In the UK, the British Telecom longevity transaction was the largest ever completed, covering liabilities worth £16bn ($28bn USD). To facilitate the deal, the BT Pension Scheme created its own captive insurer, which insured the longevity risk, and then reinsured the risk to The Prudential Insurance Company of America (PICA), creating an arrangement that is fully collateralised.With this deal, BT joined the ranks of the many companies that have used a customised pension risk transfer solution to meet their needs. The agreement sets an example for the largest pension plans as they determine how to best navigate longevity risk and a safe pension hibernation strategy.Of course, no two pension funds are the same. Each will experience unique funding levels, portfolio allocations, and longevity outcomes. And each will have its own approach to risk management that is specific to its risk profile, resource constraints, governance and sophistication. But all share a common ambition: To secure retirees’ benefits while achieving a lower risk future.With solutions like longevity risk transfer, the insurance and reinsurance community has responded to demand for more flexibility in the available solutions for pension de-risking. Insurance and reinsurance solutions can help ensure that each pension fund can tailor the solution that best meets its needs, and those of its members.William McCloskey is vice president, longevity risk transfer for Prudential Retirement ¹ Source: LIMRA and Hymans Robertson, as of June 30, 2015.² Source: LIMRA, Hymans Robertson, Towers Watson and Eckler, as of June 30, 2015.³ Source: LIMRA, Hymans Robertson, Towers Watson and Eckler, as of June 30, 2015.⁴ Source: Hymans Robertson and Prudential analysis, as of June 30, 2015.