Companies Decide the Time Is Right to Offload Pensions to Insurers
(Bloomberg Businessweek) -- Many Americans who still have a traditional pension—the kind that pays a regular income no matter what the market does—could soon have a different company paying their benefits. U.S. companies owe current and future retirees and their beneficiaries more than $3 trillion, and many have been trying to exit the retirement business for years. Right now they have a golden opportunity to buy their way out.
It’s called a pension risk transfer, or PRT: By buying a financial product called an annuity, a company can essentially place the assets of a plan and the responsibility for paying for it into the hands of a life insurance company. The insurer makes money if it can earn more from investing the assets than it has to pay out. (Another risk-transfer option is to offer to pay benefits in a lump sum; in that case, the risk of ensuring the money lasts is taken on by the pensioner rather than another company.) These deals with insurers aren’t new, but record high markets are making them especially attractive to employers.
That’s because investment gains have helped many pensions get close to full funding, meaning they hold enough assets to satisfy their obligations to current and future retirees. If a company transfers a plan that’s not fully funded, it has to pay to cover the shortfall. There’s a very small amount to make up right now. The 100 largest corporate pensions were funded at 97.1% in August, according to the consultant Milliman Inc., and they could creep as high as 102% by the end of the year under optimistic projections. A year ago, pensions were less than 87% funded.
The window to strike a pension deal could close quickly. If the markets start to fade, an employer would need to pay more to top off its plan before handing it over. Conversely, if a plan’s investments do well enough to surpass 100% funding, the sponsoring company has less incentive to exit as it could face a tax bill. And it doesn’t benefit from having excess cash sitting idle in the fund. “There’s a bit of an inflection point for sponsors as they reach full funding,” says Matt McDaniel, a pension consultant with Mercer, which advises companies on their benefit plans.
There have already been a handful of jumbo pension deals this year, including a $4.9 billion transaction by Lockheed Martin Corp. and insurer Athene Holding Ltd. and a $5.2 billion accord between Prudential Financial Inc. and HP Inc. By yearend, insurance broker Willis Towers Watson Plc expects more than $30 billion worth of transactions, which could make 2021 the busiest year since 2012.
Companies have been eager to shed the plans for several reasons. The simplest one is risk: A pension is a liability that sits on an employer’s balance sheet for a very long time, and it has to be paid even if business is slow and markets are down. Most companies now prefer to fund 401(k) plans, which put the burden of managing retirement assets on the employee. Additionally, low interest rates and bond yields mean that companies could struggle in the future to earn high enough returns to fund their obligations, even as the plans remain costly to maintain. Providers are required to pay premiums to the federally backed Pension Benefit Guaranty Corp., which insures the trillions of dollars of obligations the plans carry.
Many life insurance companies like pension assets because they can balance the obligations against other products in their portfolios. For example, pension payments are made as long as a participant lives, while a life insurance policy is paid out only upon death. The insurer can hedge the risk of people living longer than expected against that of customers dying too soon.
Insurance companies backed by private equity have also jumped into the business. Apollo Global Management Inc. is the largest shareholder in Athene, which is taking on the Lockheed Martin plan. Athene’s retirement assets have provided Apollo with a big pool of long-term capital it can invest and on which it’s earned lucrative fees. In March, Athene and Apollo announced a plan to merge.
Pension plan participants might wonder how their benefits change after a risk-transfer deal goes through. Most things will seem quite similar: Payments will still arrive monthly and in the same amounts; Prudential Financial says it matches previous payments down to the penny.
The big difference is in how these plans are supervised. Rather than being insured by the PBGC, which pays benefits up to a limit when a plan fails, they’re monitored by the state regulators who oversee insurance companies. Each state also has a guaranty association that can provide some protection if an insurance company collapses. Joshua Gotbaum, who served as the director of the PBGC during the Obama administration, told a federal panel in 2013 that there was no real difference between a plan backed by the PBGC and one managed by an insurer. James Szostek, a vice president for the American Council of Life Insurers, says life insurers have “decades of experience managing long-term obligations” as well as being subject to regulatory oversight.
Even so, retiree advocates say the shift can be a source of consternation for pension participants. “The reaction whenever there’s change is concern,” says Norman Stein, a law professor at Drexel University and a senior policy adviser to the Pension Rights Center. In a stroke, people go from relying on the company they worked for over a career to an insurer they may have never given a thought to. Stein says some of the regulations around PRT transactions and the protections for workers and retirees after a switch can be murky. He says the shift can be particularly worrying in the case of insurers backed by private equity firms, which have a reputation for risk-taking investments. Sean Brennan, executive vice president of pension risk transfer at Athene, says insurers are a safer bet than many employer-run plans “with a bunch of equity and interest rate risk.”
Since Prudential brokered two giant pension deals nine years ago, life insurers have expanded aggressively. There are now 19 life insurers willing to strike PRT deals, and more are expected to enter the fray, Mercer’s McDaniel says.
“Competition is certainly there,” says Melissa Moore, senior vice president for U.S. pensions at MetLife Inc. That’s helped bring down the main cost of a transfer, which is buying the annuity. “Annuity pricing is currently exceptional, and the annuity market is bustling as a result,” says Steve Keating, managing director at BCG Pension Risk Consultants/BCG Penbridge, which helps employers manage their retirement costs.
A recent study commissioned by MetLife found that 93% of 250 plan sponsors surveyed intend to divest all of their obligations, up from 76% in 2019. Companies can choose to fully divest the plans or reduce the scope of pensions on their balance sheets without removing them entirely. But plenty of businesses are looking to get out for good, according to Yanela Frias, president of Prudential’s group insurance business. “The reality is that an insurance company is much better positioned to manage this liability than a car manufacturer or a telephone company,” Frias says. “We do this for a living.”
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