The market for pension risk transfers is booming.
In the first quarter of 2022, U.S. pension risk transfers reached $5.5 billion in total market volume, marking its largest quarter to date, according to Legal & General Retirement America’s pension risk transfer monitor. A PRT deal happens when a retirement provider — usually a corporate pension plan sponsor — unloads a portion of (or all) of its liabilities to an insurance company.
Beth Ashmore, managing director of retirement at Willis Towers Watson, told Institutional Investor that pension plans want to enter pension risk transfer deals from a strongly funded position. “To do a pension risk transfer you [have] to make sure you have sufficient assets to hand to the insurer in order to secure those benefits,” Ashmore said. “With a strong funded position, sponsors are saying… this is an opportunity for us to manage our risks and capitalize on being funded.”
Ashmore said pension plans’ funded positions have improved recently as a result of strong equity market performance. According to WTW’s Pension 100 report released last week, the aggregate funded status of defined benefit plans in the index rose from 87.9 percent in 2020 to 95.8 percent in 2021.
Rising interest rates have also contributed to improved funding positions because as interest rates go up, the value of pension liabilities that companies have to hold on their balance sheet goes down.
But funding levels weren’t the only driver of the strong PRT market volume. George Palms, president of LGRA, said that there is an overall “secular shift to de-risking” among plan sponsors, which boosted deal volume.
“Increasingly, we see plan sponsors open to laying off those risks onto insurers via our PRT transaction to reduce their risk profile,” Palms said.
LGRA expects the growth of the PRT market to continue into the second quarter. In fact, the firm anticipates that the first six months of 2022 will be the strongest first half of a year yet for PRT deals.
This expectation is, in part, a product of recent market volatility. With increasing interest rates, rising levels of inflation, a potential recession, and geopolitical uncertainty, corporate plan sponsors now more than ever want to protect themselves from market downturns.
The thinking for plan sponsors, Ashmore said, is “if I get a pension risk transfer done, I've insulated myself from further volatility on that piece that I’ve transferred.”
There are two ways a retirement provider can complete a pension risk transfer. First, a plan sponsor can unload a portion of the income liabilities it owes to its employees and retirees through a lift-out, transferring some of its pension risk to an insurance company. In the first quarter of 2022, 40 percent of total PRT activity consisted of lift-outs, according to LGRA.
The second type of PRT transaction is a plan termination, which occurs when the insurance company takes over all of the obligations of the pension plan and becomes solely responsible for the liabilities of employees and retirees. The first quarter of 2022 was weighted toward plan terminations, with 60 percent of deals falling into this bucket.
Plan terminations “really occur when a plan is fully funded — so over 100 percent funded. Generally you have to be around 105 percent funded,” Serge Agres, managing director at Cambridge Associates, told II. “Then you can really settle your obligations, and you can sell your plan to an insurance company.”
In March, Agres and his colleague Jacob Goldberg published an article on the CA website about the downside risks of PRTs for plan sponsors. While the post focused largely on the risks associated with lift-outs — or partial risk transfers of plans that aren’t fully funded — Agres said plan terminations also come with some potential downsides.
For one thing, Agres said, plan terminations are expensive: “Plan sponsors are paying a premium to settle their liabilities,” he said.
He noted that recent regulations put in place to reduce the level of risk in the marketplace may have made the premiums higher than the value of the risk mitigation provided by PRT deals. In short, he believes that plan sponsors may be overpaying for a minuscule amount of risk protection.
And increasing demand for PRT deals could drive up costs further, Agres said, noting that prices for such deals, like all products, are based on supply and demand.
Palms, however, indicated that plan sponsors could have leverage to negotiate better prices as insurers vie for deals. “There are currently about 18 or 19 insurers that are competing in the PRT market, and I’d argue that’s the definition of a pretty competitive market,” he said.
Still, Agres argued that the best option for plan sponsors is to manage their risk through asset allocation, rather than offloading it. He said that plans with best-in-class managers and efficient asset allocation strategies theoretically should be able to reduce costs over the long-term and protect themselves from market volatility.
“If you have a good liability hedging strategy, you can reduce a lot of your risk from things like equity markets or interest rates while also being able to rely on your asset portfolio to close any funded status gap,” Agres said.
