Smaller Companies Riding The Pension Risk Transfer Wave

Pension transfers from major corporations have made headlines in the past three years with General Motors, Verizon, Bristol-Myers Squibb, Motorola and Kimberly-Clark transferring their pension liabilities. But pension risk transfers are taking place at an even faster clip among smaller companies, those with between $50 million and $1 billion in sales.

That’s the latest from pension transfer experts at the benefits consulting shop Mercer, which earlier this month released its biennial pension risk transfer survey in conjunction with CFO Publishing.

“Behind the scenes, we’re actually seeing increasing numbers of smaller big headline deals,” Matt McDaniel, a partner with Mercer Retirement, said in an interview with Insurance NewsNet. “We’re seeing much more activity in the $50 million to the $1 billion space. That doesn’t necessarily get quite as many headlines.”

If interest rates rise, as many experts expect they will later this year, pension risk transfers among smaller companies is likely to speed up, said Richard McEvoy, a partner with Mercer Investments.

“An increase in interest rates could lead to a fast increase in demand for buyouts,” McEvoy said in a news release. “Sponsors need to prepare in advance in order to position themselves to move quickly in response to changing market conditions.”

Mercer found that overall, 36 percent of this year’s finance executives said they are considering an annuity transfer.

The survey found that 9 percent said they are “very likely” and 27 percent said they are “likely” to consider the purchase of an annuity in 2015 or 2016.

Results were drawn from 213 qualified responses from finance executives employed at companies and nonprofit organizations with defined benefit plans that had $100 million or more in assets. The survey also interviewed 10 senior finance executives at large North American companies with defined benefit plans.

Mercer conducted previous surveys in 2013 and 2011.

Transferring pension liabilities of a pension plan onto an insurance company allows companies with defined benefit obligations to remove the liability from the balance sheet and reduce the volatility of the funded status.

Companies typically remove the pension liability through a lump-sum payout or by buying an annuity, but corporate finance chiefs in the past have shied away from annuities because annuities are perceived as expensive.

That may have been true several years ago.

Today, however, because the relative expense of the pension liability has gone up, annuities aren’t as expensive in relative terms, McDaniel said.

Marketplace shifts have changed the pension risk transfer equation involving annuities, according to pension experts.

For one, the Society of Actuaries over the past year updated its mortality assumptions to reflect increases in longevity.

For another, funding deficits of defined benefit plans rose last year as aggregate funding levels sank 9 percentage points to 79 percent at the end of 2014 from the previous year.

In addition, companies are paying higher premiums into the Pension Benefit Guaranty Corp., the U.S. government agency that protects 41 million people receiving pension checks from nearly 24,000 private-sector defined benefit plans.

With these changes in mind, here’s how the math works out, according to McDaniel’s example.

While a company with a defined benefit plan may have carried $100 million in pension obligations on its balance sheet every year for each of the last five years, the liability has increased by, say, 10 percent to $110 million.

At the same time the purchase price of the annuity has remained at $115 million.

The annuity is no cheaper, but relative to the company’s pension liability, ”You have 5 percent premium instead of a 10 percent premium,” McDaniel said.

Plan sponsors weight the cost of a pension risk transfer against the cost in cash, cash flows, earnings volatility and the impact on the core business of maintaining the plan. Finance departments often have overstated the costs associated with annuity buyouts, McEvoy said.

The shift toward annuities has been gradual as plan sponsors either buy an annuity or explore buying them. On July 9, the IRS said it would prohibit lump sum offers to pension plan participants “in pay status,” a development that could further favor annuities.

Annuities generally have been more common among companies looking to fund pension payments due people who are already retired, while lump sums have been more common among employees who will receive payments in the future, McDaniel said.

Results of a separate survey of 183 companies sponsoring a defined benefit retirement plan released earlier this year by retirement and benefits consulting company Aon Hewitt found that 21 percent of companies are considering buying annuities to fund a portion of their obligations to retirement plan participants.

InsuranceNewsNet Senior Writer Cyril Tuohy has covered the financial services industry for more than 15 years. Cyril may be reached at cyril.tuohy@innfeedback.com.

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Cyril Tuohy is a writer based in Pennsylvania. He has covered the financial services industry for more than 15 years. He can be reached at cyril.tuohy@innfeedback.com.