The BCG Pension Insider
September 2022 – Volume 131, Edition 1
Spotlight Series – Q&A with Prudential
A Pension Risk Transfer Market Update with an Industry Pioneer
Prudential Financial, Inc.
|Headquarters||Newark New Jersey|
|Assets Under Administration||$1.7 trillion|
|Shareholders’ Equity||$33.0 billion|
* As of June 30, 2022
U.S. Market Leader, Head of Risk Transfer & Guarantee Products Distribution
Glenn has helped numerous large U.S. plan sponsors evaluate, price and structure the most significant pension risk transfer transactions in the U.S. marketplace, spanning from the unprecedented General Motors transaction in 2012 to the recently announced IBM transaction. Glenn actively works with large plan sponsors across all sectors of the economy to support informed decision making as well as efficient implementation of large pension risk transfers.
Glenn O’Brien can be contacted at 201-887-5952 or firstname.lastname@example.org
BCG: Can you provide an organizational update on Prudential and tell us about Prudential’s position in today’s U.S. pension risk transfer marketplace?
O’Brien: Prudential continues to focus on our core markets of Insurance and Asset Management and will soon celebrate our 150-year anniversary. We entered the PRT market almost 100 years ago on behalf of the Cleveland Public Library and have been a market innovator since then. We completed the first Pension Buy-In, we were the first U.S. Life Insurer to reinsure a specialty pension insurer in the U.K., and we have worked with some of the nation’s largest pension funds on risk transfer.
We sometimes say we were an early over investor in our team and capabilities in the PRT market and did so well before the unprecedented General Motors transaction and the growth of the PRT market.
While we have been a market leader and innovator, our principles of participant security and investment discipline for the long term is unwavering. Today, we look to partner with sponsors who share the same values of flawless execution and those who appreciate that value is created both on the day of insurer selection and over decades of execution.
BCG: The pension risk transfer market continues to grow and meet the demands of plan sponsors looking to de-risk. What do you see as the latest trends?
O’Brien: We currently see two trends emerging. For years we have seen plan sponsors institute glide path asset allocation strategies as a way to preserve the value of their recent contributions. They did this with the hope that interest rates would rise over time and equity markets would perform within historical averages.
While the current level of rates is not abnormally high given history, we have bounced off the multi-decade long secular trend in yields. As a result, many plans are very well funded.
So, trend #1 is the growth in plan terminations. If you’re a sponsor with a frozen pension plan and had implemented a glide path, your moment to terminate or exit the plan has arrived and we continue to see more demand for the preparation and implementation of plan terminations strategies.
As a result, trend #2 is that we are seeing growth in the larger end of the market. Those plan sponsors who either feared doing a large transaction for some qualitative reason or were advised the market might not have the capacity to execute transactions in scale are now significantly more likely to consider and take action either to terminate (if they have the ability now to do so) or at very least to start moving down that path in a more focused way.
BCG: Settling a pension liability is a balancing act of pricing and fiduciary considerations. How have those issues changed over time?
O’Brien: Clearly the marketplace for insurers has changed and the sources of capital and appetite for risk have both increased. We have been in this business for almost 100 years and caution plan sponsors, advisors, and independent fiduciaries that the actual immediate annuity itself is a simple product. The complexity comes from how the insurer is managed.
The level of sophistication one needs today to thoroughly understand the risk of an insurer is different and we’re starting to see some key parties realize that. We continue to urge caution and stress that plan sponsors should have a well-informed economic goal based on current market conditions. We encourage plan sponsors to meet with several insurers even if you plan to hire an independent fiduciary. We encourage the independent fiduciary to apply rigor around the track record of the insurer and urge transparency related to each firm’s asset allocation and market stress tests.
When selecting an insurer for something as important as a risk transfer transaction, ignorance is never bliss.
BCG: Are there any pitfalls in the way these issues are being considered today and, if so, what should plan sponsors do to address them?
O’Brien: As much as insurance companies are in the business of creating and offering products, pension risk transfer transactions are much more akin to large asset sales. We see PRT activity similar to divesting a line of business for most plan sponsors. For example, you have a complex counterparty offering a price related to a set of assets and liabilities where the plan sponsor / company has a large fiduciary obligation.
We often remind people that these transactions are irrevocable and will persist over the next three or four decades. However, we hear the advisory fees associated with PRT advisory services are not well aligned with the complexity, risk and longevity imbedded in the transaction. I think it’s an easy pitfall for plan sponsors to think they are somehow just buying a product. Engaging with experts who thoroughly understand the issues at a level like other corporate strategic business activity would help all the parties involved.
The phrase “there’s no free lunch” is useful in many contexts and can certainly apply to irrevocable asset transfers that support the lives of so many.
BCG: Pension plan annuity purchases come in all sizes. What are some strategies used by large and smaller plan sponsors and how do they differ?
O’Brien: Smaller transactions often depend on the pure auction. It’s a relatively simple exercise in which one party is a price taker and one is a price giver. You might not hire an asset manager that way, but it seems to be the prevailing strategy. For larger transactions or if a plan sponsor has the goal to exit or move a meaningful, large amount of liabilities over time, we do see a growing desire to partner earlier with an insurer on the corporate derisking strategy. We draw a parallel to other industries where suppliers and the buyers need to work together over time to achieve certain goals.
Strategic sourcing is something the market would benefit from and would likely allow plan sponsors to achieve their goals in a quicker and more efficient process.
BCG: As the insurance market continues to expand to meet pension risk transfer demand what should fiduciaries and plan sponsors consider even more so today than maybe just a few years ago?
O’Brien: More than ever, plan sponsors and fiduciaries should take note of the activities around asset allocation. Many of the new market participants were created or acquired after the financial crisis of 2008. Some firms have a very short track record and have grown rather quickly. If we consider how asset managers are selected, one criterion is likely to be the return performance over multiple market cycles. That hasn’t been applied to the pension risk transfer insurance market in a same or similar way.
As the multi-decade long bull market in bonds comes to an end, we think a deep understanding of the credit risk each insurer is running is well warranted. At the time of this article, we have several events occurring and the biggest question is the likelihood of a recession. Those newer insurers who have taken on more risk to gain market share will likely be the most exposed. It’s worth mentioning that the Federal Government has previously intervened in the credit market in support of abundant liquidity through the Covid pandemic and financial crisis of 2008. Today, with inflation rates well above the Fed’s target, liquidity is being systematically removed and the excesses in the credit markets should be a focus of everyone.
In the end, these transactions involve real people who deserve the quiet comfort of a dignified retirement. The harder and better the questions from informed parties, the better the market can continue its growth and stand the test of time.
PBGC Premiums in 2023: Trouble Ahead
Each year as October 15th rolls around, plan sponsors (of calendar year plans) are faced with a choice related to their PBGC premiums. There are two optional methods that can be used by plan sponsors – the Standard Method¹ and the Alternative Method -- and sponsors are allowed to make a change after using a selected method for (at least) five years. The good news for plan sponsors is that the method they elect to use for their 2022 PBGC premium filing would not appear to be very critical, as both methods produce similar liabilities for most plans as of the January 1, 2022 measurement date. The bad news is what awaits in 2023 and beyond – but only for select plans.
Which unlucky plans have rising PBGC premiums in their future? That would be those plans that are stuck with the Alternative Method, which is projected to use much lower interest rates than the Standard Method in 2023.
|Most Recent Rates||First Segment Rates
|Second Segment Rates
|Third Segment Rates
The Alternative Method has produced lower liabilities than the Standard Method in recent years, as its key feature is that it uses a 24-month average of interest rates, resulting in higher interest rates to be used at times when interest rates are falling. 2020 in particular proved to be a year when many plan sponsors opted to change to the Alternative Method to reduce their premiums for the 2020 plan year. The savings continued for the 2021 plan year, and some plans may still see a small benefit from this method in 2022. But in 2023, this method will fail to fully reflect the meteoric rise in interest rates that we’ve witnessed in year-to-date 2022. The result is that the PBGC liability for those plans who have been using the Alternative Method for less than 5 years will be extremely high relative to other measures of liability, such as accounting PBO² or annuity buyout (Exit) costs.
How high will the PBGC liability be? Consider a 100% funded (illustrative) frozen plan with an accounting liability (PBO) of $100m. The PBGC Standard Method Liability tends to be lower than the PBO, and may be $95m. The Alternative Method liability for this plan could be in the neighborhood of $115m. Ordinarily, a plan sponsor has the option of contributing to the plan to reduce PBGC premiums, but to do so in this case would make no sense, as the plan would wind up being overfunded on any current-basis measurement. This fully funded plan could be staring at a PBGC premium of three-quarters of a million dollars³, simply because they are locked into their choice of interest rate methods for a few more years.
With added contributions not offering any relief, the only way to reduce the 2023 premium is to remove participants from the plan prior to 1/1/2023. Doing so could reduce PBGC premiums in multiple ways.
- Removing participants from the plan reduces the PBGC flat rate premium ($88pp in 2022)
- Removing participants increases the likelihood that the PBGC premium will be capped, limiting the total Variable Rate Premium to be paid
- The annuity premium paid to an insurer (if annuities are purchased) or the lump sum paid to participants would be far less than the PBGC liability, helping to reduce the funding shortfall and thus reduce PBGC premiums
What to do now? It is likely already too late to begin an effective lump sum window and complete it in time to wrap by year-end. But there remains a small window of opportunity to complete a retiree liftout, or even a liftout that includes deferred (i.e., terminated but not yet retired) participants. Pricing for retiree liftouts remains competitive, and is often under the PBO. But the window to start this process is very small – starting by Halloween may be too late, and waiting until Thanksgiving to begin is certainly too late.
If you have a plan or advise on a plan that is stuck with the Alternative Method for its PBGC premium in 2023, let BCG help. We can quickly identify the savings opportunities and get the ball rolling on an annuity purchase to effectively shrink the plan (and PBGC premiums) for 2023.
To reach BCG, please email us at email@example.com.
¹ The Standard Method averages high quality bond rates over 30 days, whereas the Alternative Method averages bond rates over 24 months.
² The Projected Benefit Obligation (“PBO”) measures liability using current, high quality bond rates.
³ The PBGC Variable Rate premium for 2023 may exceed 5% of a plan’s funding shortfall, up from 4.8% in 2022.
ANNUITY PURCHASE RATES
Sample Interest Rates for a Pension Annuity Buyout
(Assumes no lump sums, disability, or unusual provisions)
Retirees (duration of 7) – 4.27%
Term Vesteds (duration of 10) – 4.27%
Actives (duration of 15) – 4.23%
Annuity Purchase Rates as of September 1, 2022