Buy-Outs Gaining Traction

Part Two of Preparing for Pension Risk Transfer

In a 2013 survey of senior financial executives, approximately 40% indicated that they are likely to transfer DB plan risk to a third-party insurer within the next two years.

TYPES OF PENSION DERISKING

There is a range of pension de-risking options available to DB plan sponsors, from investment strategies that reduce risk to transactions that fully transfer risk from the plan sponsor to a third party.

BUY-OUTS GAINING TRACTION

The market for buy-out solutions is quickly developing.

 

In 2012, Prudential completed large buy-out transactions with General Motors ($25.1 billion) and Verizon ($8.5 billion), firmly reestablishing a U.S. market for buy-out solutions. Further, there have been numerous buy-out transactions executed among mid-size companies during 2012 and 201T3. Many other companies are considering buy-out transactions as well. In a 2013 survey of senior financial executives, approximately 40% indicated that they are likely to transfer DB plan risk to a third-party insurer within the next two years.

 

40% of senior financial executives indicate that they are likely to transfer DB plan risk to a third-party insurer within the next two years.Prudential Financial and CFO Research, “Balancing Costs, Risks, and Rewards: The Retirement and Employee Benefits Landscape in 2013,” p.5, July 2013

In considering a buy-out, plan sponsors should weigh the cost of the transaction against the ongoing cost, volatility, and constraints associated with maintaining the plan. In a recent survey of senior finance executives, 43% indicated that their DB plan placed a constraint on the company’s cash flow; 41% indicated an impact on earnings due to volatility of plan funded status; and 36% indicated an impact on their ability to invest in growth opportunities.


United States Single Premium Buy-out Sales

Annual amount of single premium buy-out sales in U.S. since 2002. The following table provides more details.
Single premium buy-out sales in U.S. since 2002.
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
$1,554.40 $1,661.1 $1,271.60 $777.10 $1,816.70 $2,882.4 $2,489.20 $1,231.00 $851.70 $846.80 $35,980.8 $3,841.8 $8,469.5
Source: Sales results based on a non-constant group of companies and reported in millions (000,000). For 1986 to 1992 and 1999 to 2010, sales figures based on single-premium buy-outs only; 1993 to 1998, sales include some terminal funding products.
United States Single Premium
Buy-out Sales*
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When evaluating the cost of a transaction, it is common to compare buy-out pricing to accounting liabilities. However, the calculation of pension liabilities for accounting purposes understates the true economic value of plan liabilities that an insurer would consider in pricing a buy-out.

There are two reasons for this:

First, accounting liabilities do not include the present value of certain costs that a plan sponsor bears, such as administration costs, investment management fees, and PBGC premiums.

Second, accounting liabilities today are based on outdated longevity assumptions.

For a retiree population today, the economic value of liabilities—and therefore the estimated cost of a buy-out transaction—is approximately 110% of accounting liabilities, though this amount will vary according to the characteristics of each plan.

GAAP Value Buy-out Cost
$100 current accounting value 110% of accounting liabilities, or $110 (varies with each plan)
New mortality tables increase accounting liability to $106 104% of accounting liabilities
Once updated mortality tables are adopted, the cost of a buy-out will decrease as a percentage of accounting liability, to roughly 104%

As discussed earlier, the new longevity assumptions, when incorporated, will add approximately 6% to the accounting liabilities of the typical pension plan. The new assumptions will not increase the estimated cost of a buy-out transaction. While longevity assumptions for pension plans are only updated once in a decade, insurers continuously update their longevity expectations based on their own experience in paying annuitants as well as on new longevity-related research as it emerges.

The result will be a buy-out transaction cost closer to 104% of the accounting liabilities. right to fully exit the DB arena, or to move measurably toward that goal by transferring pension risk for a significant portion of the plan.

New longevity assumptions will add approximately 6% to the accounting liabilities of the typical pension plan. However, these assumptions will not increase the estimated cost of a buy-out transaction.

 

United States Single Premium Buy-out Sales*

Annual amount of single premium buy-out sales in U.S. since 2002. The following table provides more details.
Single premium buy-out sales in U.S. since 2002.
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
$1,554.40 $1,661.1 $1,271.60 $777.10 $1,816.70 $2,882.4 $2,489.20 $1,231.00 $851.70 $846.80 $35,980.8 $3,841.8 $8,469.5
*Sales results based on a non-constant group of companies and reported in millions (000,000). For 1986 to 1992 and 1999 to 2010, sales figures based on single-premium buy-outs only; 1993 to 1998, sales include some terminal funding products.