Cost Considerations in Pension Risk Transfer
Preparing for Pension Risk Transfer
Whether or not a buy-out is imminent, there are preparations a plan sponsor can undertake to make a future transaction easier and to shorten the timeline for execution. Prudential delivers a comprehensive roadmap for the buy-out process. Download the full paper here.
In considering a buy-out, plan sponsors should weigh the cost of the transaction against the cost of maintaining the plan, measured not only by the cash cost associated with the plan for a given year, but the impact to the core business—in terms of cash flow, earnings volatility, and ultimately, the ability to grow.
In a recent survey, 46% of senior finance executives indicated that their DB plan placed a constraint on the company’s cash flow, 47% indicated an impact on earnings due to volatility of plan funded status; and 34% indicated an impact on their ability to invest in growth opportunities.1
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- Second, historically, accounting liabilities had typically been based on outdated longevity assumptions which underestimated the true value of the liability by 6–7%. Now, as more corporations have adopted the new mortality assumptions, the accounting view of mortality more closely aligns with the insurer view.