About Prudential De-Risking Strategies
To combat increasing costs and risks, and to manage financial volatility, plan sponsors are pursuing a variety of de-risking strategies for their retirement benefit obligations, including pensions and retiree medical plans. Explore these solutions and related information below.
LDI strategies, where investment risks are managed by closely matching a bond portfolio to liability cash flows, can reduce the volatility of a plan’s funded status. LDI primarily involves the use of long-duration fixed income investments. Because the plan’s assets and liabilities are correspondingly impacted by interest rate fluctuations, the sponsor is better protected from interest rate risks. Unlike risk transfer, however, LDI does not solve for longevity risk. Nevertheless, an effective LDI program can be a very useful de-risking tool for bringing sponsors closer to the end goal of pension de-risking.
Retirees are typically the largest pool of plan participants and the most efficient population to buy out. From an insurer’s perspective, the shorter life expectancy of retired versus non-retired participants carries with it less long-term longevity risk, and a reduced need for future reinvestment risk. Further, there is no behavioral risk associated with these participants because they have already retired and selected their form of annuity.
Large scale buy-outs are the most effective way to achieve significant risk and expense reduction. General Motors, Verizon, Motorola, Hartford Financial and International Paper are among the prominent sponsors that have executed large retiree buy-outs to address pension risk.
Companies that have underfunded plans and limited de-risking budgets could pursue targeted retiree buy-outs. The cohorts offering the greatest efficiency typically include retirees with the smallest benefits. In addition to cost-effective risk transfer, small-benefit cohorts offer another opportunity for cost savings since PBGC premiums and administrative costs are significantly larger on a relative basis for these participants.
This approach is the fastest-growing international solution, with noteworthy transactions having been completed in the United Kingdom and Canada.
Longevity insurance and reinsurance solutions currently available convert an unknown future liability into a fixed and known liability cash flow by locking in the life expectancy of the plan participants. With a fixed and known future obligation, pension funds can more easily manage an asset portfolio against a liability. For many large sponsors, longevity risk transfer is an important step in a “do-it-yourself” pension de-risking program.
After addressing funded status and asset risk concerns, longevity risk transfer can serve as the capstone to a pension hibernation strategy, with the sponsor continuing to manage the plan on its balance sheet, and risks and expenses carefully managed within a tight tolerance.
The current environment offers an opportunity for pension funds to transfer longevity risk under the most favorable assumptions and at the most favorable price in a decade. Transferring longevity risk is a sensible approach to the uncertainty inherent in forecasting pensioner life expectancy. No one has a crystal ball and no one can forecast life expectancy with certainty because improvements will be driven by changes in health, fitness, nutrition, medicine and public policy that will differ by country, region and socio-economic group. Given the uncertainty, many of the world’s most sophisticated pension plan sponsors have concluded that longevity risk should be insured.
Increasingly, longevity risk transfer transactions will be completed by means of captive insurance and reinsurance strategies, thus ensuring more cost-effective executions, but the right approach to transferring longevity risk should be chosen by each pension fund to suit its scale, governance and transaction objectives.
The market now has a complete set of solutions for jumbo pension funds who wish to transfer their risk into the deep and relatively liquid global reinsurance market. In each of these solutions, the key is who stands between the pension scheme and the reinsurer since they cannot transact directly with one another.
- Fully intermediated
- Straight-forward structure
- A bank or an insurer stands in the middle as a full recourse intermediary between a pension fund and a reinsurer
- Generally expensive because the intermediary is taking credit risk in both directions
- Limited recourse intermediary
- Reasonable cost
- Intermediary only passes through payments they actually receive from the other parties
- These transactions carry a risk of default by the intermediary that is beyond the pension fund’s control
- Captive solution
- Expense and risk of the other two solutions can be overcome if the pension scheme is willing to run its own insurance captive or outsource this activity
- Minimizes cost and maximizes control
- Scalable and reusable
Retiree Medical De-risking
Faced with risk exposure, rising costs and complex healthcare options, plan sponsors are looking for solutions to help them manage their retiree medical obligations without negatively impacting healthcare quality or retiree experience. Like pensions, retiree medical benefits are long-term promises that retirees expect and count on. At the same time, they impose a large open-ended liability on a plan sponsor’s balance sheet. But for many companies and private sector entities, continuing to offer retiree healthcare coverage is a longstanding tradition and moral obligation, and reducing or eliminating these benefits is not an option.
WORKING WITH PRUDENTIAL
We work closely with our plan sponsors and counterparties to understand the unique nature of each company's plans, participants and priorities. Prudential does not simply offer products, rather, we design customized solutions developed to solve each customer’s unique needs.
Completely transfer pension risk for covered liabilities to Prudential with our General Account offering, Prudential Traditional Buy-out. This solution also allows plan sponsors to:
- Transfer investment, longevity, and benefit-option risks
- Unburden themselves of administrative, actuarial, and investment management expenses
- Eliminate PBGC premiums for participants whose benefits are fully purchased
- Remove pension liabilities from their balance sheet
Settle liabilities and diminish plan volatility with our Portfolio Protected Buy-out.
This solution also allows plan sponsors to:
- Fully transfer investment, longevity and benefit-option risks
- Completely removes administrative, actuarial and investment management expenses
- Eliminates PBGC premiums for participants whose benefits are fully guaranteed
- Removing pension liabilities from their balance sheet
- Provides an enhanced level of transaction security
Designed for sponsors of underfunded plans who seek to transfer risk without triggering a settlement, Prudential's Portfolio Protected Buy-in was the first buy-in solution executed in the U.S. market.
This solution offers several additional advantages for underfunded plan sponsors, including:
- Maintaining funded status
- Holding contributions steady
- Minimizing accounting and funding volatility
Retiree Medical Risk Transfer
- Reduce or eliminate investment, longevity and morbidity risk for covered population
- Eliminate capital market risks on pre-funded assets
- Minimize balance sheet and income statement volatility
Longevity Risk Transfer
Insurers in the U.K. and elsewhere who execute pension buy-outs and buy-ins with pension funds use longevity reinsurance to create certainty around the future obligations they have assumed. In addition, the world’s largest and most sophisticated pension funds use longevity risk transfer as the capstone in their “do-it-yourself de-risking” programs to create certainty around their future liabilities. Prudential is a global leader in reinsuring longevity risk from U.K. insurers and pension scheme captives, with more than $60 billion reinsured since 2011, covering members of more than 200 pension funds in the U.K., including British Airways and Rolls-Royce. We also led the award-winning $28 billion captive longevity reinsurance transaction for British Telecom in 2014.
We bring our capital, capacity, execution credibility and credit quality to solve the unique needs of insurers and captives globally who wish to transfer longevity risk.
We are proud to have been named the Reinsurer of the Year by Risk.net for four consecutive years (2014-2017).