When is a door not a door? When it is ajar.
This brain teaser can be applied to pension risks, especially when it comes to a company transferring its pension risks to another entity such as a life insurance company. What is defined as risk, particularly the severity of a specific risk, is often in the eye of the beholder.
Longevity is a critical factor in assessing pension risks. Americans are living significantly longer than they did a century ago, a factor that insurers must consider when evaluating a pension risk transfer (PRT). In 1900, most people could not expect to live past age 50, according to the Centers for Disease Control and Prevention .1
Americans on average can now expect to live 78.6 years, according to the National Center for Health Statistics .2 Women can expect to live five years longer than men or 81.1 years compared to 76.1 years.
The increase in longevity, combined with the millions of baby boomers retiring, could mean a much larger population of retirees in the U.S. than ever before. MassMutual, in its recently published white paper, “ Pension Risk Transfer, Insights from an institutional risk manager about how to successfully de-risk and transfer pension obligations , ” assesses how these issues may impact the management of pension risks. 3
Life insurers look closely at mortality as they assess the risks associated with pension obligations. Insurers require a mortality study in order to better assess the unique mortality risk for specific transactions.
The population of participants (e.g., ages, tenure, benefits coverage options, job type, industry, geography) may also impact both short-term and long-term risks. Some employers transfer pensions for all employees (retired and deferred), while other employers mitigate the risks associated with a specific population of employees (example: retirees vs. deferred annuitants).
The greater the number of benefits options that pre-retirees have to ponder, the greater complexity for the plan, which may make it more challenging to assess and manage the associated risk. Provisions such as allowing unrestricted lump-sum payments, early retirements, cost-of-living adjustments (COLAs), disability payments, supplemental benefits, lump-sum payments and others that push payments to undetermined future dates typically increase risk, and may create complexity and risks that increase premiums for pension transfers due to uncertain timing of cash flows.
The relative quality of participant data is a factor as well. Accurate data may mean smoother administration of plan payments.
A pension plan’s assets – both the type of assets and how they are allocated among different investment classes – are also considerations when life insurers evaluate a potential PRT. Does the employer intend to transfer cash, assets in kind (AIK) or some combination of the two? It’s an important consideration because not all insurers accept AIKs and many that do impose limitations on them.
There are a myriad of considerations when evaluating a pension for a possible PRT, especially when it comes to risk. An experienced consultant may be able to help plan sponsors assess their relative risks and other considerations in mitigating their risks and keeping promises to pension participants.
Embarking on a PRT needn’t be a brain teaser. By working with an experienced consultant and life insurance company, plan sponsors may be able to help ensure PRT peace of mind to all involved.
1 Centers for Disease Control and Prevention, “Vital Statistics of the United States, 1890-1938,” Nov. 6, 2015.
2 National Center for Health Statistics, “Mortality in the United States, 2016,” December 2017.
3 MassMutual, “Pension Risk Transfer, Insights from an institutional risk manager about how to successfully de-risk and transfer pension obligations,” September, 2018.