Clarifying Risk Transfers & De-Risking Transactions
WASHINGTON; October 19, 2016 — A new issue brief from the Pension Committee of the American Academy of Actuaries, Pension Risk Transfer, explains the implications for different stakeholders of transactions intended to reduce risks such as longevity, investment, interest rate, and other types of financial risk for sponsors of defined-benefit pension plans.
“Pension risk transfers can have significant implications for the financial security and responsibilities of different plan stakeholders,” said Ellen Kleinstuber, chairperson of the Pension Committee. “This new issue brief explores how pension risk transfers can affect different parties. Whether you’re a plan participant, a plan sponsor, or a pension regulator or plan fiduciary, Pension Risk Transfer can help you take stock of how other key stakeholders view pension risk transfer and what a risk transfer transaction might mean for you.”
The issue brief explains that risk transfers may include the purchase of annuities from an insurance company that transfers liabilities for some or all plan participants; the payment to plan participants of lump sums that satisfy the liability of the plan for those participants; and/or the restructuring of plan investments to reduce risk to the plan sponsor. It examines risk transfer implications such as:
- The possible merits and downsides of different options typically offered to plan participants.
- The potential risks, benefits, and other business considerations for sponsors, including the effects on plan participants and shareholders, and on sponsor costs and liabilities.
- The responsibilities, including regulatory compliance concerns, of regulators and plan fiduciaries who serve or protect public or shareholder interests, respectively.
Excerpt from: Pension Risk Transfer
The transferring of risk from defined benefit pension plans (often called “de-risking”) has become a focus of pension plan providers, participants, and policymakers over the past few years. The Pension Committee of the American Academy of Actuaries believes that discussion of risk transfer from the perspectives of different constituents affected by these transactions will help to educate plan sponsors, regulators, fiduciaries, and policymakers and provide greater clarity regarding this topic.
The terms “risk transfer” and “de-risking” have been commonly used to describe a number of different transactions undertaken by defined benefit pension plan sponsors. Types of risks addressed in these transactions include the risk that participants will live longer than current annuity mortality tables would indicate (longevity risk); the risk that funds set aside for paying retirement benefits will fail to achieve expected rates of investment return (investment risk); the risk that changes in the interest rate environment will cause significant and unpredictable fluctuations in balance sheet obligations, net periodic cost, and required contributions (interest rate risk); and the risks of a plan sponsor’s pension liabilities becoming disproportionately large relative to the remaining assets/liabilities of the sponsor (e.g., the risk that changes in a plan’s funded status will be of very significant financial consequence to the plan sponsor, potentially causing liquidity problems due to escalating pension contributions, downgrades from bond ratings agencies, or other difficulties obtaining financing).
Risk transfer or de-risking transactions addressing pension plan risks can include:
a) The purchase of annuities from an insurance company that transfers liabilities for some or all plan participants (removing the risks cited above with respect to that liability from the plan sponsor);
b) The payment of lump sums to pension plan participants that satisfy the liability of the plan for those participants (either through a one-time offer or a permanent plan feature); and
c) The restructuring of plan investments to reduce risk to the plan sponsor.
The first two types of transactions do not actually reduce risk (except to the extent that an insurer taking on the liabilities is likely to pursue a lower-risk investment approach), but rather transfer it to another party (e.g., the insurer, or the plan participants)—thus they may be more properly categorized as “risk transfer” transactions. A complete “risk transfer” transaction (i.e., a plan termination) will typically involve annuity purchases and may also involve payment of lump sums (for participants who elect them). This issue brief examines annuity purchases and lump sum payments specifically from the perspective of a single-employer defined benefit plan,1 and does not address investment restructuring.
This issue brief does not offer a judgment about whether such transactions, on balance, enhance or detract from a retirement system. It instead seeks to provide a factual basis upon which such determinations may reasonably be made. The Pension Practice Council of the American Academy of Actuaries has sponsored an initiative that identifies characteristics of well-functioning retirement systems called Retirement for the AGES. Readers may wish to reference this framework when considering the effect of risk transfers.
Generally the constituents concerned with “risk transfer” transactions are:
- Plan sponsors and company owners/shareholders
- Plan participants (and other employees of the plan sponsor)
- Pension plan regulators
- Plan fiduciaries
A detailed discussion of the issues involved in pension risk transfer relative to each of these constituent groups follows.
Download the issue brief here.
About the American Academy of Actuaries
The American Academy of Actuaries is an 18,500+ member professional association whose mission is to serve the public and the U.S. actuarial profession. For more than 50 years, the Academy has assisted public policymakers on all levels by providing leadership, objective expertise, and actuarial advice on risk and financial security issues. The Academy also sets qualification, practice, and professionalism standards for actuaries in the United States.
