The Case for Pension Risk Transfer Buy-Ins
Once an overlooked de-risking tool, pension risk transfer (PRT) buy-ins are an emerging innovation and have become increasingly popular with plan sponsors in recent years. As the PRT market experienced a substantial post-pandemic bounce in 2021 (global premiums exceeded approximately $60 billion in the US, UK, and Canada markets), buy-in transactions became more prevalent as significant transaction figures kept pace. With their flexible features, risk protection, and ability to lock-in pricing before a full-fledged plan termination, PRT buy-ins should continue to gain traction as companies remain eager to divest pension plan risk.
PRT Buy-outs vs. Buy-ins
Both buy-outs and buy-ins involve the plan sponsors purchasing a group annuity contract from an insurer or group of insurers. Historically, pension risk transfer (PRT) buy-ins have been used less than their buy-out counterparts, which were the instruments of choice for most corporate pension plan terminations and partial lift-outs. In most cases, companies anxious to rid themselves of pension administration obligations engaged an insurance company to take over the pension, while the existing plan was closed. Among the many issues with PRT buy-outs are that they immediately trigger accounting charges, employee communications, and HR issues, and automatically hit the company’s bottom line. Under US generally accepted accounting principles (GAAP), any previously unrecognized gains or losses in a company’s accumulated other comprehensive income (AOCI) must be immediately recognized on its income statement. Plan termination via a PRT buy-out can also take months or much longer, as companies must go through a strict regulatory and government approval process. Post-termination, plan members and beneficiaries may be more exposed to market instability depending on the remaining plan assets and funding levels.
The advent of the buy-in enables plan sponsors to be more strategic in plotting a de-risking course and exercise more control, customizing transaction timing and scope. Investment and longevity risk are transferred with a PRT buy-in, without affecting the funding status of the plan. The plan sponsor retains the contractual obligation to plan members and beneficiaries and guarantees cash flows to pay expected pension benefits, while being reimbursed by the insurer for the monthly payouts. Although the plan sponsor continues to include the liabilities in the company accounts, it nevertheless retains the annuity contract as a corresponding asset. A buy-in also typically includes an option for the plan sponsors to unwind the contract at a later stage, although surrender options may be restricted, and penalties may still apply.
Insurers can also customize a buy-in transaction to meet the plan sponsor’s desired level of risk reduction. For example, the initial buy-in could cover only the retired population, or it could cover the deferred participants as well and allow for an alignment after the lump-sum election period ends. If the plan sponsor wants to consider full termination at some future date, a buy-in can lock in termination costs and help avoid market volatility during the lengthy plan termination process. A buy-in can also be converted to a buy-out at generally no additional cost at the end of the settlement process.
Looking ahead, PRT buy-in market momentum is expected to continue from 2021, with global estimates exceeding $30 billion. Currently, eight U.S. insurers are implementing buy-ins and transaction figures are expanding substantially.
As PRT buy-ins continue to offer additional features and attractive pricing relative to PRT buy-out liabilities, global markets should expect an uptick in their future implementations. Although buy-ins do not eliminate ongoing administrative costs or Pension Benefit Guaranty Corporation (PBGC) premiums, their flexibility, customization, and protection against market volatility have made them an attractive and effective de-risking option whose time has come.