What is Pension Risk Transfer
Pension risk transfer is a defined benefit pension provider offloads some or all of the plan’s risk – e.g., retirement payment liabilities to former employee beneficiaries. The plan sponsor can do this by offering vested plan participants a lump-sum payment to voluntarily leave the plan or by negotiating with an insurance company to take on the responsibility for paying benefits.
BREAKING DOWN Pension Risk Transfer
Companies transfer pension risk to avoid earnings volatility – since they'll no longer have to pay for unfounded pension obligations – and enable themselves to concentrate on their core businesses. The total annual cost of a pension plan can be hard to predict due to variables in investment returns, interest rates and the longevity of participants. Large companies had been holdouts on the trend of transferring pension planning responsibility to employees, but that began to change in 2012, when a range of Fortune 500 players sought to transfer pension risk. This included Ford Motor Co., Sears, Roebuck & Co., J.C. Penney Co. Inc. and PepsiCo Inc. (which offered former employees an optional lump-sum payment) and General Motors Co. and Verizon Communications Inc., which purchased annuities for retirees.
Types of risks addressed in risk transfer 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.
Companies have historically adopted pension plans for a variety of reasons, such as attraction and retention of qualified employees, workforce management, paternalism, employee expectations, and favorable tax policies. In light of the voluntary nature of sponsorship, plan sponsors generally believe that the ability to close a plan to new entrants, reduce or freeze benefits, or completely terminate a plan (after providing for all accrued benefits) has been and remains necessary to encourage adoption and continuation of plans.
Types of Pension Risk Transfers
- 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)
- Payment of lump sums to pension plan participants that satisfy the liability of the plan for those participants
- The restructuring of plan investments to reduce risk to the plan sponsor