Motorola recently announced the largest pension risk transfer transaction since 2012, and the third-largest ever, trumped only by GM’s and Verizon’s blockbuster deals. It’s unlikely to be the last big deal of the year.
Risk transfer makes pension plans smaller, reducing the uncertainty, cost and effort for the sponsoring corporation of administering the plan.
Any risk transfer decision—whether it’s the payment of lump sums to plan participants, annuity buyouts, or (ultimately) complete termination of the plan—is a timing decision. That’s because as soon as a plan is frozen (or even just closed to new entrants) its life span becomes limited and eventual termination inevitable. It’s just a question of whether the liabilities are met one monthly pension check at a time, or whether they are met more quickly via a risk transfer. And if it is to be via risk transfer, should that be done now, or is it better to wait? Motorola explicitly noted their assessment that “market conditions and economics are favorable” as part of their rationale for the move.
In a recent research paper, Jim Gannon identifies some of the considerations that go into this timing decision. They include:
- how well funded is the plan? It’s easier to transfer risk when a plan is well-funded. But when funded status is low, risk transfer can put strain on the rest of the plan.
- what is the level of interest rates? Liabilities are bigger—and annuities cost more—when interest rates are low.
- how much of a price premium is built into the annuity cost? The price payable to an insurance company for a pension buyout generally includes a premium (Jim calls this the “termination premium”) above the best estimate liability value. Sometimes pricing is more competitive than at other times.
- what are the expected administrative and PBGC costs? Against the premium payable to the insurance company should be weighed the costs incurred if the risk transfer is not made: these include administrative costs and PBGC premiums.
- how mature is the plan? A structural advantage of hibernation—i.e., deferring the decision to transfer risk—is that liabilities tend to fall and risk decrease as time passes lessening the eventual termination premium for those who can wait.
- what is the plan sponsor’s trade-off between cash costs and risk? Either a healthy cash reserve, or a low tolerance for risk in the pension plan, can make risk transfer more attractive to a plan sponsor.
- the value of optionality. Hibernation preserves optionality for the plan, whereas risk transfer does not. The decision to transfer risk can always be made later. The value of optionality can be significant.
So the strength of the case for risk transfer will vary from corporation to corporation and also over time. The question is not “does risk transfer make sense?” but rather “does risk transfer make sense for us now?” Different corporations will reach different conclusions.