Russell Investments has just published a pension risk transfer toolkit, which brings together eight papers addressing various aspects of this in-vogue subject. Two of these pieces are previously unpublished: a guide to pension plan hibernation, and a case study of some of the pitfalls that might be hidden in the typical annuity buyout analysis.
A frozen plan will transfer risk eventually
Once a pension plan is closed to new entrants, it is on a path to eventual obsolescence. The end of that path will not in practice be the payment of the last dollar to the last remaining plan participant, but rather of the transfer of remaining assets and liabilities to a third party (most likely an insurance company.) The new papers address the question of how quickly a plan should expect to move to the termination stage of the frozen pension plan path. Sometimes it pays to wait.
In “A guide to pension plan hibernation”, Justin Owens and I explore in depth the time period that lies between a frozen plan coming close to full funding and the termination of the plan. We look at the cost savings that may be achieved through deliberate management of this hibernation stage, arguing that “when it comes to plan termination, time is on the plan sponsor’s side.”
We look, too, at the specific case of partial annuity buyouts, in which retiree liabilities are transferred to an insurance company. We offer a word of caution, not only that the total cost to the sponsor may be lower if these buyouts are deferred for a time, but also that they can leave the sponsor with an unbalanced plan: “liability profiles that have been hollowed out by the transfer of the most-easily hedged participants can be particularly difficult to manage, and ultimately more expensive.”
Look before you leap
That theme is picked up in Jim Gannon’s “Look before you leap into annuity buyouts,” a downloadable case study looking at what’s missing from the typical indicative NPV-like analysis that is often shown to executives. Jim reprises the story of Three Peaks Equipment (a fictional corporation we created for our frozen plan handbook a few years ago) and tells of a banker pitching an annuity buyout project to a skeptical treasurer (who is “well aware of the board’s soft spot for one-page reports and brightly colored charts, and ever-suspicious of bankers bearing gifts”).
On closer inspection, the treasurer finds six ways that the analysis is incomplete. These include a “representative” cost estimate based on an unrealistic liability profile, apples-to-oranges treatment both of investment management fees and of asset allocation risk, and the omission of any consideration of hibernation as an option.
In the current environment, where annuity buyouts are a hot topic, the message here is that even though risk transfer is no longer about “if” for a frozen pension plan (it will happen), thought does need to be given to the “when.”