Can Insurance Companies Ease The Pension Problem?

Besides the gold watch and the retirement party, most people who went to work in the 1950s and 1960s could also look forward to a monthly check after they cleared out their desks.

Back then large corporations rewarded employee loyalty with a guaranteed monthly amount until their old friend kicked the bucket.

But defined benefit plans are the exception today. Defined contribution plans, where the company might match the worker's savings up to a limit and the final sum is far from guaranteed, are more the norm. No one, it seems, wants to promise anything forever.

And employees are less confident about trying to do their own savings. According to a new consumer survey by Prudential Financial, most investors (73%) believe the investments they have today are not enough to make up for the losses they’ve experienced over the past few years. "While they want and know they need growth, protection is at the forefront" with 60 percent stating they are looking for guarantees to protect their financial future," according to Prudential in “The Next Chapter: Meeting Investment & Retirement Challenges.

But the insurance industry has always taken on the risk of returning a set amount despite future risks. Now employers are looking to this sector to take on the risk of making payments to their defined benefit recipients. And the insurance companies believe they're uniquely qualified to make the payments to retirees – for as long as they live.

Prudential Retirement, for one, recently announced the Prudential's first Portfolio Protected Buy-in, wherein an employer turns over a portion of its retirement portfolio to Newark-based Prudential Insurance Company of America (PICA) in return for a guarantee that its retirees will get a fixed amount every month for life. Success will rest solely on PICA's claims paying ability. In May, North Carolina-based Hickory Springs Manufacturing Company, a furniture maker, implemented the “pension risk transfer” of $75 million of its fund to Prudential. The two companies found each other through the BCG Terminal Funding Company.

The single premium, separate account solution that Prudential calls “pension de-risking” is commonplace in the United Kingdom, which has for its size a huge, (UK Pound) 1 trillion ($3.28 Trillion) pension obligation. By comparison the much larger US economy has pension liabilities of only about twice the UK's, says Phil Waldeck, Prudential's senior vice president and head of the retirement unit's pension and structured solutions business. The UK passed its pension laws, similar to our Pension Protection Act of 2006, well before the US and implemented buy-ins with favorable results. Waldeck expects US companies to start catching on soon. For one, the US PPA rules also require companies to mark their pension liabilities to current market value using high investment grade corporate bonds, instead of the previous method of reporting an assumed value based on future earnings. So far there are only a handful of US companies valuing pension assets in real time, says Waldeck. Companies have had six years to bring their pension assets up to 100% of obligations – assets equaling liabilities – and time is running out.

Had Hickory, with facilities in 16 states and China, not transferred its DB portfolio to Prudential, matching future liabilities to assets still would be its headache. But with this deal, it has transferred “market, longevity and interest rate risks,” says Michael Devlin, a principal with BCG. Meanwhile, Steve Ellis, CFO of Hickory, noted these “times of uncertainty” in explaining the company's decision to become the first in the US to guarantee its commitment to its employees by investing with the Prudential buy-in plan.

对于保德信,unfettered because it considers itself uniquely positioned to match the liabilities. For example, if a medical miracle causes plan participants to live longer, that longevity would also reflect in Prudential's life insurance business, because customers would pay more premiums. A perfect asset/liability match, says Waldeck. Prudential will follow a corporate bond strategy plus derivatives, most likely interest rate swaps, he said. Prudential is the fifth largest bond manager of pension assets and the sixth largest of assets in stocks and bonds.

The opposite scheme, the pension buy-out, effectively ends a company's pension obligations, in which case Prudential would be dealing with Hickory's retirees directly. In the buy-in scenario, Prudential has guaranteed Hickory a check each month, which the company will distribute in a set amount to its retirees. That allows Prudential to stay within its comfort zone rather than become a plan administrator. Ellis says Hickory, which has 5,000 employees and $150 million in pension assets, considered “alternatives such as LDI (liability driven investing ) as a strategy, but nothing fit” till this offer. Ellis also likes, he said, that Hickory can retain the plan as an asset on its balance sheet.

Hickory will continue running its defined contribution plans for current, former and non-retired employees.

Prudential also is marketing the buy-in service to sponsors that want to terminate or wind down their defined benefit plans, although Ellis says his company has no intentions of ending its DB plan. In fact, Ellis said his company can add retirees to the buy-in arrangement, for an increased payment to Prudential. The buy-in's costs are figured on numerous criteria according to the characteristics of each plan's liabilities, the ages of its participants, etc, said Waldeck.

A general measure might be that if the plan sponsor is already paying $100 to manage its plan with advisors and other costs, the Prudential buy-in management fee would cost about $105 to $110. But if Prudential had to cater to unretired employees with the risks and uncertainties inherent there, the fee would probably look more like $110 to $120. The agreement is also revocable.