SESSION 102 Annuity Buyouts

Transcription

1 CCA Annual Meeting October 23-26, 2016 JW Marriott Las Vegas Las Vegas, Nevada SESSION 102 Annuity Buyouts SPEAKERS: ALEX GAGNON, FSA, EA - MERCER DAVID GODOFSKY, FSA, EA - ALSTON & BIRD LLP PEGGY MCDONALD, FCA, FSA - PRUDENTIAL JOE STRAZEMSKI, FCA, FSA, MAAA, EA BUCK CONSULTANTS SESSION ASSISTANT: SUZANNE HUGHES, FCA, ASA, EA - BUCK CONSULTANTS Copyright 2016 Conference of Consulting Actuaries. CCA retains copyright of this presentation. Content remains property of contributor. All sessions of the Conference of Consulting Actuaries (CCA) are conducted in compliance with Federal and State antitrust laws and any discussion of anticompetitive activities among participants is strictly prohibited. The views expressed here are those of the presenter(s), and not necessarily those of the CCA. Nothing in this presentation is intended to be an interpretation of Actuarial Standards of Practice by the CCA.

2 PRT Market Activity, Capacity and Pricing Drivers 2

3 A 15-Year Pension Storm Persistently Low Long-Term Interest Rates Funded Status Rollercoaster 8% 6% 4% 2% 10-YR U.S. Treasury 160% 140% 120% 100% 0% -2% 80% 60% Source: FRED, Federal Reserve Bank of St. Louis October 1, Improving Longevity Source: Milliman 100 Pension Funding Index Increasing PBGC Premiums & Regulatory Oversight Source: Prudential calculations Source: pbgc.gov 3

4 RISK MANAGEMENT TOOLKIT D E - R I S K I N G T O O L K I T R E T A I N T H E R I S K T R A N S F E R T H E R I S K D Y N A M I C I N V E S T M E N T P O L I C Y T E R M I N A T E D V E S T E D L U M P S U M S G R O W T H P O R T F O L I O B U Y O U T I M P R O V E H E D G E R A T I O B U Y - IN H I B E R N A T I O N P O R T F O L I O P L A N T E R M I N A T I O N 4

5 Pension risk transfer market size Market was vibrant in 70's and 80's when rates were high and sponsors were more risk-averse United States Single Premium Buy-out Sales ($billions) Was fairly quiet the last few decades although a steady stream of small plan terminations $7.5 $8.5 Shift to pension de-risking has resulted in market growth the last several years Largest transactions continue to be retireeonly buy-outs although there have also been some mid-market plan terminations 2016 is shaping up to show similar volume to Increasing PBGC premiums are driving activity although declining plan funded status has led to a focus on smaller, very targeted transactions $25.1 $13.7 $14.0 $8.5 $11.9 $2.9 $2.5 $3.4 $3.8 $0.9 $1.2 $0.9 $ LIMRA Group Annuity Risk Transfer Survey, 3rd Quarter Based on sales of single-premium buy-outs. $2.1 for 2016 is reported activity through 6/30/2016. $9.9b is Prudential estimate for remainder of

6 Percentage of GAAP Obligation Evaluating a Retiree Pension Buy-out RP-2014 / MP-2015 with Citigroup pension discount curve 100% 4% 3% 2% Costs borne by plan sponsors if a buy-out is not executed Plan sponsor bears investment, regulatory, and longevity risk 109% Insurer bears all risk (5%) 104% GAAP liability measures the present value of expected benefit payments but does not include other plan related costs captured by the economic value. Exhibit assumes employer GAAP mortality matches insurer view. $100M $109M $104M Insurer pricing is more efficient than the economic value due to economies of scale, savings on PBGC premiums, and availability of particular asset classes specific to the insurer. GAAP Retiree Liability 1 Administrative and PBGC Expenses 2 Investment Management Fees 3 Credit Defaults & Downgrades 3 Economic Value Additional efficiencies my be found through asset-in-kind transfer 1 GAAP liability reflects RP-2014 mortality table with MP Costs not included in the GAAP retiree obligation include per person administrative expenses of $40 per year and PBGC per person fixed premiums of $64 in 2016, $69 in 2017, $74 in 2018, $80 in 2019, and indexed after PBGC variable rate premiums assumed to be 3.0% in 2016 and indexed after Funded Status for variable rate premium assumed to be 87% (PBGC basis) and 80% (GAAP basis). 3 GAAP obligations are discounted using rates unadjusted for investment management fees and the risk of credit defaults and migrations. These are estimated at 30 and 24 basis points per annum, respectively. Pricing is indicative and provided for discussion purposes only. Percentages represent present value of estimated future costs. Pricing is subject to change per market conditions and specific client demographic information. Difference Buy-out Cost 6

7 Percentage of GAAP Obligation Evaluating a Deferred Pension Buy-out Reflects increase in GAAP liability due to change in mortality basis 100% RP-2014 / MP-2015 with Citigroup pension discount curve 8% 5% Plan sponsor bears investment, regulatory, and longevity risk Costs borne by plan sponsors if a buy-out is not executed 4% 117% Insurer bears all risk (7%)-3% 110%-120% A buy-out for deferred participants is more costly than retirees for several reasons: Behavioral Risk: Uncertainty about when participants will retiree and what form of annuity they will select - More risk when there are highly subsidized ER benefits - More risk when there are lump sum options - More risk for cash balance plans Longer duration of liability increases longevity and reinvestment risk GAAP Deferred Liability 1 Administrative and PBGC Expenses 2 Investment Management Fees 3 Credit Defaults and Downgrades 3 Economic Value Difference Buy-out Valuation 1 GAAP liability reflects RP-2014 mortality table with MP Costs not included in the GAAP retiree obligation include per person administrative expenses of $40 per year and PBGC expenses per person of $64 in 2016, $69 in 2017, $74 in 2018, $80 in 2019, and indexed after PBGC variable rate premiums assumed to be 3.0% in 2016 and indexed after GAAP obligations are discounted using rates unadjusted for investment management fees and the risk of credit defaults and migrations; estimated at 30 and 24 basis points per annum, respectively. Pricing is indicative and provided for discussion purposes only. Percentages represent present value of estimated future costs. Pricing is subject to change per market conditions and specific client demographic information. 7

8 % of PBO and count Economic/Retiree Liability Case for retiree small benefit buyout Cost of maintaining the liabilities on balance sheet is larger for smaller benefits, relative to PBO % of Ret Count % of Ret Liab Economic/Retiree Liability 100% 118% 80% 115% 60% 40% 20% 112% 111% 109% 112% 106% 0% <$250 <$500 <$1000 Total Monthly benefit size 100% Additional reasons for small benefit buyout Reduces contribution needed to maintain funded status Can limit size to avoid settlement accounting Pricing may be more favorable for retirees with small benefits State Guarantee associations more likely to fully protect benefits for participants with small benefits A jumbo plan sponsor may find more competition by targeting a smaller transaction Information shown in the chart is indicative and for discussion purpose only 8

9 Summary of Buy-out options Retirees Deferred Small Benefit Retirees Efficient pricing Significant reduction in plan liabilities Simple execution May want to leave some in plan if planning for a plan termination in near future Less efficient pricing Lump sums generally more efficient Primarily an option best suited for plan termination Efficient Pricing as well as significant reduction in ongoing administrative and investment expenses May avoid settlement accounting Leaves retirees in plan helpful if planning for plan termination in near future 9

10 Assets in kind considerations 10

11 In-kind Assets Transfers Historically, premiums for buy-out transactions were paid in cash More recently, sponsors have paid a portion of the premium in securities which creates some efficiencies Can reduce premium for large transactions Reduces lag time insurer needs to position portfolio Reduces insurer taxes on security trades May reduce other costs and risks for the sponsor How does an insurer determine the optimal portfolio for transaction? Liability characteristics Duration Pattern of cash flows Potential variability of cash flows Assets Existing sponsor portfolio Availability of private placements and mortgage loans to insurer Regulatory capital 11

12 Pension Portfolio vs. Insurance Portfolio Objectives, constraints and portfolio construction are extremely different Life Insurer Portfolio Mortgage Backed Securities Illiquid Assets Investment Grade Public Corporate Risk Assets Illiquid assets include private placement debt and mortgage loans 12

13 Developing a Solution Transaction Portfolio Mortgage Backed Securities Illustrative Future Insurer Portfolio Illiquid Assets Investment Grade Public Corporate Remaining Plan Portfolio Risk Assets Illiquid assets include private placement debt and mortgage loans 13

14 Creating the Transaction Portfolio Insurer s capabilities can be leveraged to produce the optimal transaction portfolio Insurer may prefer more or less cash in a particular transaction depending on Size of the transaction Specific characteristics of the transaction population Plan assets available for transfer Insurer will provide guidance to develop the most efficient portfolio with regard to: Key rate duration/maturity profile Credit quality Sector/single issuer limits Insurer may have an appetite for some alternatives Very important to some transactions Will vary widely among insurers This appetite can change quickly 14

15 Annuity purchase considerations 15

16 Pension risk transfer solutions Single Insurance Carrier vs. Multiple Insurance Carriers (+) ( ) Single Insurer Ease of execution Streamlined participant communication Majority of transactions to date have been under a single insurer May not provide full protection under single state guaranty coverage for certain participants Multiple Insurers May improve transaction price Provides multiple state guaranty coverage Increased transaction complexity and cost More complex participant communication May be an additional charge for the annuity administrator function and core costs that are borne more than once General Account vs. Separate Account (+) ( ) General Account Less expensive than separate account Generally fewer additional regulatory filings or approvals needed General accounts are not insulated in the event of an insurance company insolvency Separate Account Insulated from general creditor claims in the event of insurer insolvency Can be either a single or commingled separate account Assets can only be used to pay claims of separate account policyholders Specifically cited as DOL IB 95-1 consideration More expensive (ranges from 0.5% to 2.0% cost difference) Not all insurance companies offer a separate account option Generally additional regulatory filings or approvals needed 16

17 DISCLOSURES This discussion document describes product concepts that are not final. It has been prepared for discussion purposes only. It is not an offer to enter into any agreement. This document does not completely describe the terms of any potential transaction or final product design, and any transaction would be subject to applicable legal and regulatory requirements; internal, legal and regulatory approvals; and final legal documentation. Any indication of pricing provided in this document is for illustrative purposes only. Prudential does not provide legal, regulatory or accounting advice. Therefore the plan sponsor and its advisors should seek legal, regulatory and accounting advice regarding the legal, regulatory or accounting implications of the insurance contract. This information is provided with the understanding that the recipient will discuss the subject matter with its own legal counsel, auditor and other advisors. Insurance and reinsurance products are issued by either Prudential Retirement Insurance and Annuity Company (PRIAC), Hartford, CT, or The Prudential Insurance Company of America (PICA), Newark, NJ. Both are wholly owned subsidiaries of Prudential Financial, Inc. (PFI) and have no affiliation with Prudential plc of the United Kingdom. Each company is solely responsible for its financial condition and contractual obligations. Neither PRIAC nor PICA are authorized by the U.K. Prudential Regulation Authority or the Financial Conduct Authority, nor do they offer insurance or reinsurance in the United Kingdom. PRIAC and PICA do provide off-shore reinsurance to companies that have acquired U.K. pension risks through transactions with U.K. plan sponsors. PRIAC and PICA are not authorized or regulated by the Office of Superintendent of Financial Institutions for Canada or by the Financial Services Commission of Ontario. Prudential s Traditional Buy-out is a group annuity contract issued by PICA, Newark, NJ Amounts contributed are deposited in PICA s general account. Any payment obligations or guarantees are contingent on the claims-paying ability of PICA, and are subject to certain limitations, terms and conditions. Prudential s Portfolio Protected Buy-out and Prudential s Portfolio Protected Buy-in are group annuity contracts issued by PICA, Newark, NJ Amounts contributed to the contracts are deposited in a separate account established by PICA. Payment obligations specified in the group annuity contracts are insurance claims supported by the assets in the separate account and, if such assets are not sufficient, by the full faith and credit of PICA, subject to certain limitations, terms and conditions. Products not available in all states Prudential, the Prudential logo, the Rock symbol, and Bring Your Challenges are service marks of Prudential Financial, Inc. and its related entities, registered in many jurisdictions worldwide. 029xxxx

18 Due Diligence - Insurer Solvency DOL Interpretive Bulletin 95-1 (29 CFR ) (3/6/95 as amended) Fiduciary decision selection of insurer Safest available unless it is in the interests of participants not to do so But it is never prudent to buy an unsafe annuity According to DOL looking at ratings is insufficient Should look at quality and diversification of insurer s portfolio, size of insurer relative to contract, insurer s capital and surplus, lines of business and exposure to liability, structure of contract, and state guarantee association coverage. Should employ expert if fiduciary does not have sufficient expertise Factors that might lead to less than safest annuity: cost, if participants stand to gain from the cost savings; claims paying ability. Objective, thorough and analytical analysis There is a debate, likely to go to U.S. Supreme Court, as to whether an objectively prudent decision can be imprudent because of lack of analysis 18

19 Due Diligence - Insurer Solvency Counterpoint to Bulletin 95-1 See Bussian v RJR 223 F.3d 286 (5 th Cir. 2000) Bulletin is, at best instructive (not very persuasive, and not law) Hiring a consultant to perform analysis is no more than attempting to recreate what rating agencies do, but without their resources It may be helpful to have a consultant assist in reading the rating agency reports, if you lack expertise to do so Analysis will generally be post hoc (e.g. Executive Life). When insurer fails, your expert report will look just as bad as the ratings agencies Annuities last 40+ years but ratings, or consultants reports, are at best a snapshot. However, from one perspective, hiring and paying consultant does make you look more thorough and analytical (that is, optics vs. reality) 19

20 Due Diligence - Insurer Solvency Agencies Fitch AM Best Standard & Poor s Moody s Weiss 20

21 When is purchasing annuities prohibited? During plan termination process but before termination is approved by PBGC Plan is under IRC 436 restrictions Top 25 restrictions Non-qualified plans, before a distributable event occurs 21

22 Can an annuity purchase be a fiduciary breach? Concerns: duty of loyalty and impartiality Will purchase benefit one group of participants over another? (For example, leaving participants with unfunded benefits, or giving participants unsafe annuities to fully fund remaining participant s benefits) Spokeo v. Robins (US 5/16/2016): Dr Nichols:Transparent Aluminum? Scottie: That s the ticket, Laddie. Justice Alito: No, it s intangible concrete. Concrete and particularized but not conjectural or hypothetical Concrete = real injury; but risk of injury is real if not conjectural Tangible =?? But it is not necessary. (Injury to reputation, perhaps?) For annuities my interpretation: risk of loss must be significant and immediate 22

23 What plan provisions must be in the policy? Actuarial factors or assumptions used in converting benefits (protected under 411(d)(6)) Early retirement subsidies / factors, even if not yet earned What about for vested terminated participants who may be rehired? What is NOT required: Shut down benefits not yet triggered (but note that Plan should be amended to prevent participants from earning such additional benefits) Effect of future law changes (such as future changes in 417(e)) 23