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Settling Pension Liabilities

Settling Pension Liabilities. Speaker: Steven R. Pribis, EA, FSA, Dietrich & Associates. Settlement Overview. What and Why. Settlement Opportunities. Bulk Lump Sums Former employees Current actives – limited to plan terminations Annuity Purchase – in plan investment or as a settlement

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Settling Pension Liabilities

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  1. Settling Pension Liabilities Speaker: Steven R. Pribis, EA, FSA, Dietrich & Associates

  2. Settlement Overview What and Why

  3. Settlement Opportunities • Bulk Lump Sums • Former employees • Current actives – limited to plan terminations • Annuity Purchase – in plan investment or as a settlement • Retirees • Former employees • Active employees

  4. To Settle or not to Settle

  5. Reducing Plan Size – Financial Drivers PBGC Premiums • Reduce plan size relative to plan sponsor • Impact of funded status volatility on balance sheet • Expense – level and volatility • Investment management responsibilities • Expenses • PBGC premiums • Administrative costs • Audit • Actuarial • Other • Check writing / custodial fees • Investment management costs

  6. Impact of Journey Planning • Plan freeze is first step in ultimate plan termination • Asset hedging increases sponsor understanding of all costs of plan sponsorship • Plan and plan sponsorship become increasingly estranged from HR core business • Volatility and “surprises” are negative distractions • Settlements move you along the journey plan

  7. Financial Arbitrage Settlement Cost Current State

  8. The ‘Why Nots’

  9. Bulk Lump Sums Consideration and Execution

  10. Considerations in Offering a Lump Sum Window Funding • Reduced liability plus savings by avoiding mortality improvement • PBGC savings Accounting • Potential cost savings • Settlement accounting • Risk reduction Drive how the lump sum feature is offered Investment • Liquidity needs • Re-examine allocations Implementation • Communication strategy • Administrative systems • Data readiness

  11. Design Considerations Note: Retiree cash out offers are not being discussed due to regulatory obstacles to execution.

  12. Administrative readiness

  13. Factors Impacting Take Rates • Demographics • Age • Benefit amount • Lump sum value • Window design • Perceived relative value of lump sum to annuity • Amount of immediate annuity • Rollover to employer plan/IRA • Communication • Ease of election • Administrative support • Circumstance • Lump sum take rates in plan termination will exceed those in a window

  14. Annuity Purchases The what’s, the who, the why’s and the why nots

  15. Single Premium Group Annuity Sales ‐ U. S. ($ billions) $40.0 $35.0 $30.0 $7.5 <- Verizon $25.0 $20.0 $25.1 <- GM $13.6 $13.7 $15.0 $8.5 $10.0 $3.8 $3.4 $2.9 $2.5 $5.0 $1.8 $1.2 $0.9 $0.9 $0.0 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Recent Trends and Statistics Source – 2016 LIMRA Group Annuity Risk Transfer Sales Survey

  16. Recent Large Buyouts • 2016 – total of $13.7 billion (2nd highest) • PPG • United Technologies • PepsiCo • AK Steel • 2015 – total of $13.6 billion • Kimberly-Clark • Philips Electronics • Timken

  17. Plan Sponsor Thought Process – Whys and Why Nots • Why Purchase • Good value (relative to other liability measures) • Longevity/mortality risks • PBGC premiums • Plan-related expenses • Why Not Purchase • Low interest rates • “We’re catching up” mentality • Poor value (relative to other liability measures) • Settlement & accounting issues • Paternalism

  18. Why PurchaseGood Value The above chart is based on a set of retiree only liabilities with a PBO of $50 million, cash flow duration of 9 years and discounted using the Mercer Yield Curve. The figures should be used as an indication of the market pricing for annuity placements; actual pricing will depend on the plan-specific factors such as plan provisions, size, and age and gender of the population.

  19. 17.1 15.5 13.9 13.2 11.9 Liability Increase for Liability 8.2% 4.5% 8.3% 5.9% entire period Increase is 29.7% 1980s 1990s 2000s 2008-2013 Current GAM 71 GAM 83 RP - 2000 RP - 2000 RP - 2014 with Scale AA with MP - 2015 : Why Purchase Increasing Longevity Risk U.S. pension plan sponsors face increasing liability due to mortality table updates Based on Male age 70

  20. Why Purchase – Case Study • 1,000 retirees, avg. benefit $86/mo., annuity price - $6.0 million; immediate PBGC savings - $586,000 •  1,800 retirees, avg. benefit $120/mo., annuity price - $18.0 million; immediate PBGC savings - $1.05 million •  2,400 retirees, avg. benefit $132/mo., annuity price - $27 million; immediate PBGC savings – $1.41 million •  3,000 retirees, avg. benefit $148/mo., annuity price - $40 million; immediate PBGC savings – $1.76 million

  21. Why Not Purchase Low Interest rates = Poor Value (meaning poor timing?)

  22. Why Not Purchase Recent stock market performance (“we’re catching up” mentality)

  23. Annuity Buy-Out Process

  24. Department of Labor IB 95-1 • Factors to consider: • Insurer’s investment portfolio • Size of insurer vs. size of contract • Insurer’s capital and surplus • Insurer’s lines of business and potential exposure to liability • Structure of contract, including any guarantees • Availability and extent of protection from state guaranty associations • “The selection of an annuity provider for purposes of a pension benefit distribution, whether upon separation or retirement of a participant or upon the termination of a plan, is a fiduciary decision governed by the provisions of part 4 of title I of ERISA.” • “In discharging their obligations … fiduciaries choosing an annuity provider for the purpose of making a benefit distribution must take steps calculated in obtaining the safest annuity available, unless under the circumstances it would be in the best interests of participants and beneficiaries to do otherwise.” • “[t]he fiduciary obligation of prudence … requires, at a minimum, that plan fiduciaries conduct an objective, thorough and analytical search for the purpose of identifying and selecting providers from which to purchase annuities.” The Department of Labor’s Interpretive Bulletin 95-1 (“DOL IB 95-1”) provides standards for the fiduciary to consider in the selection of an annuity provider (ERISA §2509.95-1)

  25. Group Annuity Contract Structures Single insurance company

  26. Group Annuity Contract Structures (continued) Plan Sponsor Premium to #2 Premium to #1 Monthly data reconciliation Consolidated monthly payments Insurer #1 (Lead) Insurer #2 (Reimburses #1) Bulk payments (50%) • Multiple insurance companies • Spreads the solvency risk across more than one insurer • “Horizontal” split transactions: • Increases the available state guaranty association protection • “Lead” insurance company makes payments to annuitants and handles administration responsibilities • Annuitants receive a certificate from each insurer • Example: two insurance companies, general account, 50-50:

  27. State Guaranty Associations The guaranty association in a certificate holder’s state of residence at the time of the insurer’s insolvency provides the protection; per person limitations apply for multiple contracts with a given insurer Source(s): https://www.nolhga.com/ and individual SGA websites Framework Every state, and the District of Columbia, has a guaranty association to protect its policyholders (residents) and beneficiaries from life and health insurance company insolvencies Each insurance company licensed to write insurance/annuities in a given state is required to become and remain a member of that state’s guaranty association Coverage is provided up to a dollar limit that varies by state; the present value of the annuity benefits are compared to these limits:

  28. Independent Fiduciaries Role Consider interests of all plan participants Provide DOL IB 95-1 analysis and due diligence Assess potential need for separate account structure Review state guaranty association coverage Select annuity provider(s) Key reasons to hire an independent fiduciary Reduction in risk for plan sponsor and plan fiduciaries Removes potential conflicts of interest DOL IB 95-1 encourages it

  29. Assets-In-Kind (AIK) Transfers Advantages: • Portion of premium paid in-kind can be invested more quickly by insurer • Transaction costs can be minimized • Potential reduction in group annuity premium Most pension plans hold more risky assets than insurers do; however, certain fixed-income investments and alternatives are attractive to insurers

  30. Annuity Buy-In What is it? • Revocable, non-participating group annuity contract • Buy-in contract remains an asset of the pension plan; typically: • A single premium is paid to the insurer • Bulk payments are made back to the pension plan which continues to administer the monthly payments to retired participants (although the insurer might take-on administration) • Buy-in contract can be converted to a buy-out contract (irrevocable) in the future Considerations • Revocable, so transaction does not trigger immediate settlement accounting • Mitigates risks for target population: longevity, mortality, interest rate, etc. • Plan continues to pay PBGC premiums until conversion to buy-out • More popular in the UK • US: 8 cases total, with recent sales of $15.7M in 2016 and $7.2M in 2015 (Source: LIMRA)

  31. Miscellaneous Issues Anti-selection Accounting and settlement issues Deferred annuities (undesirable?) Insurers’ perspective(s) Questions

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