US Pension Plan De-Risking and Historical Background Overview
Explore the history and de-risking strategies of US pension plans, including key events like the Pension Protection Act and evolving market conditions. Gain insights into the risks, options, and considerations for pension de-risking presented by industry experts at the CIRB seminar in Mumbai. Understand the impact of legislative acts like ARPA and CARES on pension liabilities and funding. Stay informed about the evolution and challenges of US pension plans for a comprehensive view of the pension landscape.
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: CIRB : Mumbai : August 25, 2023 Seminar Name Venue Date US Pension Plan De-risking and Pensioners Journey Hemant Kumar (Director), Srinivasa Yenugudhati (Senior Manager), Yash Wardhan (Senior Consultant) | Principal Global Services The information contained in the presentation / video (media) has been taken from public sources as mentioned in the presentation. The views and opinions of the speakers as expressed in the Media, are their individual views and opinions and do not necessarily represent the views and opinions of Principal Financial Group or any of its subsidiaries / affiliates including Principal Global Services Private Limited. The Speakers do not make any representation as to the accuracy, applicability, fitness or completeness of the media content.
Overview 1. History of US Pension Plans: How did we get here? 2. Risks and reasons to De-Risk 3. De- Risking: Options and execution 4. Insurer s considerations 5. Conclusion www.actuariesindia.org
History of US Pension Plans: How did we get here? www.actuariesindia.org
Historical background on US Pension plans . Pension Protection Act (PPA): Higher premiums to PBGC Increase in tax deductible limit to Pension Plans Automatic enrollment into DC plans IRS: Pension contributions to be tax-deductible. Income on fund's portfolio tax-free Studebreaker Corporation plan closes down Plan Participants get 15% of actuarial value of pensions 1942 1974 2008 1963 1900 1921-26 Wage and salary act of 1942: Freeze in wages attempts to contain wartime inflation Doesn't apply to pension, health and welfare benefits ERISA: Disclosure of pension plan details (plan doc, benefit accruals, vesting rules etc.) Minimum Funding rules Establishes PBGC Life expectancy approx. 49 years at birth www.actuariesindia.org
Historical background on US Pension plans Inflation spikes after re- opening post-pandemic Fed starts increasing rates aggressively Pension plan assets suffer Interest rates for liability calculations start rising Housing Market collapse: Interest rates nosedive, remain low over the next decade De-risking conversations become prominent CARES Act: Contribution and tax relief for 2020 2020 2021 2008 2012-15 2021-22 American Rescue Plan Act (ARPA): Increases interest rates for liability calculations Increases amortization period to cover shortfall MAP21 (2012) 25-year average for interest rates for pension plan liabilities HATFA (2014) Extends use of MAP21 rates Bipartisan Budget Act (2015) Extends usage of MAP21 rates Increases PBGC premium www.actuariesindia.org
Risks and reasons to De-Risk www.actuariesindia.org
US Pension Plans: Risks Demographic Regulatory Longevity Disabilities Funding or Disclosure requirements Administrative expenses Other Economic Plan Sponsor s financial health and goals Global events: Pandemic, Geopolitical events Fund Performance Discount rates www.actuariesindia.org
US Pension Plans: Risks Economic Risks Monthly Segment Rates* S&P 500 annual returns 40.0% Segment 1 0-5 years Segment 2 5-15 years Segment 3 15+ years 30.0% 10.00 20.0% 9.00 8.00 10.0% 7.00 0.0% 6.00 5.00 -10.0% 4.00 -20.0% 3.00 2.00 -30.0% 1.00 0.00 -40.0% Sep-06 Sep-07 Sep-08 Sep-09 Sep-10 Sep-11 Sep-12 Sep-13 Sep-14 Sep-15 Sep-16 Sep-17 Sep-18 Sep-19 Sep-20 Sep-21 Sep-22 -50.0% 1991 1995 1999 2003 2007 2011 2015 2019 2023 *Funding valuations use averages of these rates over varying time periods. DOT-COM Bubble Housing Market Crash Inflation and Fed Rate hikes www.actuariesindia.org
US Pension Plans: Risks Demographic Risks Life Expectancy from Birth (Years) 79.11 80 78 76 74 72 70 68 68.14 66 64 62 1950 1960 1970 1980 1990 2000 2010 2020 Source: United Nations - World Population Prospects www.actuariesindia.org
US Pension Plans: Risks Regulatory & Other Risks $120 700 $652 PBGC Premiums for Single Employer pension plans $582 $598 The plan sponsor also bears other 600 $561 $96 $100 $500 $517 $523 $541 administrative costs: $88 $86 $83 500 $80 Pension Administration fee $80 $74 $400 $412 $418 $69 Actuarial and investment services $64 400 $57 $60 Pension management fee $52 $49 $48 300 $46 $45 $43 $42 Time spent by workforce on plan $38 $40 $35 $35 $35 $34 $34 $33 $31 $30 200 management $24 $20 $14 100 $9 $9 $9 $9 $9 $9 $9 $0 0 UVB = Unfunded Vested Benefits 2007 2008 2009 2012 2011 2010 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 VRP = Variable Rate Premium Per Participant Flat-Rate Premium Rate per $1,000 UVBs (VRP) Per Participant Cap (VRP) www.actuariesindia.org
De- Risking: Options and execution www.actuariesindia.org
De-risking Options Reduce Risks Transfer Risks Plan Amendments Pension Risk Transfers (PRT) Liability Driven Investments Plan Termination www.actuariesindia.org
Reduce Risks Plan Amendments: Plan Freeze* PBGC-Insured Plans-Single Employer Pension Plans Plan Sponsor could: 30,000 Close plan to new entrants 25,000 Freeze only future accruals 20,000 Freeze all benefits Continue Employee benefits in a DC plan Pension Risk Transfer events Improve funding to DB pension fund 15,000 10,000 5,000 - 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 Consider change in asset strategy to LDI No Accrual or Participation Freeze Terminate the plan Partially frozen, open to new entrants. Partially frozen, closed to new entrants. *This presentation only focuses on Plan Freeze. In practice, other options are available to plan sponsors. E.g. Cash Balance Accrual continue, closed to new entrants Source: PBGC 2020 Pension Insurance Data Tables. www.actuariesindia.org
Reduce Risks Liability Driven Investments (LDI) 100% Pension Plan liabilities behave like high- quality, longer duration bonds Allocation to fixed income increases as funding ratio improves ASSET ALLOCATION Regular payments like coupons Low risk of default Duration of fixed income moves toward long duration as funding ratio improves Investing in bonds with similar durations to liabilities reduces the interest rate risk/reward since the two behave similarly when rates move 50% Hedging characteristics of portfolio increase as the need to take investment risk is reduced The focus shifts to net return on assets vs. liabilitiesrather than gross asset returns 0% <75% 80-85% FUNDED STATUS 90-95% 100%+ Fixed Income Return Seeking www.actuariesindia.org
Transfer Risks Pension Risk Transfer: Plan Termination Number of US DB Plan Terminations 2,000 Often use phased De-risking approach: lump sum distributions offered to Terminated participants prior to Plan Termination 1,500 Group Annuity contracts purchased for the remaining participants 1,000 Lump Sum distributions shift the risks of managing the retirement fund to the employee 500 Group annuity purchases: plan participants deal with another party for their pensions - Standard Termination Filings Trusteed Terminations Source: PBGC 2020 Pension Insurance Data Tables. www.actuariesindia.org
Transfer Risks Lump Sum Window 80% 1200 Estimated incidence Rates of PRT Activity in PBGC - Insured plans 66% 65% 62% Select Plan participants get the option to take a Lump sum for their plan benefits during a given time period 57% 57% 60% 900 49% 47% 45% 42% Reduces administrative costs and long- term PBGC premiums 39% 40% 600 Lump Sum is an elected form of benefit* 20% 300 932 584 769 446 469 0% 0 *Plans can directly distribute Lump Sums up to Small Amount Force Out (SAFO). The SAFO limit for 2023=$5,000 and it will be $7,000 in 2024. 2015 2016 2017 2018 2019 Number of Plans offering LS windows Percent of TVs offered a LS Acceptance Rate TV : Terminated Vested Participants LS : Lump Sum Acceptance Rate: Participants of the offer group who opted to take the Lump Sums Source: PBGC 2020 Pension Insurance Data Tables. www.actuariesindia.org
Transfer Risks Example - Lump Sum Offering IRS 417 (e) Lump Sum Equivalents $1,000 monthly benefit payable at age 65 2022 Assumptions 2023 Assumptions Percentage Drop Age 45 $94,000 $53,000 44% Age 55 $134,000 $87,000 35% Age 65 $191,000 $150,000 21% Other Assumptions Single Life annuity form of payment deferred to age 65 2022 results based on Sept. 2021 IRS 417 (e) rates and 2022 unisex mortality 2023 results based on Sept. 2022 IRS 417 (e) rates and 2023 unisex mortality Calendar year plan with annual stability period www.actuariesindia.org
Transfer Risks Group Annuity Purchases Estimated incidence Rates of PRT Activity in PBGC - Insured plans 60% 350 50% Single premium paid to an insurer to transfer part of or entire pension liability 48% 300 50% 44% 40% 250 38% 40% Full plan terminations generally end with a final group annuity purchase for the remaining participants 200 30% 150 18% Even in the case of a full termination, liabilities for actives and deferred vested participants largely settled by lump sum offers prior to a final annuity purchase 17% 20% 15% 100 91 10% 10% 50 3% 76 159 213 315 0% 0 2015 2016 Number of Plans Purchasing Annuities Percent of Retirees Annuitized Percentage of TVs Annuitized 2017 2018 2019 Source: PBGC 2020 Pension Insurance Data Tables. www.actuariesindia.org
Insurers considerations www.actuariesindia.org
Group Annuity Group Annuity Purchases Market Update Group Annuity Sales ( in $billions) 60 50 40 30 20 10 0 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 Source:Release: Quarterly Retirement Market Data, First Quarter 2023 | Investment Company Institute (ici.org) Source: LIMRA www.actuariesindia.org
Group Annuity Plan Sponsor s consideration Tender / Bid Process Typical timeline, takes 6-18 months (approx.) Price Considerations Regulatory considerations Plan Sponsor s View (Illustrative only) Comprehensive market coverage 115% Decision not solely based on price Regulatory guidelines for fiduciary responsibilities 110% 105% Meet standards of Department of Labor interpretive bulletin 95-1 when selecting an insurance 100% Participant Communication 95% Capital and Surplus 90% PBO Investment Management Administrative Expenses Investment Default Risk PBGC Premium Economic Liability Settlement Premium Group Annuity Cost www.actuariesindia.org
Group Annuity Insurer s consideration Insurers provided plan specifications and census data. Considerable Q&A on provisions and data issues. Insurers submit competitive bids for client review. Annuity vs. PBO (Illustration) Insurers View ( Illustrative only) 110% Key Assumptions drive pricing deals 108% Mortality 106% Gender, Lifestyle, Occupation etc., 104% Need to get mortality right 102% Plan Feature Utilization 100% Investment Earnings 98% Expenses 96% Reserve & capital 94% 92% 90% Annuity PBO www.actuariesindia.org
Group Annuity Insurer s consideration Emergence of Profit Capital Release (illustrative only) 20 A PRT case has no recurring premium deposits Setup a large reserve for 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 future benefits -20 Initial Capital Loan from Corporate = -40 (STAT Reserve + RBC) Premium -60 Return capital to corporate as earnings -80 emerge over time Key pricing metric is IRR on -100 corporate transfers -120 -140 www.actuariesindia.org
Conclusion www.actuariesindia.org
Participant Protection Before/After PRT Purchased Annuity DB Plan ERISA sets funding requirements, authorizes DOL, IRS, PBGC to administer/enforce NAIC establishes reserve and investment standards, state regulators enforce Underfunding is common, may fall to as low as 80% before triggering adverse consequences by law Higher standard for funding constant solvency regulation requires all liabilities to be funded at all times PBGC guarantees benefits up to statutory limits, funded by premiums paid by DB plans State guaranty associations cover failures, funded by licensed (solvent) insurers Insurers generally have more assets available in failure Separate accounts have become common to provide further insulation protection in PRT www.actuariesindia.org
De-risking : Solution Risk Matrix Stakeholders Plan Participant Plan Sponsor Insurer De Risking Solutions Plan Amendments Liability Driven Investments PRT Lump Sums PRT Annuity Purchase Minimal to No Risk Partial Risk Owns Risk www.actuariesindia.org www.actuariesindia.org
De-risking : What the future holds? Plan Sponsors continue to Will the Low interest Decoupling of show desire to reduce their environment return as a product economies global Pension footprint. Are the of another shock? What level of chains weakening. Defined Contribution volatility will the pension plans solutions good enough? be able to safeguard against by then? www.actuariesindia.org
Thank You! www.actuariesindia.org
