The buyout market is virtually non-existent in the US, but market volatility and tough funding regulations means that is all set to change, as Chris Panteli reports
US pension consultants and insurers are gearing up for a swell of interest in de-risking strategies including buyouts, buy-ins and longevity risk transfers.
The market is practically non-existent at present, but experts expect it to grow considerably over the next few years, with initial activity starting as soon as this year. This will come as corporate schemes make good the losses incurred during the financial crisis and sponsoring employers seek to rid themselves of what has become a troublesome burden once and for all.
Unsurprisingly, de-risking has been taking place in US schemes for some time already, with employers using a number of techniques in order to get their pension fund into a more stable position. However, following the introduction of the Pension Protection Act (PPA), this has become more pressing than ever.
Signed into law by President George Bush in 2006, from this year the PPA subjects defined benefit plans to a 100% of current liability funding target, requiring higher funding of "at risk" DB plans and imposing new benefit limits on underfunded DB plans.
Risk reassignment
A buyout - or bulk annuity buyout as it is sometimes known - involves the trustees of a defined benefit pension scheme transferring the risks of the scheme to an insurance company in return for the payment of a premium. An insurance policy is purchased in the trustees' name. The liabilities of the scheme are then insured, but the trustees and employer continue to have legal responsibility for the scheme.
From that point on the insurer has responsibility for paying pensioner benefits. When the scheme winds up, the trustees' insurance policy is replaced by individual policies in the members' names and those members become policyholders with the insurer.
The key difference between a buy-in and a buyout is that a buy-in does not involve the closure of the scheme and the employer and trustees retain their responsibilities. Instead, an insurance policy is set up to cover the risks presented by either all the scheme members or by certain subsets such as retired members.
"People are looking at this and thinking, ‘if my plan is closed to new entrants, at some point I'll freeze it to benefit accrual," said Phil Waldeck, senior vice president, pension and structured solutions at US insurance firm Prudential (known as Pramerica in the UK). "If I have to fund it up and get to the point where I'm in range of being wholly funded, I'll then chose to take less risk by reducing our equity allocation, then I'll choose to take interest rate risk off the table through an LDI strategy. Ultimately I'll look to have slices of liabilities transferred as they do in the UK and ultimately you'll see buyouts, buy-ins and longevity insurance'."
The first chapter for many schemes looking to reduce their risk was to reduce benefits, followed by the payment of large voluntary contributions through cash, debt or a combination of both. In the past year, UPS issued $2bn of debt and pledged to pay $3.2bn into its plan, while department store chain JC Penney has also issued debt and contributed $400m into its fund. Major firms such as General Motors and Honeywell have also made similar announcements.
"When you start tracking who has announced enormous contributions it is actually getting to be a pretty massive list," said Waldeck.
The most recent step taken by almost half a dozen jumbo firms in recent months is the move towards greater transparency when reporting pension expenses against real operating earnings. Under financial accounting standards debt accounting rules, companies can use a smoothing measure to book an expected return of assets whether they go on to return it or not. They can then close any gap or unamortised gain or loss outside of the quarter and spread it over the life of the liabilities, making it difficult to calculate the true cost of their losses.
In January, telecommunications giants AT&T and Verizon each took $20bn in charges to cover previous losses and pledged to separate operating earnings and pension expense beyond the servicing costs for that year's benefit accruals. Honeywell, GE and IBM also intend to take similar action.
