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The pension risk transfer (PRT) market has experienced remarkable growth over the past 12 years.
The pension risk transfer (PRT) market has experienced remarkable growth over the past 12 years. Since January 2020, over 2.5 million participants have been part of PRT deals, a number that continues to climb. The U.S. PRT premium hit a remarkable $ 26 billion in the first half of 2024, with a record-breaking 327 buyout contracts sold, underscoring the market's impressive expansion.[i] [ii]
The transformation began in 2012 when General Motors, Verizon, and Ford transferred billions of dollars in pension liabilities to insurance companies. Since then, PRTs have proven to be a highly effective way for companies to manage their costly and volatile pension obligations, providing a sense of reassurance in their financial strategies.
“We went from being a $3 billion marketplace that year to a $35 billion marketplace in just a few years,” Mark Unhoch, partner and PRT practice leader at October Three, said. “That opened the country to doing lift-outs. It was a monumental change for PRT.”
The Pension Risk Transfer (PRT) market has exploded from a $3 billion industry in 2012 to over $26 billion in the first half of 2024, driven by major corporate lift-outs from companies like GM and Verizon.
Historically used by "pension raiders" in the 1980s to capture surplus funds, PRTs have evolved into a critical strategic tool for companies to remove volatile and costly frozen pension liabilities from their balance sheets.
The market has matured significantly, growing from only eight active insurance carriers a decade ago to 23 today, reflecting the increasing demand and standard practice of transferring pension risk to safeguard participant payments.
Despite its recent surge in 2012, the PRT market has a rich history that spans over 80 years. Since the inception of pension plans, there have always been methods for their termination. The evolution of PRTs from serving the terminating plan market to effectively managing the risk, expenses, and liability of massive pension plans is a testament to their resilience and stability. Understanding this historical context is crucial for a comprehensive view of the PRT market.
For many years, most pension plans were managed by insurance companies, which invested the assets. The discount rate was determined based on the plan's potential earnings from bonds, a prevalent practice due to the widespread investment in fixed income.
In the 1980s, many pension plans were overfunded, giving corporations a new opportunity to make money. Buyers would purchase a company with over-funded pensions, terminate the plan, and take the excess pension money as a profit. Between 1980 and 1987, “pension raiders” removed more than $17 billion of surplus pension funds from plans to bankroll takeovers, leveraged buyouts, and other transactions.[i] During this era, demand for PRTs was very high as “raiders” snatched more money from funds.
After a public backlash against draining pension funds, the IRS introduced a significant regulation that altered the landscape. The IRS declared that any termination of an over-funded pension plan would incur a hefty 50% excess tax, effectively dampening the appeal of PRT.
However, the market proved its adaptability with a new strategy. Companies could avoid the 50% tax by using some or all of the over-funding for a replacement plan. This discovery led to crafting replacement plans using the excess funds, demonstrating the market's ability to navigate changes and challenges.
[i] https://www.latimes.com/archives/la-xpm-1987-11-17-me-21895-story.html
A seismic shift in the retirement landscape was on the horizon. As pensions became less financially viable, more organizations adopted defined contribution plans, such as 401(k)s, to shift the financial burden for retirement onto employees. This was before market-based cash balance plans, which combine the best features of pensions and 401(k)s, were common.)
The situation came to a head in 1998 when the S&P 500 lost 19.3% of its value in 45 days, significantly accelerating the shift to 401(k)s. Companies received massive contribution bills, causing many to freeze their pension plans and adopt 401(k)s. However, the frozen pension plans were an asset and liability that the companies couldn't touch despite yearly contributions.
With pension liabilities mounting on corporate balance sheets, adopting PRT transactions as a robust risk transfer tool to safeguard participants' future pension payments has gained momentum. This strategy, beneficial for insurance companies acquiring pension liabilities, has witnessed substantial expansion. From a mere eight active companies in the market a little over a decade ago, the number has now surged to 23, underscoring the burgeoning popularity and relevance of PRT transactions.
"I wouldn't say it was an insignificant industry, but with $1 to $2 billion a year, nobody's paying much attention," Unhoch said. "But when you start having massive growth rates and the number of frozen plans is increasing, people become interested."
Unhoch is not just optimistic, but bullish about the future of the PRT market, expecting it to maintain its strength and continue its robust growth. This positive outlook is a testament to the market's potential and should inspire confidence in its future.
"There is a lot of activity going on in the marketplace, and I believe it will continue," he said. "When you consider changing interest rates, you're only looking at half the equation because rates can go down, the market can go up, and your funding ratio can stay the same or increase."
If a company's funding ratio increases, the interest rates don't matter because the company is fully funded and wants to eliminate the liability.
"It's only when funding starts to decrease is when you're going to see people pull back," he said. "As long as the funding stays somewhat similar to what it is now, we're going to continue to see a very robust PRT market."
It’s an excellent time to decrease the expenses of a frozen plan and manage risk by starting a PRT transaction. At October Three, an independent and objective actuarial consultant can be your trusted partner through the entire journey. We can help you clearly define your pension goals, create a customized roadmap, and deliver successful results based on decades of expert experience. With us by your side, you can rest assured that we will always steer you in the right direction and away from increased risk and costs.
Kickstart the PRT process with a free wellness check on your frozen plan.
Footnotes
[iii] https://www.latimes.com/archives/la-xpm-1987-11-17-me-21895-story.html