What is Pension Risk Transfer?
If you are a pension plan sponsor, your current plan could be putting you at risk. Here’s why pension risk transfer should be your next move.
What is pension risk transfer?
Pension risk transfer (PRT) is the process of transferring some or all of a defined benefit plan’s liability away from the organization that sponsors a pension plan to a third party. A defined benefit (DB) plan is an employer-sponsored retirement plan in which participants accrue a monthly benefit based on the plan’s benefit formula. That benefit is payable, usually monthly, once they’ve reached retirement age.
Reasons for transferring risk
The volatility of the plan’s liability and assets can cause plan sponsors to look for ways to reduce or eliminate all or part of this risk and associated costs. One of those expenses has been rapidly rising for plan sponsors – PBGC premiums.
The Pension Benefit Guaranty Corporation (PBGC) is a federal agency created to insure participant benefits from a qualified defined benefit plan up to the maximum coverage. The PBGC premium is calculated in two parts, a fixed per-participant fee and a variable fee based on the amount of the plan’s underfunding (capped at a per-participant maximum). The fixed portion of the PBGC premium has more than doubled in the last 10 years, while the variable premium rate has increased by almost 400%. There are two ways to reduce this annual expense:
1. Increase contributions to improve the plan’s PBGC funded status
2. Reduce the number of participants in the plan
How does pension risk transfer work?
Transferring financial risk can be a complex process – let’s break it down into the two most common types of PRT:
A lump-sum window project
A DB plan sponsor can opt to offer participants a single lump-sum payment equivalent to their vested accrued benefit. Usually, this process takes around three to four months.
The employer purchases a group annuity contract from an insurance company
A DB plan sponsor can transfer all (terminating) or part (lift-out) of the risk to a qualified insurance company. If the plan is terminating, the process could take as little as six months or as long as 18 months. If the plan is lifting out a portion of their retiree population, it could take as little as three weeks.
Pension risk transfer benefits
Both types of PRTs are executed with the participant’s best interest in mind. Both the plan participants and sponsor benefit from the transaction. PRT helps organizations commit to providing benefits to applicable current and past employees. Participants end up with more secure benefits than their original pension plan offered. Let’s look at the specific advantages for both parties.
For the plan sponsor:
- Expense control – As mentioned earlier, PRT will significantly reduce pension liability and related expenditures, which will naturally improve the overall financial position of the plan sponsor.
- Decreased plan size – PRT will help “right-size” a plan, so the size of a pension plan is relative to a company’s balance sheet.
- Business freedom – The organization will be able to redeploy resources and capital to support its growth.
For the participant:
- Additional security – Participants will likely receive annuities from a qualified insurance company that may be larger and higher rated than the organization they worked for.
- A promise becomes a guarantee – Under a DB plan, the plan sponsor promises to fully fund the plan based on regulatory funding requirements. The plan sponsor changes the promise to a guarantee when it provides the participant with a single lump-sum payment or an annuity purchased through a qualified insurance company.
PRT is often the right financial decision for employers, especially those who want to reduce volatility by decreasing PBGC premiums, managing risk and planning for the plan’s fate. Transferring risk can benefit your company and set the stage for a financially secure future.
Want to transfer your pension plan risk? Contact October Three today to get started.