Pension Risk Transfer

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As recent reports have shown, pension risk transfer (PRT) is a booming sector of the insurance industry. The National Association of Insurance Commissioners (NAIC) says a PRT is “when a defined-benefit pension provider seeks to remove some or all of its obligation to pay guaranteed retirement income or post-retirement benefits to plan participants.” With $52 billion in premiums paid, 2022 was a record year for PRT transactions in the U.S. market, and sales are expected to continue climbing.

What are the elements of a truly successful PRT transaction, and how do the various teams work together to package a competitive quote for a pension plan? I believe multiple functions within a company could come together to become a strong player in the bustling PRT market. In the “recipe” for an efficient PRT deal, these teams are the ingredients. And as with a culinary recipe, the individual ingredients combine to create a dish that is more than the sum of its parts—a carefully crafted transaction that offloads the significant risk of plan liabilities.

The Teams (Ingredients)

Before getting into how the various functions can collaborate to increase effectiveness, it is important to understand the role each function plays in the PRT quote process. Here is information on some (but not all) of the players in a PRT quote.

Pricing

The PRT pricing function involves setting assumptions and modeling both retirees who have commenced benefits and deferred participants who have not yet commenced benefits. The pricing team then presents a final premium, along with associated metrics, to management.

Modeling retirees is usually a simple process similar to modeling an immediate annuity—there are no premiums and all that needs to be modeled is the future stream of payments to the pensioner. The benefit amount and form of payment (e.g., single life, joint and survivor, etc.) are already known. However, modeling deferred participants is more complicated and involves setting election assumptions (such as age at commencement and form of payment) and interpreting plan provisions to correctly calculate future payments.

Business Development and Project Management

The business development and project management functions are the main connection between the broker and the rest of the team on a given transaction. They are responsible for communicating all information regarding the transaction to the various internal teams and setting frequent check-ins. Additionally, if any of the functions have questions for the broker regarding any aspect of the transaction, the business development team is expected to pass along the questions and relay any responses.

Because PRT transactions often have quick and inflexible timelines compared to the pricing of other insurance products, it is critical that a project plan runs on schedule. A delay for any deliverable risks not getting a premium out on the day of the bid. Together, business development and pricing develop a competitive strategy that provides attractive premiums to clients at return levels acceptable to the company.

Investments

The investments team is responsible for creating an investment and reinvestment strategy for a given transaction that results in either an earned rate or an asset portfolio for asset and liability modeling. The request for proposal (RFP) for a transaction will specify what market date to use for all rounds of bidding. Because the earned rate or asset portfolio will need to be provided at an earlier date for purposes of working on pricing, the investments team should monitor how markets are moving in the weeks and days leading up to the quote so the pricing team can adjust accordingly.

Investments has additional work when the plan requests quotes on both a cash and assets-in-kind (AIK) basis. For a cash quote, the plan will pay the premium amount in cash or cash-equivalent assets. For an AIK quote, the plan will replace some of the cash with existing assets. As part of an AIK transaction, the investments function must sift through the list of the plan’s available assets and determine which they would accept or reject as a part of the transaction. Depending on the insurer’s investment strategy, cash vs. AIK quotes may result in different premiums.

In-force Management

A flurry of activity starts as soon as a bidder wins a PRT deal. First, the in-force management team must convert the pricing models to their own systems (if necessary) and load the pensioners into the administration system. The in-force management team will model the business and track performance in future quarters, so this is a crucial step.

Second, the in-force management team will true up data between the bid day and the first payment date. The data true-up has a couple of purposes. One is to correct pensioner information such as gender, date of birth or any other relevant fields that may affect the price of individual records. Another purpose is to remove any records of people who have died before the “mortality assumption date.” The RFP will specify a mortality assumption date that usually aligns with the date the premium is transferred to the winning bidder. However, the data provided for pricing is based on an earlier date. The true-up process generally reduces the premium for any adjustments, which are typically deaths that have occurred between the time of pricing and the mortality assumption date. If data true-ups push the calculated premium outside an agreed-upon threshold (usually specified in one of the quote documents), the in-force management team may need to request a pricing update from the pricing team.

How Collaboration Can Enhance the Work Product (the Recipe)

For the sake of brevity, these examples focus on collaboration among the pricing function and the other functions. However, all teams working on a PRT transaction can employ creative strategies to effectively collaborate with other functions.

Pricing and Business Development

The pricing team can enhance the business development team’s project plan by providing estimates for key pricing deliverables and explaining any tight deadlines. Throughout the process, the pricing team can keep the business development team up to date on any progress, so they can have a good idea of how the process is moving.

When developing a premium for a quote, the pricing team should communicate with the business development team on which combination of results and metrics is useful for review. PRT quote processes usually involve at least two rounds: a preliminary and a final quotation. Between the preliminary and final quotations, it is suggested that pricing and business development align on follow-up questions or outstanding assumptions. They also should collaborate on current assumptions, outstanding unknowns and any anticipated changes to the pricing request. Strong collaboration between the business development and pricing teams allows for more clarity in obtaining approvals during internal governance processes and, ultimately, developing the final quotation.

Pricing and Investments

At minimum, pricing will provide the investments team with best-estimate cash flows or some duration target to start building a portfolio. However, the more information that pricing provides, the more effectively investments can build the portfolio.

For example, a material deferred population will include additional participant optionality, which could require more dynamic future portfolio management. In addition, the underlying investment portfolio may differ for a buyout vs. a buy-in transaction. In a buyout transaction, the administration of and responsibility for payments will transfer to the chosen bidder in a relatively quick time frame—usually a few months. A buy-in transaction results in a longer transition period where the plan still administers the business before it ultimately transfers responsibility to the chosen bidder. During the transition period, the plan also may offer a lump-sum window to deferred participants, which creates more uncertainty around the size and shape of future cash flows. By providing alternate cash-flow scenarios in these situations, pricing can assist investments in understanding and managing the underlying risks.

Although the pricing team members may be the go-to experts in liability modeling most of the time, this collaboration with the investments team can enhance their asset knowledge as well.

Pricing and In-force Management

Once a deal is won, in-force management would take models from the pricing team to register the transaction in the company’s systems and model and monitor the future course of the business. Pricing and in-force management can work together to prepare for the deliverables the in-force management team will require if a deal is won. This will ensure a smoother transition and reduce the need for the in-force management team to request files piecemeal.

Because the pricing team was working with the business development team during the presale process, they will be the experts on product features and plan provisions. Pricing professionals should be prepared to field questions about the transaction from in-force management as they set up their models. As stated previously, the pricing team also can serve as a resource during the data true-up process.

Knowing that the in-force management team will rely on the pricing team’s models and files, the pricing team can sharpen their documentation and model management skills to ensure that the in-force management team receives the most recent versions of all files and that files are organized and easy to use.

Create Your Own Recipe

Within a complex PRT transaction, each team can fulfill its basic function fairly independently. However, when teams collaborate and share information, each team can find ways to do its individual job more effectively, which benefits the project as a whole.

While collaboration is key to the recipe for success, how the teams (ingredients) work together best will be different for every company. Think about how your team is currently operating and consider how the various functions can elevate one another through 1+1=3 collaborations. Similarly, don’t be afraid to try adding new ingredients. Are there any teams not currently included in the PRT quote process that could provide value?

Whatever the mix of ingredients, the goal of the recipe is the same: Efficiently and effectively craft a risk transfer approach that offloads risk, stabilizes liability profiles and simplifies investment strategies.

Statements of fact and opinions expressed herein are those of the individual authors and are not necessarily those of the Society of Actuaries or the respective authors’ employers.

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