Life Insurance
Panning for Gold

• Terrence Dopp
• April 2020
• 

Key Points

• Demand: The U.S. market for pension risk transfers increased from less than about $3 billion prior to 2012 to 10 times that amount.
• The Impact: Insurers are counting on that revenue to bolster income squeezed by years of low interest rates.
• The Risk: Market going south or longevity gains could leave insurers who entered the deals on the hook to cover losses.

When Ed Root was pulling together a jumbo—over $1 billion—pension risk transfer deal five years ago, he'd sometimes find just two or three insurance company bidders. Not an ideal position for a company looking to unload the liabilities.

Root, managing director and head of the annuity purchase group at Willis Towers Watson, said that's changed for the better. The firm bills itself as the largest placement adviser in the U.S. pension risk transfer market.

“Now, you might get five or six insurance companies bidding on a jumbo deal and perhaps 10 bidding on smaller deals around $100 million and this increased competition has led to better pricing for plan sponsors,” Root, whose firm advised on the $6 billion buy-out FedEx undertook in 2018's largest deal, said.

“The overall U.S. life insurance market is very mature and products have low growth rates,” he added. “Pension risk transfer is the only large U.S. product that has very large market-growth potential.”

There's about $3 trillion in outstanding U.S. pension funds. Somewhere between about a third and half of that pool consists of plans that have been fully frozen by their sponsors. Think of that pot of money like a ripped-up dollar bill—companies want to get rid them as soon as they can afford to.

The growth speaks for itself.

U.K.-based Legal &General in a February report said the U.S. pension risk transfer business in 2020 could surpass the prior year and post the biggest year yet for a growing business.

Markets for PRTs grew in both countries, with the sector climbing from average annual volumes of less than $3 billion in the U.S. prior to 2012 to an expected $30 billion in 2019. Despite the growth, America's market is dwarfed by that seen across the Atlantic Ocean, where U.K. transactions were on track to total more than £40 billion (US$52 billion) for the same year.

The sheer volume of U.S. PRT deals also has ballooned in recent years, according to a February survey by the Secure Retirement Institute that looked at the full market.

There were a record 501 so-called single premium pension buyout contracts sold totaling $28 billion in 2019. Total sales in 2019 were up 5% above the prior year and the highest total sales volume the group has recorded since 2012. Group annuity risk transfer sales rose 8% to $30.5 billion in the 12-month span.

Major Drivers

Several factors sped up the pace of U.S. pension deals. A strong equities market in 2019 and ramped-up employer contributions left the plans better funded. Life and annuity insurers also were willing to bet on the market as a low-risk way to augment bottom lines struggling with years of low interest rates.

But low risk doesn't mean the pool of money isn't completely without some possibility of danger. Medicine could make a quantum leap. Markets can go south, leaving companies on the hook to pay pensioners the same liabilities they'd budgeted for with rosier projections.

“Once an insurance company enters into one of these transactions the pricing is set. If these people live longer than expected, they are not likely to realize the returns that they priced for,” said Thomas Rosendale, who is a director in the AM Best Rating Services division responsible for the ratings of companies active in the PRT market. “Asset risk and longevity risk are the two primary risks here. Also, since the companies active in this market often take on the responsibility of making monthly payments to large numbers of retirees, there is also some operational risk.”

Rosendale said the transactions are generally seen as a positive development for insurance companies, with insurers typically taking on pools of retirees with a weighted average liability duration of eight to 10 years. The longevity risk associated with these transactions can also serve as a natural hedge for insurers with large mortality books.

The Art of the Deal

In a PRT deal, a defined benefits plan provider sells either all or a tranche of liabilities to an annuities provider. This allows the companies to offload risk, while shifting focus back to running their business. For the companies who assume the risk, it's a pool of new business and fits in line with the age-old operations of a life insurer.

Athene Holding Ltd. announced Feb. 25 it carried out a pensions deal with Armstrong World Industries that totaled about $1 billion.

“While retail sales were impacted by low interest rates, we more than made up for it with record deposits across our pension risk transfer and flow reinsurance channels and reemerging activity in funding agreements,” James Belardi, chief executive of Athene, told investors during a Feb. 18 conference call to discuss fourth-quarter earnings.

The tax overhaul signed by President Donald Trump early in his term lowered corporate taxes to 21% starting in 2018 from 35%. As a result, some companies sped up multiyear initiatives to put more money into their pensions in order to take deductions at the higher rate. In fact, a study out of the University of Wisconsin-Madison found firms increased pension contributions 25% to 31% in 2017.

At the same time, the federal Pension Benefit Guaranty Corporation, which guarantees the defined-benefits plans of some 35 million American workers, raised premiums to $83 per participant in single-employer plans this year from $35 in 2010. In short, companies are paying more to carry pensions at precisely the same time higher funding levels are translating into better terms.

“If I was the CEO of a basic corporation that had a defined benefits plan that has been closed for quite a while, its funded status was good and there's a chance to sell that to an insurance company and remove that as a source of future extra earnings drain on my balance sheet?” said Colin Devine, principal of consulting firm C. Devine & Associates. “I would do it in a heartbeat.” A well-designed PRT deal can have a 10%-12% return on equity at a time when interest rates on 10-year Treasury bills remain near historic lows, he said. The deals prove especially attractive to large insurers that originate their own investments and have the flexibility to customize and obtain a bit more yield on those investments, he said.

Life/annuity insurers understand mortality and have shown a particular interest in transactions that scoop out only plan beneficiaries that are retired, he said.

“It's a very lumpy business line. You can see a bunch of deals one year and then the well's dry for three years,” Devine said. “It's opportunistic; it's augmentative to what you're doing. It creates a long-term source of stable earnings.”

MetLife in January said it had entered into a $1.9 billion agreement with defense contractor Lockheed Martin to provide annuity payments to 20,000 people in its defined benefits pension plan.

Legal & General listed that transaction as the third-largest U.S. deal in 2019, after separate $2.4 billion agreements entered into by Bristol-Myers Squibb Co. and Baxter International Inc. For the U.S. PRT market, the Legal & General report said $3 billion in plan terminations are expected to close in the first quarter of 2020, compared with $1.8 billion that closed in the same period of 2019.

The largest U.S. deals to date both took place in 2012. That year General Motors entered into a $25.1 billion deal that saw Prudential Financial provide annuities to 110,000 people. Also that year Pru closed a $7.5 billion group annuities deal with Verizon Communications Inc.

In 2019, MetLife surveyed U.S. defined-benefit plan sponsors on their attitudes toward PRT transactions. Among the findings: 76% of those plans with so-called de-risking strategies plan to completely divest of pensions at some point in the future. That poll threw in interest rate changes alongside funding levels and Pension Benefit Guaranty Corporation premiums as reasons for the increased interest in PRTs.

Root, of Willis Towers Watson, said further market growth could be dramatic if the average market funded status of pension plans gets above 100% from a current rate of about 85% and very large plan sponsors start regularly doing deals of more than $5 billion every deal. The U.S. could quickly be a $50 billion market, he said.

“Think of it as a door and everyone's kind of nosing around the door, and the door can only handle so many people going through it all at once,” he said. “So the first two or three people are going to get through the door and it's just going to get bottlenecked after that as everyone runs through the door.”

On the other side of that door, he said the number of financially solid insurers waiting for the business has doubled in the past five years and more enter each year. Some of them managed to double their business in the past few years. “Actions speak louder than words; so obviously these insurance companies see the growth,” he said.