After a record year for U.S. pension risk transfer (PRT) deals in 2022, we anticipate more insurers will want a slice of the expanding premium cake. Based on WTW’s involvement in supporting both insurers and plan sponsors on PRT transactions, we look at some of the likely criteria for making a success of the opportunities.
The PRT market in the U.S. is thriving. Bolstered by a third quarter $16 billion IBM deal, 2022 PRT premiums reached almost $52 billion, surpassing the previous annual high and continuing the upward trend of recent years (Figure 1).
And with current economic conditions, there is no sign of any short-term cooling of the market.
Higher interest rates have decreased pension liabilities, typically improving funding ratios (the ratio of assets to liabilities). In fact, when examining pension plan data for 356 Fortune 1000 companies, WTW analysis found that, based on current market conditions, the average funded status of U.S. defined benefit (DB) pension plans is approximately 95%. This better positions plan sponsors to use assets to cover the premiums of a PRT.
Allied to that, increasing costs and growing participation from insurance companies looking to transact are likely to incentivize plan sponsors to cut deals that reduce or eliminate their longevity risks.
So, if you’re an insurer potentially looking to join the nearly 20 companies already active in the market, what things do you need to know and consider in order to make a success of the PRT opportunity?
Three key PRT risks: mortality, investments and expenses. Three main sets of assumptions underpin PRT pricing, and insurers’ approaches to them are becoming notably more sophisticated.
One is the expected longevity of the plan’s members. How do you mitigate against estimates being too low or too high? One approach can be to use more and better information in setting mortality assumptions. Assumptions have also become more granular and robust, providing greater differentiation of mortality expectations by plan and participant. Other available mitigation techniques would be reinsurance strategy and diversifying the book of business over time.
Second is the balance between risks and rewards related to investments. Risks such as interest rate movements, defaults, movements in credit spreads, and equity and mortgage risks need to be carefully balanced with the desire for higher yields. We have seen some insurers move to riskier assets, which adds competitive pressure on others in the market. Flow reinsurance could be one possibility for insurers looking to compete.
Third is the expenses incurred in building a market presence. To overcome the risk of operations not achieving scale, options might include outsourcing pricing or administration. Another factor that insurers must increasingly allow for is the impact of inflation.
Target market. What piece of the available cake are you looking for or suited to bite into? PRT deals vary from small (less than $10 million) to jumbo ($1 billion or more) and involve both annuity-based plans and cash balance plans. You also have to decide if you want to focus on retiree only plans (in which all policyholders have already begun benefits) or are willing to take some deferred obligations (policyholders who have not yet elected benefits). Of course, deferred lives come with additional considerations and risks, including understanding sometimes complicated plan specifications as well as setting assumptions for policyholder behavior.
Pricing competitiveness. With insurer interest in the PRT market rising, pricing is likely to become even more competitive. The ability to compete in your preferred market segments will depend on a combination of investment performance, mortality assumptions, capital management and the level of targeted return.
The ability to satisfy DOL safest available criteria. The Department of Labor (DOL) Interpretative Bulletin 95-1 provides that, when purchasing annuities for the purposes of distributing benefits under a qualified DB plan, plan fiduciaries must select the safest available annuity provider. The specifics of what that means for insurers is left to interpretation. But criteria that are likely to be taken into account include the quality and diversification of the investment portfolio, capital strength, size relative to the proposed contract, and the insurer’s lines of business and accompanying risk exposures. Further, the SECURE 2.0 Act of 2022 has directed the DOL to review its existing guidance for fiduciaries engaging in PRT, highlighting the need to manage future regulatory changes in addition to satisfying the current requirements.
Ratings matter. Given the above, plan sponsors need to transact with insurers whose financial robustness they can trust. Virtually all PRT players have total U.S. entity balance sheets of $20 billion or more. Furthermore, every organization currently active in the PRT market has an S&P rating, and most PRT writers are rated AA- or better, with a few at A+. Exceptions to these “rules of thumb” have tended to make inroads into the market through competitive pricing.
Understanding of the quoting process. Requests for quotes (RFQs) are typically managed by annuity placement advisors or brokers. They will compile a list of insurers to invite to quote and subsequently help in selecting finalists and ultimately, a final decision. Insurers need to have available resources and technology in place to meet what are usually short time frames for bidding.
Administration and staffing are important. The need to administer PRTs effectively shouldn’t be underestimated. Indeed, in some cases we see, this can determine whether companies make a short list for an RFQ.
The key point is to be able to replicate the existing processes, particularly those related to benefit payments, so that administration appears seamless to retirees. This may well entail multiple forms of payment, including the ability to make inflationary and other cost-of-living adjustments. Call centers often form part of the ongoing support to plan members for such needs as notification of a change of beneficiaries.
Over and above the administration staffing needs, which can of course be outsourced, smaller players in the market typically employ one person for plan relationship management. Larger players have larger teams doing this kind of work.
These are just a few things you will need to think about if you’re an insurer considering whether to get involved in the PRT market.
And while evaluation is important, the PRT market appears ripe for further expansion given economic conditions and the ongoing attraction of the broader investment strategies that many insurers can bring to the table to meet future DB plan liabilities. So, take care that procrastination doesn’t hinder your chance to grab a larger slice of the expanding U.S. PRT cake than might otherwise be the case.
