Companies ‘Splitting Defined Benefit Pensions Risk into Chunks’

The global risk transfer market will grow in 2014 as companies with defined benefit (DB) pension obligations in Germany, the UK, Ireland, Netherlands, US and Canada become more ambitious in their efforts to eliminate pension risk, says Mercer.

The consultancy, outlining eight trends in pension de-risking, has also predicted that schemes will parcel liabilities into ‘bite sized chunks’ to de-risk.

According to Frank Oldham, global head of Mercer’s DB risk team, “Globally, in 2013, we saw an increase in asset activity with active or dynamic de-risking coming to the fore. Organisations sought to lock in increases in return-seeking assets and increase their hedging of rates. We anticipate that the risk transfer market will thrive in 2014. In the UK, the volume of buy-ins, buy-outs and longevity protection transactions steadily increased in 2013 and we also saw more interest from pension schemes in the US and Canada.”

Mercer is also seeing schemes parceling up specific chunks of liabilities to ensure that they can afford to take some risk off the table, for example, through pension increase exchange or other liability management exercises. Some of these exercises will be influenced by the UK government’s view of DB to defined contribution (DC) transfers which is currently under consultation.

“Liability management tactics, such as provision of flexible options for individuals in DB plans at retirement, are becoming more common in the UK,” said Oldham. “The picture is the same as in the US – there are now ways and means to offer cash-outs to deferred pensioners, pensioners and even active members. In Ireland, and to a limited extent in Germany, there are also instances of cash-out activity taking place.

“In Germany, we also anticipate more interest in advance funding through, for example, contractual trust agreements (CTA). While in Holland, the focus is on risk sharing with more organisations moving to collective DC (CDC), while looking to de-risk their remaining legacy schemes.”

To help companies meet the de-risking challenge, Mercer has launched a new website,
Meet the DB Risk Team
. According to the website, the current trends in pension de-risking are:

More active management of legacy liabilities:
With more DB schemes closing across all markets (likely to accelerate with state benefit and legislative changes in markets like the UK and Holland), more focus will be placed on the management of legacy liabilities.

Pension schemes behaving like insurers:
Pension funds will place more focus on long-term credit as a core, or lower risk, asset class. This will provide a more predictable cash flow to help meet pension obligations.

Growth of risk transfer market:
Behaving like insurers is only one step away from a company outsourcing pension obligations to an insurer or a third party to manage financial risk levels on their behalf. The risk transfer market will be busy in 2014 onwards.

Development of more complex risk transfer solutions:
More complex solutions to parcel up and outsource pensions risk will be developed. This is already happening in larger markets, organisations are combining liability management and risk transfer. For example, this might be transferring pensioners to a separate arrangement, or offering pension increase exchanges or cash-outs to reduce liability and applying the savings to secure a buy-out for the residual total pensioner liability.

Segmenting of pension risk:
Plans will be restructured to segment liability into ‘manageable chunks’, where the risks can be parceled up and outsourced to a third party. This partial de-risking will make the process more affordable for many companies.

Increased corporate ambition to eliminate pension risk:
Organisations are setting clearer and more ambitious business goals to manage or eliminate pension risk. One Mercer client has set a clear target to remove 40% of its global pension liability from its balance sheet by 2018.

Stronger governance:
Delivering to the goal outlined above requires very strong governance and a clear focus. For many organisations, this requires a shift in gear amongst their fiduciaries – many can be without the skills or resources to effectively manage complex financial transactions.

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