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HICKORY, N.C.—More employers are likely to follow a North Carolina manufacturer's lead in using an innovative product to transfer pension plan risk to a third party but still offer the plan to its employees, experts say.
Prudential Retirement, a unit of Newark, N.J.-based Prudential Financial Inc., announced last week that Hickory Springs Manufacturing Co. had purchased Prudential's “portfolio protected” buy-in policy. That effectively transferred to Prudential the liability for about $75 million in pension benefits earned by about 1,000 retirees in the plan offered by the diverse Hickory, N.C.-based company.
Under the arrangement, Hickory Springs transferred just less than $75 million from its pension plan to Prudential Insurance Co. of America, which holds the assets in a separate account. Under pension rules, the value of the account is counted as an asset in Hickory Springs' pension plan.
Each month, Prudential draws an amount from the account needed to pay the retirees their monthly pensions and transfers it to the Hickory Springs plan. The company then issues the pension checks to the retirees.
Through the arrangement, Hickory Springs is shielded from risks associated with a defined benefit plan. It no longer faces the possibility of having to kick in extra money to its plan if, for example, retirees live longer than expected or the value of plan assets fall due to a slide in the equities markets.
“We have promised a pension to these individuals and we are not moving away from that promise,” said Hickory Springs Chief Financial Officer Steve Ellis. But now, “I will sleep very well knowing this has been done,” Mr. Ellis added, referring to the Prudential arrangement.
For an insurer like Prudential, the appeal of offering the product is that the pension assets it receives and the investment income generated on those assets will exceed the value of the liabilities it guarantees.
“Prudential's price—in this case a $75 million single premium—is designed to be sufficient to cover the present value of covered benefit payments and provide for an appropriate return on capital to Prudential. Prudential's earnings will emerge through time as the difference between the net investment income of the assets supporting the transaction and the guaranteed payments due Hickory through time,” said Dylan Tyson, a vp with Prudential Retirement's pension and structured solutions unit in Iselin, N.J.
Transferring pension plan longevity and investment risk in exchange for a fixed payment is likely to appeal to a growing number of plan sponsors, Prudential executives and others say.
“We have been discussing this with a lot of people. Now that the first transaction has been announced, I expect the conversations we've been having to increase,” Mr. Tyson said.
“We think this is a positive development. Sponsors are looking to reduce their exposure” to financial volatility, said Kevin McLaughlin, a principal with Mercer L.L.C.'s financial strategy group in New York.
“We see buy-in as another useful addition to the suite of tools available to help plan sponsors manage pension risk. We expect growing demand for this product over time and that further innovations will emerge,” Mr. McLaughlin said in a statement.
That volatility can be enormous. Many employers had to ramp up their pension contributions after the Great Recession and the accompanying plunge in the equities markets that battered the value of plan assets, turning overfunded plans into significantly underfunded ones.
Last year, for example, 100 U.S. employers with the largest pension plans contributed a record $59.4 billion to those plans, nearly double what they contributed during 2008, according to analysis this year by actuarial consultant Milliman Inc.
In separate research, Mercer found that plan sponsors in the S&P 1500 contributed about $72 billion to the plans in 2010, far more than the $43 billion they estimated they would have to funnel into their plans.
Given the volatility of plan contributions, fixing the size of the obligation through a pension buy-in program is something that has “broad appeal,” said Ari Jacobs, retirement strategy leader with Aon Hewitt Inc. in Norwalk, Conn.
While the concept of pension buy-ins has been discussed for years and used by some employers in the United Kingdom, employer interest significantly increased after the 2008 recession, which reinforced the financial risks associated with offering a pension plan, said Mike Archer, a senior retirement consultant with Towers Watson & Co. in Parsippany, N.J.
Still, the pension buy-in concept will not be for every employer, experts say.
Aon Hewitt's Mr. Jacobs noted that the policy will hold little interest for very large employers whose pension plan obligations are small relative to the overall company's size, allowing them to weather fluctuations in costs of required contributions.
A key variable affecting employer interest will be size of their pension liabilities relative to their size, Towers Watson's Mr. Archer said.
In addition, employers have other ways to reduce pension plan risk, said Mercer's Mr. McLaughlin. For example, employers, especially those with a large proportion of retirees in their plans, could reduce their holdings of equities and load their plan portfolios with bonds of varying maturities to reduce investment risk volatility, experts say.
“It is not a solution for everyone,” as you have to pay a premium, Mr. McLaughlin said.
Boston-based BCG Terminal Funding Co. served as a consultant to Hickory Springs on the project.