MASTERCLASS: Pension Risk Transfer - November 2018

Recent changes in US tax laws have affected how companies look at their current financial situation. Firms across America rushed to take advantage of last-minute opportunities to cut down on their 2017 tax bills. One of those ways was to fund pension obligations. Three experts in pension risk transfer join together to discuss how to fund these pension obligations, addressing liabilities and how changes in the pension risk transfer market.

  • Michael Devlin - Principal at BCG Pension Risk Consultants

  • Wayne Daniel - Senior Vice President and Head of U.S. Pensions Business at MetLife

  • Glenn O'Brien - Managing Director, Head of U.S. Market at Prudential

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  • 52 mins 47 secs

Laura Keller: Recent US tax changes have affected much of investing but also companies' day to day operations. Firms across America rushed to take advantage of last-minute ways to cut down on their 2017 tax bills -- the final ones with a 35% corporate rate. One way was to fund Pension obligations, and so we thought it was time to reexamine the pension landscape. I'm Laura Keller and pleased today to be joined by three experts in pension management. Welcome to the Asset TV Pension Risk Transfer Masterclass.

Laura Keller: And thank you to my three guests for joining me here today, appreciate it. It's very rainy outside so thanks for coming in. So, Glenn, maybe if you could just start us there. Just to explain to us how companies were taking that 2017 tax bill, trying to reduce it by paying down these pension obligations early on.

Glenn O’Brien: Sure, so we did see another of really large debt issuances going to pension funding. That was really a hedge against the expenses born by the pension fund, the variable rate premium specifically. So, we saw across the economy really every segment of sponsor really doing some sort of debt issuances and/or using repatriated cash to help fund up.  And sort of the byproduct to that was clearly a larger cash positions inside the pension fund. So, traditionally we do a lot of transactions using some assets from the pension fund and we saw more transactions really deliberately done in cash.

Laura Keller: OK.

Wayne Daniel: So longer term perhaps the situation might be little more nuanced with some financial commentators predicting perhaps a reduction in corporate debt issuances, and that could have an impact on the pension risk transfer market. But definitely in the sort-term we saw a very strong payment of employer contributions.

Laura Keller: OK. And now that you know is no longer an option, of course, I think the deadline for this was September 15th. So now that that's no longer on the table, companies of course still are benefiting by having a lower corporate tax rate now at 21%. So, Mike you do see, you know, them using that savings to actually help fund some of their pension obligations going forward?

Michael Devlin: Yes, we see companies even after, you know it's only been a couple days but we still--, the benefit of putting cash into the plan is still a strong case -- mainly because of the holding cost and the PBCG variable rate. Not too long ago it was 0.9% but next year it's going to be over 4% so with the 21% tax reduction -- and even on not for profit companies that won't be able to benefit, they're still trying to figure out ways to put more money into the plan because it is actually a pretty wise investment. You put it in, you get some good return on your investment.

Laura Keller: And is that something you think would happen even if we-- maybe Republicans are thinking about maybe not keeping this as a permanent change. Do you think if they maybe boosted somewhere between 21% what it was 35% that we'd still see some of that effect?

Michael Devlin: Possibly. But we tell our clients that the what-ifs and the hopes that something’s going to happen is going to be pretty expensive. So, deal with what you have and now is the time after a record ten-year run of companies putting historic amount of money into the plans finally at adequate or close to full funding. Now is the time to transact. Waiting longer could result in ending you back into where you are before.

Laura Keller: Right. And Glenn you mentioned about repatriating earnings. Were there other things that were helping some of these companies pay down some of -- you know, what they had in 2017 or maybe now that they can bring forward those earnings from overseas. Maybe they'll pay a little more down in 2018?

Glenn O’Brien: Yeah, I think if you are going a debt issuance or you are repatriating cash you think about all your options to distribute your capital, so whether share buybacks, dividends, or funding of other obligations, retiring debt. So, I think the pension funds are really been highlighted over the last decade as being a huge consumer of capital and how can we really use some of the proceeds here or maybe service all of those needs. Continue with the share buyback program and at the same time really try to fund up our pension obligations, shore up a plan that's becoming more expensive to keep on balance sheet and possibly transact and move some of those liabilities off balance sheet.

Wayne Daniel: I would be a strong advocate for a plan to be well funded because, subject to affordability, I think that just enables the plan sponsor to have more options in terms of choosing to transact and de-risk. So, if you're fully funded you’ve just got the advantage of timing and you can choose when to transact.

Laura Keller: Yeah. The one thing though in terms of thinking about these repatriated earnings, I think the Wall Street Journal actually went through and looked to a lot of companies just to see if they had actually moved some of those earnings to the US. And they didn't actually find many companies had done that. So, I'm just wondering if you talked to some of those firms, really any large companies in the US, and seen maybe what their plans are. Perhaps they'll be doing this maybe in the back, the very, very back half of 2018 year.

Glenn O’Brien: Yeah, we’ve talked about it with our clients and really those assets are domiciled in those jurisdictions and they’re putting them to work in those jurisdictions. So there hasn't been necessarily a rush to bring those back. So I would say it wasn't a blanket-- you know good guy for corporate America to have this ability to bring it back to a lower rate because they've been very used to keeping those assets in those jurisdiction and reinvesting the proceeds in those operations and now's a good time to be a you know a global investor in some regards. So, I think, they've been very strategic about their repatriation strategy.

Laura Keller: And I'm sure some of the changes with some of the currencies and emerging markets in general-- it's good to have some cash, and domicile, and operations domiciled elsewhere.

Glenn O’Brien: Right.

Laura Keller: I wanted to ask you is to-- about, you know, where we might see, just kind of going forward-- will we see more of these pension risk transfer agreements, you know, as a result of companies being able to provide funding to the defined benefit plans.

Wayne Daniel: Well I think affordability is a key issue so, to the extent that the plan is well funded, you can afford to transact -- it just gives you a lot more options. You also need to consider that, you know, the stabilization of the funding rate through liability driven investing strategy. Generally, we see plans moving you know away from an equity strategy and more towards a bond strategy, and that helps facilitate a transaction as well, coupled with the additional liquidity that Glenn mentioned. I think we're seeing you know very useful bond assts that are suitable for transfer to an insurer coupled with cash and that again facilitates ease of transaction.

Laura Keller: Great. And I think that's probably a good segue into where we stand with the whole-- with funding status right now. I think when we were talking before earlier before the filming, we had-- what was it? 93% in the first half of '18 as far as funded status. Which I believe we talked about being you know better than any time prior to up until 2008. So, I mean that seems to be pretty positive should investors be not worried at all going forward?

Wayne Daniel: It depends on the unique risk characteristics of each plan. But if a plan is you know well-managed and with a view to its risk profile and cash flow of liabilities, then, you know, it should be somewhat insulated to investment risk. But to the extent that the plan sponsor retains the plan liabilities within the plan there is always risk, and that's really you know what ultimately is behind the desire of plan sponsors to transfer that risk to an insurer.

Laura Keller: Great.

Michael Devlin: In the last two decades, plan sponsors are gone through a roller coaster ride. So, this is not the --this is the third time that they’ll probably reach 90% or above. The first two times it didn't work out so well  you know you had-- the first time 2001-2003 timeframe then 2008 so I'd be surprised if a plan sponsor is going to make that same mistake again by not derisking at the very least and locking in your funding levels. So, I still think that you’re going to see a tremendous amount of transactions happening in the next five-ten years.

Laura Keller: And do companies need to be spurred to think that way, or how does it work? I mean are there marketing professionals that go there and say, "This is something you should be doing now"? Do you see that from the plan sponsors themselves? People who are very well informed and saying this is an action that we might want to consider?

Michael Devlin: So, they need to look for independent advice. There are firms that would go out and be able to get you independent look and to see what your options are.

Michael Devlin: I mean the beauty of pension risk transfer is you get to transact on your own terms and conditions. If the economics don't work out or don't seem right or they are accounting impact you are under no pressure to do it. But when you do eventually get to termination you are gonna have to transact on the regulatory rules and timing. So, there's a lot of flexibility and there is no downside to letting these two insurance carriers know that you have liability that you want to move and interested in engaging conversation.

Laura Keller: Right, well and I think that we've touched on it a little bit but maybe it's helpful to understand what insurance company actually needs in order to take on that obligation. We mentioned cash, obviously these bonds are helpful, funding where-- you know, at high levels is helpful. But what are the things that really need to be there in order for an insurance company to wanna take on that liability?

Glenn O’Brien: Sure, so we are very data dependent institutions. We really -- especially in the larger end of the market, we'll need very good participant data and historical data related to mortality experience. Because if you think about what we're really doing is that we're buying insurance companies which are called pension plans in the United States but we're really buying in an insurance company. So, we really are data dependent on how that insurance company has performed over time, what the liabilities look like, and history for those liabilities, so, we can make an accurate assessment of what we think the future might look like. So very data dependent, and then how do we make transactions efficient because we're really looking to strip out the inefficiencies of transactions that really don't benefit anybody. So how do we do asset-in-kind portfolios, how do we take advantage of tax free status of the pension fund early in a transaction, so there are a lot of things that we can do on the asset side but certainly on the data side it becomes very important.

Laura Keller: And what are the things too, Wayne, that can be done, you know, beyond just actually transferring the entirety of the obligation. Maybe you know helping around the edges some of these transactions like Glenn had talked about.

Wayne Daniel: Well I think if we think of derisking as a spectrum, Mike touched on some of the activity-- that's one of the first things we would recommend a plan sponsor obtain independent advice if they're thinking about derisking. MetLife runs a regular pension risk transfer poll and we see the results coming from that: the majority of plan sponsors actually want to transfer risk from their plan to the insurance market. And so, it's about timing and affordability and then getting all of the resources together. The data point that Glenn mentioned is a critical one, the data standards and the data requirements that the insurer has maybe higher than what the plan sponsor or the plan may typically have been used to operating. And so, you know getting independent advice, doing a feasibility study as Mike suggested, of, you know, what a transaction could look like? How much it would cost not only in terms of money but just in terms of resources and the time that the plan sponsor needs to devote to the process. And then data is a big part of that -- making sure that you've got a mortality experience investigation ready. But then beyond that, of course, the insurance company also provides services, you know, explaining to the participants what is happening and why and you know trying to allay any concerns they may have.

Laura Keller: Which seems like also a big piece of it as well obviously the end -- the end goal is to make sure the retiree has the money and has the resources they thought they would have probably they're not always thinking about "Well if I was with GM for example and now MetLife or Prudential is managing this for me," probably needs a little bit of education around that point.

Glenn O’Brien: Yeah absolutely, I mean there’s a lot of time and energy spent on how to communicate with retirees because that's most often the group of people that are affected. So how do you give them confidence that really nothing is changing, you know, the check will show up every month in perpetuity as always promised. But how do you orient them to the fact that there will be a new phone number and the payments will continue as planned. So, there's some real education and… and you know make website tools and other tools available for folks just to educate them around the transactions.

Laura Keller: Sure. Sure. Well I'm thinking about this too. You now the time that where in, I don’t know if this may promulgate some of it, but I was struck from MetLife you know having this six billion dollar transfer with FedEx in May. I don't know if you can talk that--  about that too much Glenn ah I'm sorry with Wayne but is there-- is there any thought that we'd seen more of those mega transactions?

Wayne Daniel: Well it's a good question, I think you know each plan is independent and each plan sponsor has got its own unique set of circumstances and so they will be choosing you know whether and when to come to market independently. But to the extent that, you now, a transaction is publicized that does raise questions at least, you know, the other teams of management are sitting and saying, "Should we have a look at our plan, is now the right time to do it?" I think in terms of timing t really does depend on the facts of the plan, the plan sponsor, and really you know what resources they have to devote to a transaction. It's not an easy transaction to do if this is the first transaction that a plan sponsor is undertaking so there's lots of assistance that they may require from their advisers and consultants, working together to get a good well run project.

Laura Keller: Sure. But still that's very big number and maybe like you said others-- other companies will have large liabilities would see that -- I know Verizon was something that you guys had done few years back.

Glenn O’Brien: Yeah, I think, I think it's-- I think it's the hope of our market that the discipline around divesting you know businesses because we think of, you know, pension plans as small businesses and sometimes very large businesses. So, will the same discipline about buy, hold or sell an operation like your insurance entity persist into the pension market. So, we've seen certain large sponsors really think about that thoroughly and take large actions and we think that the market will continue to develop over time. But I think we're starting to see more and more discipline around that especially as funded statuses have improved around really exit strategy of a non-core business. If you think about, you know, the pension market in the US about two-thirds of them are frozen now, so the actual business purpose of the pension plan you could argue is-- no longer exists in many of those programs. So, will I continue to run a runoff insurance company, or will I divest myself off of it, you know, over some period of time, opportunistically maybe.

Laura Keller: I feel like guys are making some really great segues for me. That -- that was what I wanted to talk about next. Just that idea of this, you know, hibernation or just having this frozen status going on -- I mean is there a -- is there an argument to be had that that shouldn't be happening that's not what funds or firms should be thinking rather maybe thinking about engaging in a transaction to transfer that risk. Maybe you want to talk a little about that Mike too?

Michael Devlin: I mean hibernation does work for some plans -- I mean every plan is different as far as their funding level ah as far as their different types of liability between term vested, actives and retirees and the average age of those groups. But if you’re-- and especially if your plan is only being in a soft freeze the people are still -- it's still being used to retain top talent. So, there's a lot of different variables that go in. So, hibernation does have its place and pension risk transfer has its place and still lump sum windows still have their place. The idea is making sure you understand all your options, so you can make an informed decision because all of these have their pros and cons, but it really depends on so many different variables. You need someone to be able to easily lay them out and figure out what your path is.

Laura Keller: What I-- I wanted to ask you about that a little bit more because it's two different sets of people, it's the plan sponsor of course and it's also the retiree. Now obviously there are independent advisers that you know can be engaged from the plan sponsor side. But where does the retiree go for some of that? For someone who’s thinking specifically about the lump sum or actually continuing to be able to you know getting payments into not perpetuity but through life’s end.

Michael Devlin: Sure, well on the retirees it's a prohibited transaction now for you to offer a retiree a-- the bill you take a lump sum unless your terminating their pension plan and even then, it might not be such a good idea. So the retirees typically are going to end up you know at the insurance carrier level. And, as we talked about before, it is key to have a communication plan. These guys have one on their side when they win it but there are things that need to be done in advance to help educate the retiree and make sure they understand that this is not a bad thing -- your benefits not going to be taken away. You know its-- you're getting the same monthly benefits, same withholdings and that they should be looking at this as a good thing because the plans always been to look and feel like an annuity. now actually it is. They’re going to get a certificate from one of these insurance carriers saying, you know, we've got the obligation for the rest of you-- rest of your life.

Laura Keller: Can you talk about hat little bit -- what are the things that should be one in terms of communication or tools that should be given prior to an insurance company actually taking hold?

Michael Devlin: Well it's -- it's very difficult when you're doing a pension risk transfer which is what we are talking about obviously and that's done on a non-termination basis. So, you really can't engage your retirees unless you really know you’re gonna transact and you really can't know if you're gonna transact  until you go through all the -- all the different things from the counting impact, and how-- it's the ripple effects and does it make sense  for the organization to do that. And it's a little bit different in the over billion-dollar marketplace versus the under billion dollar marketplace. The transaction that these guys are typically working on are a lot more complicated and has a lot more moving parts. When you get below a half a billion its-- they move a lot faster so you really, it's-- you don't have that much of a window to communicate with the retirees but when it does happen you have to have the communication plan in place and implement it ASAP.

Laura Keller: Well speaking of implementation, I'm telling you guys, we're just making my segues here. I wanted to think about you know the actual process of transferring, you know we talked about having the insurance company really at the ready, what does that look like from beginning to end?

Wayne Daniel: So once the plan sponsor has made the decision to transfer a segment of the risk over to the insurance company it's usually retirees only. That’s typically the transaction…

Laura Keller: It's not the incoming new participants.

Wayne Daniel: …that are occurring in the market.

Wayne Daniel: Right. Perhaps there's a public announcement of the-- of of the transaction and following that you know, as Mike was talking about there's a-- there's a communication plan to communicate [with] each and every one of the retirees. But then we begin the hard work of actually transferring the payroll data from the plan to the insurance company, or from the plan administrator to the insurance company. And so that has to get transferred and that has to get checked and then maybe some incorrect or incomplete data fields, and those would need to get finalized which takes a process typically of a few months because  there may need to be correspondence with the-- with the retiree to actually you know make sure that you've got correct and complete information. Once that is done that is done, that sort of gets locked down and memorialized as the final listing of liabilities that has been transferred. At the same time while that is happening, there's the call center which the insurance company is establishes so that you know if the retiree has any questions regarding you know what is happening to my benefits, or I've got some changes, you know when I change my bank details or my address they can call the call center. There's also the transfer of the premium from the plan to the insurance company, which could be a mix of cash and assets. So, there's a lot moving parts happening at the same time during that implementation phase.

Laura Keller: Ang how long is that overall? How long should a company plan from beginning to end?

Wayne Daniel: It does depend on the size and the complexity of the liabilities that have been transferred. So, it could be anywhere between sort of three and nine months depending you know, the larger the deal the more complex the deal the longer that is going to take to finalize all of those -- all of those aspects.

Laura Keller: And Glenn any advice for these companies who might be going through that implementation in transfer process?

Glenn O’Brien: Well again we're very data dependent so -- so, you now, the better quality the data, the better experience for everybody involved. So, we spend, you know, as institutions a lot of time scrubbing data trying to make it as complete as possible and then you know communicating with the retirees and then also communicating with the people who are potentially not part of the transaction. So, we've seen a lot of small balance transactions where maybe only five or ten percent of the population are moved. So, you know that sort of begs the question am I part of the transaction or am I not part of the transaction as a retiree? And a lot of companies have thought about how I communicate with those people who are not impacted to let them know that they're not and why, as opposed to those who are impacted and, you now, the future and what it looks like being moved to an insurer.

Laura Keller: That's interesting, it's not something that I would have thought of because I guess it's not always the entirety of the liabilities of companies; it’s certain segments. And how do you normally see like-- is that done by age of retiree, I mean is it-- how what's the vintage, what the seasoning that you normally see?

Glenn O’Brien: We can’t do it by age and so normally it's done by benefit size. Right that's the maturing of the market over the past year-- two years. It’s really about, how do I think about the cost to provide, what might be a de minimis benefit versus the expensive holding on to that liability pension fund. So, it’s what we've called the small balance transaction.  So, even though the -- the actual value of the liabilities, it might be $500 to 600 million dollars, the head counts could be in the tens of thousands. So, typically, people that you know worked there for a period of time earned potentially a small benefit. They’re being paid every month and they'll be annuitized. So, there is-- those pockets of people that you need to communicate who are transferred and then potentially the people who are not transferred,              

Michael Devlin: In the small to mid-marketplace a lot of the-- we're still surprised a lot pf plan sponsors don't realize that's it's not this all or nothing idea. Should I move all of my retirees or not? A lot of times that’s what been presented to them and what they need to understand is that, no, you can build tranches within your retiree liability and systematically eliminate risks and once again the thing that we always continue to say is, you know, we're trying to put you in a position to transact under your terms and conditions. And everybody's terms and conditions are different but there is ways to be able to develop and design a pension risk transfer strategy that makes sense and it always -- most typically the other way to do it is by benefit commencement date but every single one of our transactions has always been -- as Glenn as pointed out -- by that monthly benefit. And also, coincidentally not for me-- we went back and look out of the 52 transactions that we did last year every single one of them said they had-- their data was in good order…

Wayne Daniel: [LAUGHS]

Michael Devlin: …and there's only one that was actually in good order. So, everybody thinks they are in good order and a lot of is because-- as Glenn point out before-- it's because they're looking at it from requirement from their actuary standpoint. But you know when someone retires we’re not capturing the spouse's date of birth, you know there's things of that nature that never been captured. So, this whole exercise is a good exercise too because remember from most of these plans, eventually you're going to engage these insurance carriers.

Michael Devlin: So even if you don't transact you start to understand the process and you start to get the data cleaned up because you could be 93% funded today and next year all of a sudden, you've got a funded pension plan and you want to terminate; you don't want  data clean up and all these other things all sort of delay you and then have something happen in the marketplace. So these are all good exercises and majority of our clients when we educate them on the process and things they would do, usually about eight out of ten actually do some type of pension risk transfers.

Laura Keller:  Yeah, and that's again that’s not something I would have thought of -- having to collect all this additional data – sounds like not even just the participant but people who are involved in their family as well.

Michael Devlin:  Yeah, the custodian, you know, as Glenn was saying, not just communicating with the retiree, there's a lot of moving parts, there's a lot of people investing, managing the money. Ah, you know, there's a lot of coordination with a lot of interested parties.

Laura Keller:  How long does that effort usually take in-- really cleaning up the data?

Michael Devlin:  Uhm, it depends. I mean, if there's-- if the company has done a lot of acquisitions, then, you know, you went from paper files to, you know tapes, to you know you went through all these changes over the last 20, 30 years. We’ve had clients have literally have gone to archives and get boxes out, but it's , a necessary process. I mean, eventually too, remember, you do have to play your hand to the regulatory agencies, so, when-- if you're going for final favorable determination letter, the IRS wants to make sure that, if Wayne’s benefit is this, we know your actuary can do math, we're gonna challenge the information you put into that so, you need to be able to make sure that you have data that can support that benefit.

Laura Keller: In terms of-- when you think about these tranches, you know as we talked about, it doesn’t need to be the entirety of the liability. Do you usually seek companies trying to manage that-- in terms of a dollar amount that they'd like to transfer out to someone else or do you usually see it based on some other factors that they're looking for some number of employees to offload their liabilities?

Wayne Daniel: No, I think it is more at the size of benefit amount that seems to be to be the immediate cutoff points, so for example, a plan may have, you know, tens of thousands retirees, you know and choose 15,000 or 20,000 of retirees and those are the ones that have benefits less than 400 dollars a month. And then, what does  imply is that if you're just transacting on a tranche of your liability, you will likely come back to market and so that what we've observed in the market where plans would, you know, derisk a tranche and then, a year or so later, they would come back and derisk another tranche and so you would go.

Laura Keller:  And that is to eventually be come in to a zero?

Wayne Daniel: That would be the ultimate intention.

Laura Keller:  Right, and, and normally how long does that take-- I'm sure depends by company, but is there any sort of average that you normally see?

Glenn O’Brien: Ah, you know, we've said, sometimes it could be as fast as 90 days if everything is in order and they have their fiduciary process already outlined, they might have done a transaction in their history so they understand how to move forward so it could be as quick as 90 days, could be as long as a year just depending on, you know, really, all these other factors so if they're gonna use for instance, again,  if they're going to borrow money in order to facilitate the transaction, uhm, there's the debt issuance so they might wait for the proceeds of that.

Glenn O’Brien: Once they enter into a transaction, there is the need to potentially 8-K the transaction if you're publicly traded and then there is all the data they needs so you know, it could be three months if you've really planned out your actions over the last few years; could be nine months or 12 months depending on the circumstances of how you fund or finance the transaction.

Michael Devlin: And you have to be able to navigate your way through, I mean, you're coming up to the fourth quarter and historically, the fourth quarter is one of the busiest times for transactions and it's not just these pension risk transfers its plain old terminations, good old fashioned, I'm terminating my pension plan and I need to buy annuities for my retirees; some term vesteds and actives, so there's a tremendous amount of volume and that may not be the right time for you to try to solicit responses from the insurance carriers. So, when the volume is at an all-time level, you know, sure, you can test the marketplace but, you know, be prepared that-- Q1 might the best time; 

Michael Devlin: So, there's a lot different thing to go into and one thing that we get a lot is people will look at their, look at their-- the accounting impacts so they have unrecognized losses that being amortized so they like us to develop a pension risk transfer that is going to stay within that accounting impact. They don't want to go dollar before, so it's another way that that way we get asked to design the pension risk transfer.

Laura Keller:  And is there any reason why that seasonality exists, in the fourth quarter; is it just because everyone wants to close their books and offload that liability at that time?

Michael Devlin: You can try to get around now, you start to think about terminations-- you know, we have a lot of new clients that think about termination, when you go through the regulatory process; when you go through all the communications that goes on. There's a lot of heavy lifting for the plan sponsor and most everybody ends on the same path and ends up being in Q4 and this goes back to, once again, why pension risk transfer makes a lot of sense because not, to say it again, but they're transacting under their terms and conditions. When you do get to into terminations, these other people, they either operating off the PBGC's timing or the IRS but they’re certainly not free, you know free to go and do this any time they want; they have to fall within the regulatory guidelines.

Laura Keller: Again, great segue, ah, thinking about regulatory changes, I think it's important as well. We talked obviously about tax changes, but on the regulatory side, what kinds of things are changing with the new administration or over time that you are seeing in the space right now.

Glenn O’Brien: I think, we still, you know noticed and  said, there is always the potential for more regulatory change, so the thing that we've really warned clients over the past decade is the risk of regulatory changes, so we can go back to when the PBGC premiums were $18 per person per year and no variable rate premium existed and we were using a 25-year old mortality table. We were really warning people that that situation could very much go against you and be careful. So, in hindsight, it's easy to say all of that and what we don't know is what the future holds so we still know that there's, you know, significant, unfunded liabilities in the US related to the PBGC exposure and what does the future look like, we don't know; but we know it is a risk to existing plan sponsors, that they own by being in the qualified plan market.

Wayne Daniel: So, to the extent that a plan sponsor has exposure to an ERISA denominated liability within the plan, you know you're always subject to those potential, you know, future changes, likely increases in accounting cost to regulatory cost of holding that long-term liability. By, on the other side, the insurance companies themselves are also subject to regulatory regime which regulates the amount of capital and the solvency that the insurance company needs to have at every point in time. The insurance company needs to ensure that its assets exceed liabilities, and it needs to have capital on top of that, and that doesn't exist, you know, within the pension plan and so thinking about the regulatory changes on the insurance side, you know we've had the debate about SIFI or not SIFI post-financial crisis.

Laura Keller: That of course being systemically important financial [institution].

Wayne Daniel: Thank you and potentially having additional capital requirements for an insurer. Now that that maybe receding, we're seeing the regulators look more closely, perhaps, the capital charges relating to the asset classes that the insurer holds within their portfolio and perhaps also the longevity the C2 charge. So, the insurance company, as well, needs to ensure that, you know, if it’s appropriately setting aside funds for any additional capital that it may be required to hold for these liabilities.

Laura Keller: And there you seen any additional charges that has have happened—I know the Fed had some concern about CREs for example, high yields, sometimes has some questions around it and corporate debt; anything you are seeing there that you expect could change from the top of the house in the insurance company?

Wayne Daniel: I think, you know, the-- the starting point for an insurance company to quote on any pension risk transfer, is to understand the cash flow that they're taking on and then to consider what appropriate portfolio to deploy against those liabilities; once you do that, you then begin to start to look at the risk reward and the capital charges. So that's a continual evaluation within every insurance company.

Laura Keller: Okay.

Michael Devlin: On the plan sponsor side, I mean, one of the things we point out is that there will be mortality improvements -- and people are living longer. The good news is, if you’re a company, your people that worked there and retired are living long healthy lives (at least you hope so), and statistics in your plan show that it is happening. The bad news is its putting a lot of strain on the pension plan and the last mortality update, you know, could have dropped funding level by 3, 4 percent and maybe they're not curing certain things but certainly they're prolonging people’s lives and extending it. And then next, the baby boomers are retiring at 10,000 a day and they're healthier than the retirees at the pay status now, so,  there will be potential mortality changes that could impact your funding level, and with this rising PBGC variable rate, it could increase what you're paying to the PBGC, cause the PBGC variable rate is really putting a lot of stress on plan sponsors.

Laura Keller: Which seems to me, these put in even more in terms of transferring some of that risks wherever you can.

Michael Devlin: Exactly. I mean, Glenn pointed out before, you know, we're buying--the insurance carrier's buying an insurance company. I mean, a lot of these, a lot of clients that we've worked with-- the pension plan is almost as big as the company, if not bigger, you know-- someone else is-- the most common thing is, you're not selling widgets you're an insurance carrier that does sell widgets on the side.

Laura Keller: Right.

Glenn O’Brien: One of the things that Mike mentioned is really the quickly aging population -- so ten thousand a day people are retiring-- uhm, you know, we really look at this a lot because we're post financial crisis 10 years funded statuses are high a lot of plans have been frozen but one of the things that we've noticed is that the accumulation of the retiree population become bigger and bigger. So, as the retiree population has become 50-60 percent of the overall portfolio of liabilities the cash flow drain on the plan just continues to increase. So, as you think about hibernation, an earlier point, it's really hard to hibernate in a runoff insurance company, because -- your asset portfolio has to either more risk in it to offset that outflow or you need to put capital in frankly and fund it. So that concept of hibernation sort of mentally creates a picture that things will be okay if you just go to sleep. There is no sleeping in a hibernated pension fund. It will eventually come and ask you for money and it's one of things that we continue to notice post financial crisis and how people manage liabilities and the strain that the funds are gonna continue to be under.

Wayne Daniel: And I think that really highlights why, you know, I really believe that this long duration illiquid risk, the longevity risk -- the best place for that to reside is on the balance sheet of a well-diversified insurance company, because then you don't have the runoff challenge, the dwindling cash flow. You know it's very difficult to create an asset portfolio that's gonna exactly meet those cash flows.  But if that risk is transferred into, you know, a very diversified balance sheet, the insurance companies managing many hundreds of thousands to millions of liabilities and cash flows, it becomes a lot easier to manage overall.

Laura Keller: Right. And I think even from the perspective of American workers. We've been talking mostly pensions today but even 401(k)s, people are worried about the company being able to actually go forward and make those payments. So, in some ways almost seems that, you know, they would be more comfortable by having an insurance company manage those.

Glenn O’Brien: We get asked that question quite a bit and if you think about most corporate America are not really managing its credit profile the same that we would so if your liability, your pension benefit, is backed by, you know, a plan that is legally allowed to run underfunded and but nonetheless underfunded and if the company is managing its credit rating to a triple B which is just investment grade so you know, you could look at the insurance community who has much higher capital -- well we have a standard -- sponsors don't. So, we have a capital standard, a credit rating bias, we always have to have more assets than liabilities at all times -- we get that question a lot, but I think quickly people understand how our jurisdiction is built to really run out these liabilities versus sometimes the pension plan sponsor.

Laura Keller: Right and I think there are-- I mean in recent years I can think back to my days covering corporate credit some of the coal companies for example -- a big question -- and some of the retail companies even now -- will this company in bankruptcy have the ability to fund some of these liabilities? So, I think again, in that way, maybe people who have those pensions with these companies that they know might be in a little bit of trouble might be more, more-- getting the feedback and feeling happy that they can actually have this payment continue on by having it with an insurance company.

Glenn O’Brien: Yeah, we have certainly spoken a lot about-- and this is sort of a maturing of our market as well, where does the pension liability sit in the capital stack of a company in the credit profile. We've seen some relatively large high-profile bankruptcies where the pension plans has been actually super senior, where the bond holders have been remediated; equity investors have been wiped out, but the pension plan remains completely intact. So that's another sort of curing of the market as where is the pension liability in the capital stack and often, we see, would argue that it's at the top. So, it is part of that corporate credit landscape about how large is the liability and our ability to service that debt.

Laura Keller: Do you think it's still appropriate that both regulators and the average worker has concerns and questions about about the transfer being moved to an insurance company?

Wayne Daniel: Well, I think, you know, if I were a retiree, used to receiving a regular benefit from a plan and then I've got informed that would be changing as a result of a transaction that perhaps I had no knowledge about, I would have some questions. Is my benefit going to remain the same? Do I need to notify you [about] my tax withholding you know? What do I need to do, do I need to call a call center, or go online? You know, there is an immediate anxiety, but I think, with an appropriately planned communication program, hopefully we can allay most of those understandable fears and questions fairly quickly. And then, once people see that the benefit is being paid regularly, hopefully, they can enjoy the security that comes from being secured with an insurance company.

Laura Keller: Ok. How about new competitors? Are there any new insurance companies small or large or other firms that you are seeing coming to this space and maybe Mike that you're recommending come into this space.

Michael Devlin: Yeah after 2008, I think we’re down to six insurance carriers that were in the business and rightfully so-- some tough years, 2009, 10, and 11. The insurance carriers are not fast followers, they’re I think slow followers. They like to see a couple of people test the waters for them. Uhm, so were up to 15, 16 insurance carriers right now…

Laura Keller: New firms or firms that have gotten bigger

Michael Devlin: …No, in total. And it’s been quite a few new entrants that have come into the market place. But what we've noticed, kinda like on the 401(k) side is that everyone really used to be, I always say to clients that, when you had six insurance companies everybody's fighting over crumbs because there wasn't much out there, and these two companies and all the insurance carriers would quote on everything. Now that the market has really matured, and the inventories are all time high, we're seeing insurance carriers fall into we’re in the jumbo market, we're in the mid-size market, we're in the small market, we're in the micro market. So even though there are 16 insurance carriers, they are all specialized or focused in specific areas.  So, a lot of people are caught off guard when we're doing a, you know, $50-60 million transaction, and it's only two or three carriers bidding on it.  That was unheard of four or five years ago but that's the new market that we're in.

Wayne Daniel: Well I think given the volume of transactions that is being processed through the market, I mean, we're seeing a really peak activity in the market. Last year, there was $23 billion transferred from plans to insurers, and you know, this year, it's going to be $20 billion plus. That's just given the volume of activity; I think it would be very challenging for insurance company to quote on every single transaction.   Insurance companies definitely do, you know, try to select those transactions where they can believe they can have the most value and security and focus on those deals.

Laura Keller: So, certain specializations and certain kinds of insurance companies that want to have certain kinds of risks.

Glenn O’Brien: Yeah.

Michael Devlin: Yeah, absolutely. I mean, we have insurance carriers like a mix of deferred and in pay retirees. Some insurance carriers just want in-pays, you know pension risk transfers, so they won't be in the termination business because termination transactions, there's always going to be term vested and actives. Some people want 75% retirees, 25%, everybody's-- once again the inventory is so rich that you actually want to start to figure out what actually meets the way you look at the liability and the way you think of risk.

Laura Keller: And just one more thing I want to touch on before we kinda move on to other things, but in terms of how an insurance company can actually offer services that the pension fund can’t. We've talked a lot about questions or concerns that the retirees might have, but certain things that the insurance companies able to offer the pension, the pension firm itself could not?

Glenn O’Brien: I think, the structural, I don't know if I'm answering your questions or not; I think structurally we're designed to really, you know, really run out liabilities. We always have to have more assets than liabilities -- unlike a pension fund which can legitimately be underfunded for a long time. So I think that the security profile of an insurance company is measuredly different than a plan sponsor -- just given the different regimes and regulatory platform for insurance versus ERISA plan sponsors -- so that's not obvious to a participant that there are those enhancements, but they are there.

Glenn O’Brien: And then beyond that, its, you know, frankly, you know, the education around how to do different kinds of planning where I think certain pension plan sponsors may be really hesitant to help people understand, you know, their options related to different forms of benefit are those kinds of things. When we take those kind of liabilities over -- we price them, we’ve analyzed them and we just have the ability to communicate on things that maybe the sponsor didn’t communicate specifically around or maybe have the footprint in order to do that robust of a job at it so we have a really robust infrastructure in order to work with these people about their forms of benefit, if you will, for the deferred populations

Glenn O’Brien: And then frankly, you know, one of the things, it is sad to say, but supporting people in a joint survivor payout -- there is specialized service where if the primary beneficiary passes away, there's a huge support that we’ve  built to the beneficiary work through those issues and help provide some guidance about all the things they need to think through in that moment. So I think, you know, decades of experience on our side have pointed us in those directions.

Michael Devlin: I think there's a big difference too in the type of plans you are a part of. In the over $100 million marketplace, probably had a call center, a lot more access to people, and under a hundred-million-dollar marketplace, it could be a huge enhancement because you’re usually just calling someone from HR. Now you're calling somebody, and so there's really depends on what type of plan you were originally in we’ve seen some significant enhancements on some of the plans under $100 million

Laura Keller: Ok, and I'm wanted to close our conversation as we move on to the last chapter here, just with a little bit of a better understanding on where the market is and how it impacts all those pensions. It seems like, as the market is rising, obviously on the equity side, bonds are also doing well, but there could be some complacency here -- the thought that pensions are funded well, the markets are up, we're all good.  Anything that can counteract that at all? -

Glenn O’Brien: I think, you know, we don't know where the rate picture will go, we don’t make forecasts on rates, but I think it’s always helpful to acknowledge we are really long in the credit cycle.  So even if you think about 2008, that was really a liquidity crisis as mostly it has been written about. So, it’s been a while since we have a credit cycle, a true credit cycle and where are we in that picture and then we are topping out here potentially on equities. So, the complacency issue is something that we are worry and awful lot about a lot of people who are in the decision-making role now in pensions may not have been in those roles pre-2008 and haven't lived through the pain.

Laura Keller: Ah, the plan sponsors, you mean?

Glenn O’Brien: Sponsors, correct. And you know, we do worry about that. You know, there's a lot of analysis that’s given to sponsors around a one standard deviation credit event in the market and what does that look like. If you really think about a two standard or three standard deviation events in the market you really quickly get to the picture that you might not want to own as much as these liabilities as you currently have on balance sheet. So, those are the messages that we are trying to remind sponsors of.

Michael Devlin: I think that's on complacency too -- a lot of times we're reminding sponsors, once again, pointing out what Glenn was saying, about how long this person been in this position? Even if they came on in 2013, 2014, in the middle of it, a lot of people sometimes feel that they’ve got to this adequate or full funding based on, you know, the equity run we’ve been on but really, it’s been because they continue to pour cash into their plan. That’s why they are funded the idea they got their 93% funded, as, because of their savvy investments, typically is not true.  So, we do a lot of lookbacks.

Michael Devlin: We say let’s have a little bit of reminder that if we go back to 2008 when you were at the bottom, and what your underfunding was, you’ve probably put more in cash than what that underfunding was. And you're still underfunded.  This is why liabilities are so difficult to manage. You’ve got people living longer than expected, you have interest rate risk, longevity risk, market risk, regulatory risk. These things that I am talking about when you have a frozen pension plan, liability still grows. Everyone gets a year older, so even if you’re even getting a 6-7% return year in, year out, when you add in the holding cost you might just be breaking even.

Laura Keller: True. And of course, if there were some shocks to the economy, whether its trade wars, or something else, companies would obviously have a little bit more strain putting forward that cash.

Laura Keller: And thinking about that, and the bond market, obviously rates are rising but they’re still quite low. Which seems like a good environment to issue some of those bonds that are helping to pay those pension obligations. I just want to ask you a little but further Wayne, you know, do you think given the rate picture that we are in that we’ll continue to see more of those kinds of transactions?

Wayne Daniel: I think that is likely. I think that a number of companies have taken advantage of the conditions in the marketplace to issue debt and to really ensure that their pensions plans is well-funded and that should give them the advantage on choosing when to transact to de-risk. We don’t detect any, you know, rising complacency amongst plan sponsors that we survey.  I think there does seem to be, a very strong desire to continue to transact. And, where issuing corporate debt to enable a PRT transaction to occur, you know, that still may be part of the picture going forward.

Laura Keller: They’ll still do that, but still that’s an interesting concept to me as a former bond reporter, to have a bond that's issued because you’d rather not make the cash payments, you’d actually rather pay some interest and have investors, essentially, front that money. So maybe if we could just talk through that, just a little bit, Glenn.

Glenn O’Brien: Sure

Laura Keller: Just to see, you know, why companies are choosing to do that at this juncture.

Glenn O’Brien: Yeah, if you think about the pension liability, it varies in principal, unlike a bond. So, you have a fix maturity, it’s a 10-year bullet and you might have a very predictable set of cash flows, and the principal payment at the end of ten years is known. A pension liability actually varies in principal, so as rates decrease, your, your liability increases and now my funded deficit has grown and the principal, you know, that I owed to this plan has grown.

Glenn O’Brien: So, a lot of people have thought I’d really rather rotate out of a ERISA obligation which the principal can vary based on the prevailing market rate, interest rates, and fix [it] through a contractual bond obligation. That's point number 1. Point number two is under the rules if I did do a 10-year issuance and as the yield curve is flattening, a 20-year issuance, I get to, you know, really amortize the interest cost over 20 years.

Glenn O’Brien: Under the rules under a pension fund, you’re really supposed to amortizing that deficit over 7.  So now, we've always lived under pension relief, but should those rules actually hold steady, you're going to have to amortize that deficit over 7 years so, would you rather actually amortize over 20 or over seven? So there is a bit of an arbitrage that is available through the bond market, tax advantages aside, and all those kind of things that might be helpful for funding up the pension liability.