Intensifying competition in the U.S. pension risk transfer (PRT) market in recent years has seen more bidders taking an interest in plans where members have yet to take their pension – so called “deferred” lives.
In the past, many insurers were wary of the added complexity of setting policyholder behavior assumptions. These are the assumptions that capture how, unlike retirees or other beneficiaries already receiving a fixed amount, deferred pension participants will most likely have several elections to make regarding the timing and nature of their eventual pension income.
Given the uncertainty and the chance of misstating benefits in the valuation for a bid price, insurers have understandably feared cooking up a recipe for future trouble. But new evidence shows that the market appetite has changed. So what can insurers do to compete but avoid ending up with a potential lingering bad taste from doing such deals?
The first thing to recognize is that while the elections available to plan participants can be plan-specific, there are similar traits across many plans. The key therefore, as Willis Towers Watson has done in its work with several market players, is to identify which elections impact the price or could impact gains and losses in the future.
As a starting point, standard PRT valuation law does not generally place requirements on the other demographic assumptions used in pension pricing besides mortality. Instead, insurers and their actuaries need to turn to:
These two standards provide guidance on the types of assumptions that may be needed and also ways of selecting them that, for example, take into account concepts of financial economics as well as traditional actuarial practice. A pension actuary (either internal or external) can provide valuable guidance.
From this base, some information to feed into assumptions and modeling can usually be gathered to inform a bid such as:
Information that won’t typically be immediately available, but can normally be gathered from the Form 5500 plan filings to the U.S. Department of Labor, includes the assumptions used by the current or prior pension actuary.
Insurers will also need to make sure their models have the proper level of sophistication to accurately reflect deferred life policyholder behavior and allow them to test the impacts of differing retirement ages on reserves, which may require evaluating the respective merits of various software or building a customized model.
Adding to the complexity in setting deferred life assumptions is the more recent interest from some plan sponsors in advance commitments on pricing, where insurers need pricing dynamic enough to deal with deferred life changes from the commitment date to the closing date.
The above still leaves plenty of gaps in information. What is most valuable to bidding insurers, but isn’t usually available, is experience data. Insurers therefore may need to look at alternatives.
One option, albeit with some limitations, is to look at the in-pay census information from the plan. Limitations of this approach are that the current plan census may be incomplete, or it doesn’t make allowances for deaths and lump-sum choices. Nor will it reflect segments within the deferred population that may influence the timing and choice of benefit uptake, such as those with prior plans, location and union affiliation.
Therefore, another useful guide in the absence of experience data is to look at outside influences, such as the Social Security National Retirement Age (SSNRA) and plan provisions. The importance of plan provisions is that they can flag risks that may be overlooked. For example, there could be subsidies inherent in the early retirement or late retirement rules and, in the case of the latter, they may create a loss relative to the reserve being held. Equally, there may be subsidies with implications in plan options, such as lump sums and the selection of contingent annuities.
What these points should illustrate is that there is no escaping the fact that the valuation and pricing of pension plans with deferred lives is more complex than those without them. But the complexities are surmountable and can be better understood with good analytics.
PRT players with ambitions for a growing slice of the expanding market for plans with deferred lives will increasingly need to factor ways of addressing those complexities into their thinking.
Stan Roberts is an Associate Director in WTW's Insurance Consulting & Technology Life practice. He has extensive experience in all aspects of PRT deals, including helping insurance companies to enter the market, price transactions and handle post-deal activities.
