New tax law could increase pension risk transfers

Pension risk transfers are poised to pick up this year as employers race to meet a tangential deadline imposed by the new tax law.

A pension risk transfer allows employers to offload the risk associated with their defined-benefit plans to an insurance company. Employers buy a group annuity contract for all or a portion of its pensioners, and insurers take over the liabilities.

Such transactions have risen in popularity over the past five years, as pension plans are becoming more difficult for employers to manage and costs associated with the plans have soared.

Now, tax reform offers yet another incentive for employers to consider doing one this year. A change in the corporate tax rate will make funding pension plans sooner more appealing, which many try to do before completing a risk transfer anyway.

The Republican tax measure, signed into law in December, lowers the corporate tax rate to 21% from 35%. Many employers have until Sept. 15 (for those with a calendar-year tax year) to make a pension contribution and have that contribution be tax deductible at the 35% tax rate, said Jared Dickow, a consultant in the financial strategy group at Mercer. If an employer were to wait longer, their contribution would be deductible at the lower 21% rate.

“Tax reform is the straw that helps plan sponsors” decide to do a risk transfer, Mr. Dickow said. “There’s nothing like a deadline in the sand for plan sponsors to move quickly. We’re certainly seeing that short window of opportunity this year.”

(More: Tax reform: 7 essential strategies for financial advisers)

Mr. Dickow expects between $25 billion and $30 billion of pension risk transfers to be completed in 2018, up from roughly $23 billion last year.

Those figures are up substantially from just a few years ago — in 2013, that figure was just shy of $4 billion, according to the LIMRA Secure Retirement Institute, which tracks insurance data.

“I think the rate differential is very important to funding up the [pension] plan,” said Jan Jacobson, senior counsel of retirement policy at the American Benefits Council. “It creates additional funding, and the additional funding makes de-risking easier to do.”

Pension risk transfers have generally become more popular for employers for several reasons. For one, it has become more expensive to maintain pensions. Employers have to make annual payments to the Pension Benefit Guaranty Corp., a federal agency, to insure against their future inability to pay plan participants. Employers pay both a flat rate and variable rate, which have respectively doubled and tripled since 2013.

The flat rate corresponds to the number of plan participants, and the variable rate to the amount a plan is underfunded. Corporate pension plans were 84% funded on average at the end of 2017, according to Milliman, a consulting firm.

In addition, increasing longevity has caused plan sponsors to make monthly payments to pensioners for longer periods of time. Low interest rates have also hurt investment returns.

The number of pension plans peaked in 1983, at 175,000, and the number has steadily decreased to below 45,000 today, according to Department of Labor figures. At the same time, defined-contribution plans have grown in popularity, since employees shoulder much of the economic risk.