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Flexible Analysis Helps a Sponsor Make Optimal Risk-Transfer Decisions

Cowden generally offers consulting services based on the client’s needs and short- and long-term goals. For most of our single employer defined benefit pension plan clients, a primary goal is to eliminate long-term risks when the cost to transfer or eliminate risk is reasonable. Some sponsors are willing and able to settle or mitigate risks all at once, but many others chose a longer-term strategic approach. An approach like this may be accomplished through any combination of matching investments to plan liabilities, offering lump sum benefits to terminated vested or retired participants, or transferring benefit obligations to an insurer via a group-annuity contract. Strategy aligns resources with efficient use when resources are not unlimited.

Analysis helping sponsors make the best decisions can be complex for various reasons. Markets are ever-changing, and some assumptions remain steady for a fixed period while others fluctuate daily with financial markets. Also, fast changing circumstances can create a hurdle when approval is needed from several groups of individuals or decision-making boards.

To help mitigate this in a recent case, Cowden provided analysis that would weather changes in market conditions during the fall of 2022, a time when assets and market forces most useful in mitigating plan risk were most volatile. Rather than provide specific analysis based on the current market or a simple potential changing variable or two, Cowden provided a different solution. That solution was an array of options that could meet various objectives in varying conditions instead of locking decision makers into choosing a specific strategy only to find that the market changed too much for the strategy to applicable by the time action would be taken.

Once stakeholders had the chance to review various objectives, a delegated group could review the market conditions and lock in the best decision instead of restarting the analysis process.

Fast-Changing Markets Favor the Prepared Plan Sponsor

In this case, a client is well-experienced in strategic risk transfer events, undertaking several rounds of temporary lump sum offerings. These offerings allowed the sponsor to reduce the plan’s participant count, using a bottom-up strategy where cashing out participants with lower benefit obligations provides a more favorable reduction in plan expenses. Eventually, lump sum offerings become tired in that remaining participants show little interest, and other risk-managing efforts will yield better results.

For example, remaining participants can be transferred in a group annuity purchase where those participants will continue to receive the annuity form of benefit that they prefer. This seems simple, but until mid-2022, the relative cost to settle benefits via a group annuity was high compared to budgeting for expected future contributions. The comparative basis is important, as some sponsors will choose balance sheet liabilities for comparison, but balance sheet liabilities may not be an accurate metric for sponsors who are more interested in managing the expected cash cost of their plans. While lump sum and annuity settlements will look relatively affordable compared to balance sheet liabilities, when the equity market outlooks are positive or status quo and fixed asset rates are very low, the expected increase in future cash costs can be very stiff.

In mid-2022, markets suddenly began to change and drastic increases in fixed asset returns reduced the relative cash cost of settling risk to the point that some groups with smaller benefits could be settled without any increase in expected future cash contributions. Cowden notified clients of this opportunity, and in this case study, identified that the sponsor and stakeholders would not be able to review and approve specific options as fast as the market was changing. This could lead to a frustrating merry-go-round of presenting options and informing stakeholders that before they could be implemented, the market changed. When markets are favorable, an opportunity could be missed, and when changes are unfavorable in the short term, objectives may not be met. In short, relative savings could be missed, or poor execution could lead to unexpected increases in costs.

By providing analysis for an array of various groups of participants based on relative changes in expected asset returns vs. fixed asset yields, the odds of poor execution were drastically reduced. In late 2022, the value of this flexibility was proven when initial strategy conclusions were made, and by the time the remainder of the stakeholders convened one week later, staying the course with the initial decision would have significantly increased the cash contribution outlook.

Instead of declining to make a move, the client was instead able to modify the group size to be slightly smaller, take advantage of the still-favorable markets and transfer a significant portion of the remaining retired participant group. All without increasing expected cash contributions in future years.