A growing number of plan sponsors have purchased annuities from insurance companies to remove pension plan liability from their balance sheets. Historically, an annuity purchase was viewed as the final step in a plan termination. However, in the last decade, the prevalence of annuity purchases as part of a partial de-risking strategy has increased significantly. Regardless of why plan sponsors are purchasing annuities, a multitude of factors — including the mode of premium payment — can affect the final price of annuities.
Cash is still the most common way to buy annuities, but recently many plan sponsors have realized savings by purchasing annuities with assets-in-kind (AIK). AIK allows plan sponsors to transfer physical bonds from the pension trust to the insurer in lieu of cash to satisfy all or a portion of the annuity purchase premium. Traditionally, AIK has been reserved for very large deals ($500 million and up), but continued market development has made AIK more widely accessible.
Continue reading the article below for more information on asset-in-kind transfers.
Why Transact with AIK?
Plan sponsors looking to de-risk likely have allocated a large portion of plan assets to investment-grade corporate bonds that closely match the duration of the plan’s liabilities. These types of bonds are generally similar to the assets insurers would choose to buy after receiving a cash premium, so using bonds rather than cash can create efficiencies.
AIK can create both explicit and implicit premium savings. Explicit premium savings occur when insurers charge a lower premium for the same liability when the premium is paid with AIK instead of cash. These explicit discounts are commonly offered to plan sponsors executing very large transactions or holding highly attractive asset pools containing off-the-run bonds insurers would otherwise have difficulty accessing.
Even if explicit discounts are not offered by insurers, plan sponsors can still realize transaction cost savings by transacting with AIK. Bonds transferred to insurers to satisfy premiums are typically valued at the midpoint of the bid-ask spread. This methodology creates value for plan sponsors and insurers alike. Historically, before transferring cash to insurers, plan sponsors had to first liquidate their bond holdings at the bid value. Then, after receiving the cash premium payment, insurers would purchase bonds at the ask price. Using AIK to eliminate these transaction costs can result in 20–50bps of savings for the plan relative to an all-cash transaction.
AIK can create both explicit and implicit premium savings.
How Should Plan Sponsors Transact with AIK?
Planning is critical to successfully executing an AIK transaction. Plan sponsors interested in AIK should alert their annuity consultant at the project outset so a listing of bonds held by the trust can be included with the request for proposal sent to insurers. Interested insurers then provide feedback on the bond holdings, which will be consolidated into a single view across all insurers — allowing the plan to adjust or liquidate assets as necessary.
A “dry-run” valuation should be completed in advance of the actual transaction date to ensure all parties agree on valuation methodologies when it’s time to transfer the assets.
Is AIK a Good Fit?
There are definite advantages to AIK, but it is not a fit for every plan. The size of the transaction, the transaction type and the type of fixed income investments held by the plan all affect the viability of transacting with AIK. See the graphic below to determine the scenarios best suited to AIK.
Plan sponsors contemplating an annuity purchase should consider working with their annuity consultant and investment manager(s) to optimize the plan’s fixed income holdings for potential AIK value prior to proceeding with a transaction.
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