PS: Why would a plan sponsor choose a buy-in or buy-out?
Proctor: A buy-out is used when the plan sponsor is either terminating the plan, and has to buy annuities to complete the plan termination, or wants to completely settle a portion of the liability. A buy-in is more of a steppingstone to get to a buy-out; the plan sponsor may want to transfer most of the risk now but can't fully settle the liability yet.
One scenario where a buy-in may be helpful is for a plan sponsor that has borrowed money to fully fund the plan. A buy-in lets the plan sponsor lock in the annuity cost now and worry about terminating the plan later when the IRS [Internal Revenue Service] and PBGC approvals are received. This eliminates the risk of having to contribute or borrow more money 12 to 18 months later when unfavorable investment performance may have eroded the funded status of the plan.
It's also fairly common that companies have a large pension loss on their balance sheet, and it may be that completely settling the liability now would require that they recognize the loss on their income statement. A buy-in lets them secure the liability and the risks, transferring those to the insurance company, but leaving the pension liability unsettled until a better time in the future.
Menin: A buy-in is also an opportunity to capitalize on interest rate spikes. The plan sponsor may like where current interest rates are and want to lock that in, then complete the buy-out process later. The buy-in contract gives the plan sponsor more flexibility and time—something we try to emphasize with all our pension risk transfer products.
In the old days, you terminated the plan or you kept the plan. Today, a plan sponsor may desire to dollar-cost average into the interest rates applicable to a buy-out annuity contract. In other words, a plan sponsor may say, "I want to de-risk my pension plan, but I don’t want to do it all at once—I'd like to do it over a longer time frame, perhaps in segments."
Another benefit of a buy-in can be removal of longevity risk from the plan. Longevity risk has been in the news a lot lately. A plan sponsor can use a buy-in to transfer the longevity risk to Pacific Life without having to worry about full plan termination. Thus, a buy-in can be used for a longer transfer of risk without necessarily serving as a short-term bridge to a buy-out.
PS: If the endgame for the plan sponsor is a buy-out—as you said, plan termination—how does a buy-in fit into that strategy?
Menin: A buy-in contract lets the plan sponsor decide when to settle the liability and notify participants. Because a buy-in remains a plan asset, the sponsor can put a buy-in contract in place, then complete the regulatory paperwork required in a plan termination. The more plan sponsors seek flexibility in the pension risk transfer market, the more they’ll see a buy-in as a creative solution.
PS: Continuing with flexibility, if you decide to pursue a buy-out strategy, how do you exit a buy-in contract, and are there additional fees?
Proctor: For Pacific Secured Buy-In, all the plan sponsor needs to do is provide a letter requesting the conversion to a buy-out. There are no additional charges, administrative costs or any fees. At that point, the liability and assets are completely transferred to Pacific Life and removed from the plan and the company’s balance sheet. This may trigger the settlement accounting, but the plan sponsor controls when a conversion and settlement occur.
It is this control and flexibility that makes a buy-in a valuable tool for U.S.-based plan sponsors as they develop their strategy to manage their pension plan risks.
The author of this article is not an employee or affiliated with Pacific Life. Pacific Life is not affiliated with PLANSPONSOR, PLANADVISER or Ernst & Young. This article was reprinted with the permission of PLANSPONSOR. Copyright © 2014 by PLANSPONSOR.
Pacific Secured Buy-In is a group annuity contract.
This material is not intended to be used, nor can it be used by any taxpayer, for the purpose of avoiding U.S. federal, state, or local tax penalties. This material is written to support the promotion or marketing of the transaction(s) or matter(s) addressed by this material. Pacific Life, its distributors, and respective representatives do not provide tax, accounting, or legal advice. Any taxpayer should seek advice based on the taxpayer's particular circumstances from an independent tax advisor or attorney.
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