There have been more inquiries as to whether captives can be used to terminate or de-risk pensions plans in the United States, partly due to the current interest rate environment, according to Spring Consulting’s Karin Landry and Prabal Lakhanpal.
Captive Intelligence reported in July that the US Department of Labor had tentatively authorised an ERISA exemption for the New York-based Memorial Sloan Kettering Cancer Centre (MSKCC), concerning a pension risk transfer to its Vermont-domiciled captive.
Spring Consulting Group worked closely with MSKCC on the application to the DoL and in the latest episode of the Global Captive Podcast, Spring’s Karin Landry and Prabal Lakhanpal discuss pension risk transfer to captives more broadly, how they work and whether we might see more activity in this area.
Explaining how the captive approach came about in the case of MSKCC, Landry explained: “We did an RFP, went to market and what we found was the market was charging substantially more to take the risk on because they were uncomfortable with the liability, the shape of the risk.
“We looked at utilising the captive, and because it’s an ERISA benefit, just as any other ERISA benefit funded in a pure captive, you had to go through a prohibited transaction exemption process, similar to any other process you’d go through for life or disability, structured in a similar way, fronted with an A rated carrier, ceded to the captive, and reinsurance on the back end.”
MSKCC already owns a mature pure captive in Vermont, so a separate cell was formed to keep the pension risk separate.
Concerning the broader landscape and motivations for US pensions plans, Lakhanpal said it can be viewed as similar to other lines recently seen going into captives.
“The way I think about captives in the pension transaction is similar to all the other lines where captives have been an extremely efficient tool for risk mitigation and creating an alternate program structure,” Lakhanpal said. “There is two plays to it.
“One is with the idea of leveraging a captive to take back control of underwriting risk and how you’re pricing for that risk. And then there’s the second aspect, which is having a better control on how investments are structured.
“A lot of pension plans in the US leverage illiquid investments as a core component of their investment portfolios.
“As you think about illiquid investments, a lot of pension plans are overfunded right now. To undertake a pension termination transaction, illiquid investments will need to be liquidated.
“Doing so prior to maturity can be extremely inefficient and there’s a massive haircut attached to them.
“So, for organisations that are overfunded, are looking for a way to terminate the plan and have a fair amount of illiquid investments, leveraging a captive provides them a phenomenal alternative to going through with the commercial market.”
Lakhanpal added that there is a lot more interest compared to five years ago in exploring how a captive strategy could be deployed to support a pension plan termination or de-risking strategy.
“A lot of folks have been reaching out, trying to better understand how captives can help play a role in a pension transaction,” Lakhanpal added.
“It’s important to note that the exact programme structure, the exact policy structure, the exact captive structure will morph and evolve based on the fact patterns of each individual deal rather than copy paste an existing transaction.
“There’s a lot of nuance there and I think it’s important to work through all of those pieces, but certainly given how many pension plans are overfunded, the amount of folks out there that are sitting with actives on their pension plans, the amount of folks out there who have illiquid investments on their pension plans.
“I think we certainly are seeing a lot more interest than we did maybe five years ago. With the current interest rate environment, a lot of those pension plans are getting more aggressively overfunded than they were two years ago when interest rates were low. And I think that’s just starting to create a cycle of folks looking for potential ways to leverage a captive.”
Listen to the full episode with Spring Consulting’s Karin Landry and Prabal Lakhanpal here, or on any podcast app. Just search for ‘Global Captive Podcast’.