De-risking Opportunities for Multiemployer Pension Plans

Financial risks for Multiemployer Defined Benefit (DB) plans have increased in the last 20 years as plans have become more mature and investment markets have been volatile. De-risking strategies aim to reduce the financial risks associated with DB plans and can become more favorable as bond market yields rise. Two key strategies, annuity purchases and cashflow matching, are significantly influenced by market bond yields.

• Annuity Purchase: In an annuity purchase, a DB plan transfers all or a portion of its obligation to pay benefits to an insurance company. The plan enters into a contract with an insurer, who then becomes responsible for making future pension payments to the selected group of plan participants.
• Cashflow Matching: This strategy involves investing the plan’s assets in a portfolio of bonds that generate cash flows that closely match the DB plan’s future benefit payments.

Impact of Higher Bond Yields:
Higher market bond yields can make both de-risking strategies more attractive.

• Annuity Purchase: When bond yields are higher, insurance companies can offer annuity purchase contracts at a lower cost to DB plans. This is because insurers invest the assets received through the annuity buyout process in higher-yielding bonds to fund the future benefit payments. As a result, DB plans may find it more affordable to transfer liabilities through an annuity purchase.
• Cashflow Matching: Higher bond yields improve the feasibility of cashflow matching. With higher yields, it becomes easier to construct a bond portfolio that can generate the necessary cash flows to meet the plan’s future benefit payments. This can help stabilize the plan’s funding status and help reduce its exposure to market volatility.

These de-risking strategies can impact a plan’s unfunded liability.  In general, when market bond yields are lower than the plan’s long-term rate of return assumption, annuity purchase or cashflow matching strategies can increase a plan’s unfunded actuarial liability.  Therefore, it is important to understand the relationship between bond market yields and a plan’s rate of return assumption when evaluating these strategies.

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