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The Use of Captives To Fund Pension Risk

IRA Pension Retirement
June 12, 2015

In the June 2015 issue of Risk & InsuranceMatthew Brodsky provided a concise history of the use of captives to fund pension risk. The story begins in 2003 when Towers Watson was asked to explore the feasibility of managing pension obligations in a captive. But it was not until 2011 when Coca-Cola followed the original pioneer that the idea of using captives in this manner really began to be taken seriously.

There are three options for consideration when using a captive to mitigate the risk associated with a defined benefit pension plan. The first is known as a buyout option where the company transfers the full responsibility for the pension obligation to an insurer. The second option is known as a buy-in. In this case, the company transfers the obligation of paying benefits to the insurer on a part-time partial basis. The third option is a longevity swap, where the company hedges its risk against the plan assets not being sufficient to last for the lifetime of the participants, either with an insurer or through the capital markets.

Because this use of a captive takes significant resources and time, there aren’t many pension captives in existence. A presentation at the 2015 World Captive Forum counted 10 worldwide with Ireland and the United Kingdom with 3 each. These captives are estimated to have annual premiums of $3.3 billion.

However, growth in the captive market may begin to accelerate, especially in the use of longevity captives. In July 2014, BT Pension Scheme entered into a longevity swap with Prudential Insurance Company of America using its captive in Guernsey. The notational risk hedged in the transaction was $24.2 billion.

Astute readers will recognize that all of the pension captives mentioned in this article are offshore. The question arises of when we may see similar transactions in the United States. The short answer is not any time soon. Regulatory bodies that would need to be involved here include the Department of Labor (DOL) and the Pension Benefit Guaranty Corporation. Any Employee Retirement Income Security Act-based benefit needs a special DOL exemption to be underwritten in a captive. These impediments likely mean it will be a while before pension captives become a fixture in US domiciles.

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