By 2013, the funded status of BMS's closed pension had improved significantly. Investment returns on company contributions made during the depths of the crisis, largely allocated to equities, generated strong returns. Still, the treasury team was concerned about the ongoing risks the plan presented. For one thing, they knew that if equity markets or interest rates turned, the plan's funded status could fall precipitously. Likewise, a change in participant longevity expectations might impact funded status. And even a closed plan exposes the company to ongoing regulatory and compliance risks.

Moreover, administration of the plan on behalf of its 25,000 participants required a significant commitment of resources from the BMS benefits team, while managing its assets and strategically planning the company's cash contributions to meet future obligations required treasury team resources. Just letting the plan wind down naturally would mean exposing the company to significant risks while diverting company resources for the next 50 years or so.

For all those reasons, in 2013, the team engaged with insurers in the nascent U.S. pension risk-transfer market. The team educated themselves on all the potential ways to de-risk and began taking steps to prepare the company to act quickly when market opportunities arose. The goal was to get all the "no-regrets actions"—those that did not commit BMS, financially or otherwise, to a transaction—out of the way while waiting for the plan's funded status to improve further. For example, BMS invested resources in ensuring that participant records were accurate and organized, to ensure that plan data would support an efficient transaction at the best price.

The first de-risking opportunity came in 2014, when the company negotiated a $1.5 billion sale of retiree obligations to a large insurance company, reducing the plan's liabilities to about $4 billion—but from there, de-risking became more challenging. Most of the plan's remaining participants were active and deferred vested employees. "Most insurers tend to prefer buying obligations to retirees," Galik explains, "because the annuity's longevity risks offset the mortality risk in their life insurance business. The costs to transfer active and deferred vested participants was less-defined and expected to be significantly more expensive than retiree liabilities."

The market for pension risk transfer solutions continued to develop over the next few years, especially for active and deferred vested participants, so BMS treasury continued to prepare for the full termination of its pension if and when conditions became right for a deal. Then they faced another significant challenge: locking in transaction economics and insurer capacity for terminated vested and active participants as soon as the timing was right.

"Most often, these de-risking transactions are undertaken by distressed companies with underfunded plans," says Scott Grisin, assistant treasurer for BMS. "The company will make a large payment into the plan at closing to make the transaction happen. BMS wasn't in that situation, and we didn't want to enter a transaction if it wasn't right for our participants, or if the economics weren't attractive for the company. We did not want to pay more than we had to just to terminate the plan."

Grisin and his team leveraged the experience gained from prior transactions to improve the plan's transaction-readiness and attractiveness to insurers. "We simplified our investment lineup," he says. "We exited, at opportunistic times, certain asset classes that we knew would be burdensome in a transaction, such as hedge funds and other less-liquid assets. We divested our private equity portfolio and steadily reduced our ratio of equity to fixed income as funded status improved. We then looked for specific assets that insurers would want to hold, because there's an asset-in-kind element to these transactions. You can receive a financial benefit for giving the insurer the assets instead of cash."

Despite all this up-front effort, Grisin says, "there are large uncertainties in a de-risking transaction." The value of assets and liabilities—and, therefore, transaction pricing and deal economics—fluctuate with the markets. In addition, participants in a plan that is terminating have the opportunity to choose a lump-sum distribution prior to closing, instead of having their benefit transfer to the insurer. Until the deal is complete, the size and demographics of the population that will choose each option remains a question mark. "You have a wide range of potential economic outcomes, and you don't know which one will come to pass until the day of closing," Grisin says.

These uncertainties are especially challenging because regulatory consideration of a prospective de-risking transaction means the deal cannot be completed quickly. "Pension benefits are covered under ERISA [the Employee Retirement Income Security Act]," Grisin explains. "De-risking transactions are subject to oversight by multiple government organizations, from the Department of Labor to the IRS. A company engaging in a de-risking transaction is looking at lengthy prescribed notification and review periods."

Due to these regulatory steps and participant communications, BMS did not want to start the process of terminating its pension, then stop if market conditions changed. "We committed early on that once we took the first steps, we would see the transaction through to completion," Grisin says. "But we faced the possibility of committing to a transaction based on economics that look good today, but that might not be the same a year from now. We needed to protect the economics to ensure the transaction would remain viable, with no additional cash contributions, despite the regulatory timeline."

In the fall of 2018, market conditions and insurer pricing converged briefly to create an opportunity for a transaction, and the company was ready. To ensure the final deal would contain no surprises, BMS treasury needed to effectively mitigate the risk of market movement between the date it signed the agreement with an insurer and the closing date. "The de-risking agreement is similar in some ways to an M&A deal," Grisin explains. "You sign an intent to close at a future date, at market conditions that will exist at that time. For a pension plan, the pricing might be based on participant demographics and various market products or indices on the closing date. We ensured the contracted pricing parameters were hedge-able, and then worked with one of our asset managers to design a custom hedge portfolio that mirrored the terms of the agreement."

Other factors couldn't be hedged, such as the uncertainty around which participants would elect the lump-sum payout rather than continuing in the plan after the transfer. "Six months into this nine-month transaction, we were going to be making a multi-billion-dollar lump-sum payment to those who elected to take the lump sum. But we didn't know the amount, and we didn't know the final demographics that would remain as the basis for the insurer transaction," Grisin says.

BMS treasury had to be sure that they raised the right amount of cash to pay the lump sums, while maintaining their hedge portfolio against the pricing terms as the final demographics of the insurer transaction came into focus.  To manage the uncertainty, Grisin and his team developed a custom model for expected participant behavior and then kept a close eye on participants' actual election decisions during the 45-day election window. "Our plan administrator fed that information to the team in real time," he says. "As we were unwinding assets, we were also making adjustments to our hedge portfolio based on the actual participant behavior we were seeing each week."

The company committed to the transaction in November 2018, hedged against market shifts and participant behavior, and closed the deal in August 2019. During that time, interest rates fell considerably. "If we hadn't been so proactive with the hedges, we would have been watching the economic value of the transaction erode on us," Galik says. "We avoided several hundred million dollars of value deterioration because of the way the markets moved during that period."

Still, he stresses, the deal was not a losing proposition for the insurer on the other end. While BMS eliminated the risks associated with the closed pension plan, the insurer ended up with a natural hedge for its life insurance liabilities. "The transaction was truly a win-win," Galik concludes. "It was groundbreaking. It was the largest non-stressed plan termination ever; it was the largest transfer of active and deferred vested participants ever; and it was the first time this type of transaction had locked in pricing of the deal nine months in advance. We ended up with a cash surplus in our account that we will use to fund our employee 401(k) for years to come."

See also:

• Security and Business Continuity for SWIFT Connections
• Collaborative Risk Analysis Find Big Benefits in RPA