Illiquidity in defined benefit plans 

Pension plans should ensure they have sufficient liquidity to meet their obligations. A liquidity budget may help them manage the balance between investing in illiquid assets for potentially higher returns and maintaining enough liquid assets to cover short-term cash flow needs, such as paying out benefits to retirees as well as satisfying collateral or capital calls. Plan sponsors often work with investment advisors to assess their specific circumstances and establish an appropriate liquidity profile for their DB plan. Once developed, a pacing analysis can help plan sponsors implement or maintain private asset investment programs – diversifying across strategies, regions, and vintage years while incorporating the projected liquidity needs and shifting payout profile of the plan.

However, there are times when liquidity needs shift dramatically. With the rapid increase in funded position in recent years, some plan sponsors are now looking to increase liquidity to facilitate pension risk transfer or plan termination activity.

We examine five solutions for potentially generating increased liquidity by transferring the illiquid assets to a:

Theoretically, insurers have a long investment time horizon and would be natural holders of long-term private assets, so could be willing to take private market positions as payment for annuity purchases.    

Anecdotally, this has not been viable in practice except in very rare circumstances. Insurers can be highly selective about the assets they accept as part of a transaction, and very cognizant of maintaining their own target investment strategy to align with regulatory requirements and considerations. Mercer surveyed¹ 17 insurers in the pension risk transfer market (approximately 75% of the insurer universe in this market) to better understand their appetite for AIK transactions.

All 17 insurers were willing to accept liquid AIK. However, there were some nuances, even among liquid assets.² Illiquid assets presented additional hurdles. None of the surveyed insurers responded that theywould ‘usually accept’ any illiquid asset class. However, there was interest in investment-grade private debt, which most insurers said they ‘may accept’ or ‘rarely accept’. Unsurprisingly, caps were common here too, with a median cap of 5% on investment-grade private debt. By contrast, the majority of insurers said they ‘would not accept’ any type of private equity (fund-of-funds or direct), private real estate (open-end or closed) or hedge funds.

Of those that are willing or have accepted illiquid AIK in the past, most responded that they would need access to data rooms and to run due diligence and legal reviews to move forward, with 2-3 weeks required for their review. However, that timeframe was based on all data being available. Oftentimes, this data requires authorization from the GP or borrower, subject to executed Non-Disclosure Agreements (NDAs), which could significantly extend the total timeframe (approximately 1-3 months). Because of these considerations, illiquid asset transfers are only likely to be worthwhile in the context of very large transactions.

_{¹All responses are sourced from the Mercer Asset-In-Kind PRT Insurer Survey obtained June 10, 2024 obtained on June 10, 2024. Responses were provided by participating insurers. It is important to note that they did not receive any form of compensation. It is important to recognize that survey results are subject to inherent limitations and uncertainties. The survey results may not capture all relevant factors or market conditions. These results should not be construed as personalized investment advice.} 

_{²Not all insurers expressed willingness to accept public equity, non-US bonds, high-yield bonds, or securitized debt (ABS, MBS, CMBS) – as clearly the market favors cash or US government and investment-grade corporate debt, closely matched to the liability profile, to fund risk transfer activity. Insurers who would accept these less desirable liquid assets generally had caps on the amount they would accept. The median cap on equity was around 2% while non-US bonds and securitized were typically capped at around 10%,}

Selling an LP stake in a private equity fund to another LP is the most common and long-standing means of potentially achieving liquidity in a private markets investment before the fund itself makes its final distribution. Secondary market pricing for illiquid assets is more subjective and less standardized than for publicly traded securities, due to the lack of transparent pricing mechanisms. Therefore, it's crucial that sellers and buyers conduct thorough due diligence. Professional intermediaries, such as brokers or investment banks, may also be involved in facilitating these transactions and providing guidance on pricing.

Non-performing venture funds tend to trade at the steepest discount to NAV, while performing buyout funds may see smaller discounts on a relative basis. It’s worth noting that private assets may still achieve a higher return potential than their public counterparts over the experienced holding period, even after reflecting a discount to NAV when sold in the secondary market.

 

^{Source: Source: https://www.jefferies.com/wp-content/uploads/sites/4/2025/02/Jefferies-Global-Secondary-Market-Review-January-2025.pdf}

 

 

In some cases, a DB plan sponsor may have another asset pool, such as a foundation, that desires to buy or trade liquid assets for the private fund stake in the DB plan. In general, transferring plan assets between related entities would be considered self-dealing and be a prohibited transaction under ERISA. However, exemptions can be requested from the Department of Labor (DOL). In principle, a sponsor purchasing illiquid assets from the plan or transferring those assets from the plan to another pool in exchange for liquid assets could argue that participants are better off than if a secondary sale had taken place, which could support the argument for a prohibited transaction exemption. Similarly, the receiving pool may be able to gain diversified private asset exposure while mitigating any J-curve impact. However, while the DOL has approved exemptions in some cases, the process typically involves considerable time and expense with no guarantee of success. Where the DOL has granted exemptions in similar situations, sponsors generally had to engage an independent fiduciary to represent the interest of the plan and its participants in evaluating the transaction and determining the sale price. Plan sponsors interested in this route should seek advice from ERISA counsel.

Additionally, tax considerations will need to be evaluated, and it may be prudent to seek tax advice. Transfers from the plan to another nontaxable entity, such as an endowment or foundation, may require IRS approval to maintain tax-exempt status. Transfers to a taxable entity, such as the corporate balance sheet, may have material tax consequences.

In a plan termination setting, one option is to extend the time horizon for generating liquidity by transferring the illiquid assets to a QRP. The sponsor may be able to let the illiquid assets distribute naturally or take additional time to evaluate secondary market pricing. We believe this approach is most effective if the QRP is another DB plan, as they are often able to hold illiquid assets over a longer period. This unfortunately limits its usefulness, as many sponsors terminating overfunded DB plans look to transfer the surplus to a defined contribution QRP. In a DC QRP, the assets should be allocated to participant accounts by the end of the seven-year period, with at least a ‘ratable’ (1/7^th in year one, 1/6^th in year 2, etc.) portion allocated each year. This requires a level of emerging liquidity which may not be feasible.  

In a DB QRP, sponsors should also consider the post-transfer asset allocation. Some level of overconcentration to illiquid assets in the QRP is likely manageable given that liquidity needs are likely to be low at the outset, but a QRP comprised substantially of private assets could pose liquidity and risk-management challenges.

Captive insurance companies are used by organizations to reinsure a variety of risks, including healthcare and other employee benefits. In January 2025, a large plan sponsor received a prohibited transaction exemption from the DOL to use their captive to reinsure their DB plan. To our knowledge, this is a first-of-its-kind transaction. We think it may be a trail-blazing deal that paves the way for other plans looking for an alternative pension risk transfer solution.

A potential advantage of the captive approach is the avoidance of sales of illiquid assets in the context of a pension risk transfer under the standard approach of transacting with an insurance carrier. This is because the captive’s investments are governed by the state in which the captive is domiciled. In the United States, Vermont appears to be a popular state to domicile a captive³ (this is where the aforementioned plan sponsor’s captive is located). Vermont’s captive insurance regulations allow for significant illiquid holdings to be maintained in the captive’s investment portfolio. Other states that allow for captive insurers have similar rules regarding illiquid investments. For the plan sponsor who received approval, illiquid assets constituted over 50% of the portfolio. By using the captive strategy, the sponsor would be able to move these assets seamlessly, and without any forced sale haircut, to their captive.

_{3 Source: https://www.vermontcaptive.com/wp-content/uploads/2025/02/OurNumbersSpeakForThemselves_0225.pdf}    

Many pension plan sponsors find themselves wanting to exit their plans but feel they cannot act because of their illiquid holdings. While certainly an impediment, we’ve outlined in this article, and summarized below, several viable solutions to address the problem. The key is to begin planning early, as several options require DOL approval or prolonged underwriting periods.

Contact us for further insights into pension risk transfers and investing in illiquid markets. Our experienced pension specialists bring extensive actuarial and investment knowledge, supported by our annuity placement and investment consulting and research teams, to help you spot high-quality opportunities and navigate the complexities of these decisions.

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