Companies that sponsor defined-benefit plans areconfronted with a conundrum—whether to de-risk their pensionliabilities by transferring them to an insurance company ormaintain the liabilities in the hope interest rates will soonrise.

What's a pension sponsor to do? The answer is not an easy one,and at this juncture sponsors seem to be falling into threedifferent camps. Some are hanging tight waiting for interest ratesto rise and their funding status to improve. Others are not makingsignificant changes now, but are committing to implementingde-risking strategies as interest rates and their funding statusperk up. For the third, much smaller camp—like General Motors and Verizon—de-risking is the name of the game.

These varying decisions depend in large part on one'sexpectations of interest rates rising, and when this might actuallyoccur. If hindsight is a good predictor, the likelihood iscertainly not in 2013.

“Some sponsors feel that rates can only go up and they arewilling to wait until that day comes, while others think they maystay at current levels for quite some time, and therefore arewilling to throw in the towel and de-risk their obligations,” saysRichard McEvoy, leader of the financial strategy group at Mercer. “It's a mixed bag.”

This uncertainty is understandable, as many pension plansponsors enter 2013 with significant increases in their pensionfunding deficits, requiring potential balance sheet adjustments andhigher P&L expenses. Mercer put the aggregate funded ratio forS&P 1500 companies with plans at 72% at the end of November andestimated their aggregate shortfall was $607 billion. To addressthese problems, General Motors and Verizon transferred theirpension liabilities to Prudential Insurance Co. this year vialandmark annuity purchases.

The rationale behind thesedecisions is compelling: By de-risking, sponsors trade potentiallyvolatile investment activity for a predictable expense—the paymentto insurance companies—although that payment carries a premium.“Sponsors can expect roughly a 20% to 30% increase in their pensionexpenses on their income statements, which is a very broadestimate,” says McEvoy, pictured at left.

Nevertheless, for some companies the premium may be worth it. Inaddition to a reduction of funded status volatility frommark-to-market gains and losses, they can pare plan expensesrelated to PBGC premiums, administration and investment costs.

Both Mercer and Vanguard believe the trend of de-risking willaccelerate in 2013. “As conditions get worse, we will continue tosee more of it,” says Evan Inglis, principal and chief actuary atVanguard. “Nevertheless, I don't predict a flood of de-risking.People are wary when interest rates are so low, crossing theirfingers they will go up and then the insurance will become lessexpensive.”

As an analogy, Inglis provides the example of a neighborhoodwhere five houses burn down without any insurance, prompting theremaining uninsured house on the block to buy coverage, even thoughthe premiums are much higher. “It's just human nature to dosomething about risk only after it rears,” he comments.

Regarding sponsors that are likely to resist de-risking, Inglissurmises they have more confidence in their funding status andinvestment expertise. “GM has evolved from an investmentperspective to a corporate finance perspective,” he explains. “Theywanted stability instead of taking on the equity and interest-raterisks. They make cars—that's their core competency. They'd rathertake risks they know about, as opposed to equity and interest-raterisks that they can't get a handle on.”

Slightly complicating this decision is MAP-21, the federal“Moving Ahead for Progress in the 21^st Century Act,”which eases the higher pension funding obligations produced byhistorically low interest rates. With regard to MAP 21, bothconsultants say it will have little impact on de-riskingdeliberations. “A lot of plan sponsors are taking it with a grainof salt,” Inglis says. “Just because the rules have changed and youcan put less money into your plan now doesn't mean it won't costless.”

“It's hard to tell if sponsors are going to take the relief,”McEvoy says. “We're seeing many staying the course, understandingthey have this relief but knowing the reality of this funding holethey still have to fill.”

For more coverage of this issue, see The Challenge of Transferring Pension Risk andPension Derisking Is a Double-Edged Sword for PBGC.

Russ Banham can be reached at www.russbanham.com