The hot trend in defined-benefit pensions last year involved companies offloading some of the risk involved in their plans by doing lump-sum buyouts or annuity purchases. So far in 2013, announcements of such risk transfers have subsided, but consultants said they expect a robust number of transactions, especially lump-sum buyouts, this year.
Companies’ de-risking moves are occurring amid widespread underfunding of pension plans as persistently low interest rates boost plan liabilities, limiting the positive impact the stock market rally has had on plan assets. The situation improved during the first quarter of this year, but many plans remain significantly underfunded. Mercer put the funded ratio for S&P 1500 companies’ plans at 82% at the end of March, up from 74% at the end of last year.
The underfunding means some companies have had to make sizable cash contributions to their plans. Meanwhile, hikes in the premiums that plan sponsors pay to the federal Pension Benefit Guaranty Corp. have increased the cost of operating such plans.
In 2012, Ford, General Motors and Verizon were among the companies that made headlines with sizable transactions aimed at reducing the amount of risk posed by their defined-benefit pension plans. Ford offered lump sums to 90,000 retirees and former employees who were vested in the pension plan. General Motors offered lump-sum buyouts to 42,000 retirees and transferred its obligations for about 110,000 retirees to Prudential by buying a group annuity for $25 billion. And Verizon used $8.5 billion in plan assets to purchase an annuity from Prudential and transfer its obligations to 41,000 of its retirees.
Consultants said that while they expect more annuity purchases this year, the total is unlikely to approach last year’s given that the GM and Verizon annuitizations were so huge.
“There may be a jumbo transaction out there waiting, but you certainly won’t see those every year,” said Sean Brennan, a principal in the Financial Strategy Group of consultancy Mercer. “We expect something lower than last year by a large margin but higher than what we’ve seen in the past, prior to 2012.”
Jason Richards, a consultant in the Retirement Risk Management Group at Towers Watson, predicted this year’s annuity purchases would be in the $50 million to $1 billion range, rather than the multibillion-dollar deals done by GM and Verizon.
Annuitizations usually involve retirees, while companies tend to offer lump-sum buyouts to vested former employees who have not yet retired. The trend of companies offering buyouts is still going strong.
“You’ll see a lot of plan sponsors moving in that direction,” Mercer’s Brennan said.
Richards estimated 150 to 200 companies did lump-sum buyouts last year. He expects significant volume this year but said it may fall short of last year’s total. Companies that offered buyouts last year aren’t likely to repeat that offer again this year, he said, but noted that some companies are considering routinely offering lump-sum buyouts when vested employees leave the company.
In buyouts administered by Towers Watson last year, on average 60% of plan participants accepted the offer, Richards said, adding that one reason the take-up rate is low is that companies have a hard time finding some former employees. “The day a person leaves, you know where they are, you’re communicating with them, and they’re in a situation to think, ‘What do I want to do with my retirement savings?’” said Richards, pictured at left. “For that reason, we’re seeing a lot more plan sponsors thinking about offering the [lump-sum] option to actives when they leave.”
With interest rates still low by historical standards, companies may be reluctant to undertake transactions for fear rates will soon move higher, leaving them having priced near the low in rates. But the low rates also mean it’s cheap to borrow, and borrowing to finance a de-risking may alleviate companies’ concerns about the timing of a transaction, he said.
“If rates rise, my debt that I have outstanding just went down in value, and if I want to, I can get rid of that more cheaply,” Richards said.
Mercer’s Brennan added that getting the data together for a lump-sum offering, including the current addresses of former employees and calculations of the benefits they’re owed, involves considerable effort. Last year, some plan sponsors wanted to offer buyouts but found their data was not in good enough shape for them to do so, he said. “In 2013, plan sponsors are saying even if we don’t want to pay these lump sums today, we want to be sure we’ve done everything so we can pull the trigger when we want to,” he said.
Companies also have to consider how removing a chunk of assets and liabilities from their plan will affect the asset allocation, Brennan noted.
The recent news that a U.S. District Court judge awarded class-action status to a lawsuit challenging Verizon’s purchase of annuities to cover 41,000 of its retirees isn’t expected to discourage other employers from undertaking such transactions.
Verizon retirees whose pensions were being transferred to Prudential sued to stop the transaction last fall, but a U.S. District Court in Texas refused to halt the annuity purchase. Now the court has granted class certification to the lawsuit. The challenge comes from two different groups of retirees, the 41,000 whose pensions are now paid by Prudential and about 50,000 who remain in the Verizon plan. Some whose pensions now come from Prudential are unhappy that they lost the protection of federal pension laws and the backing of the Pension Benefit Guaranty Corp. Retirees who remain in the Verizon plan argue the company wrongly used plan assets to cover some of the expenses of the annuitization.
Carol Buckmann, a counsel in the pension and benefits group at law firm Osler Hoskin & Harcourt, said Verizon argued for the case to be dismissed, but also supported the class certification. That suggests the company is confident it will prevail in court, she said, because if the case is dismissed, “everyone in those two classes won’t be able to sue Verizon on those same issues in any other court.”
Further, the lawsuit has made plan sponsors a little more cautious but existing law says companies can annuitize pensions, she said. “The laws are pretty clear in this area.”
Buckmann recommends that companies considering a de-risking transaction hire an independent fiduciary whose job is to represent the interests of the plan participants. “Otherwise you have to deal with perhaps conflicting interests and having to reconcile them,” she said.
Companies should also disclose the possibility of a de-risking transaction in the summary plan description they’re required to send to participants, keep records of their decision-making process, and investigate the financial soundness of the insurer, Buckmann said. “That’s also where the independent fiduciary can be helpful,” she said.