This year’s improvement in pension plan funding is seen as paving the way for a groundswell in pension de-risking transactions next year. And the prospect of additional rules for such transactions from the U.S. Department of Labor isn’t expected to interfere significantly with that pickup.
Companies can lower the risk involved in defined-benefit pension plans by reallocating plan assets to hold more fixed-income securities, by offering lump-sum buyouts to some participants, or by buying an annuity to cover a group of plan participants.
The two types of de-risking transactions—lump-sum buyouts and annuity purchases—hit the headlines in 2012 when General Motors, Verizon and Ford did big deals. Verizon transferred $7.5 billion of pension obligations to Prudential by purchasing a group annuity for 41,000 retirees, while Ford offered buyouts to 98,000 retirees and former employees. General Motors unloaded $26 billion of its pension liabilities by offering buyouts to some retirees and buying a group annuity for those who didn’t accept the lump sum and other retirees.
While there were no mega-transactions this year, consultants cite a steady stream of smaller pension de-risking deals. And they expect activity to pick up next year, in part because plan funding improved so much this year. Mercer’s calculations put the funded ratio of S&P 1500 plans at 93% in November, the highest level in five years and up from 74% at the end of 2012.
“Clearly funded status is one of the—if not the—leading indicator for pension de-risking activity,” said Matt Herrmann, leader of the retirement risk management group at HR consultancy Towers Watson. “As funded status improves, it improves the options that are available to plan sponsors, or makes them more palatable.”
According to a Towers Watson survey of executives at 180 companies, 75% say they have a journey plan—a program for de-risking the pension plan that includes triggers for making future changes—or are planning one. And half of the executives surveyed said their company’s journey plan includes unloading some of its pension obligations.
Journey plans, which have been around for seven or eight years, started as a way to implement investment strategy more effectively when markets were changing rapidly and investment committees met only periodically, said Herrmann, pictured at left. “There was a recognition that we needed to put some triggers in place, so as funding status improves, the sponsor is in a position to take action,” he said.
In the last couple of years, Herrmann said, journey plans have become “more holistic.” Now they can include transactions like lump-sum offers as well as asset allocation changes.
The Towers Watson survey suggests that small pension plans are more likely to undertake de-risking transactions. Half of the respondents whose pension plan has more than $5 billion in assets said they only plan to change their investment allocations, versus just 31% of those with under $5 billion in assets.
Fifty-eight percent of respondents said they have offered or plan to offer lump sum buyouts, while just 16% said they have considered such buyouts and decided against offering them.
Herrmann said that lump-sum buyouts have been “a materially larger tactic over the last couple of years than annuity purchases.” Companies usually offer such buyouts to “terminated vested” employees, those who are not yet retired but no longer work for the company, he said, and that smaller portion of the plan population makes “a nice starting point.”
Recently, though, the ERISA Advisory Council, a group that makes recommendations to the Labor Department related to ERISA, suggested that Labor provide companies with additional guidance on pension de-risking.
At public hearings the council held earlier this year, some speakers argued that transferring pension obligations from the company to an insurer via an annuity purchase leaves plan participants less protected because their benefits are no longer backed by the federal Pension Benefit Guaranty Corp.; instead, they’re protected by an annuity backed by a state guaranty fund. Speakers also expressed concern that lump-sum buyouts are not in the best interests of employees.
The council is expected to recommend that the Labor Department make clear that buying an annuity for a de-risking transaction involves fiduciary standards identical to those that apply when a company buys an annuity for a plan termination. It’s also expected to suggest additional disclosures to participants for lump-sum buyouts and ask Labor to warn companies about the consequences if they breach fiduciary standards.
Lawyers say there is little in the council’s recommendations that companies aren’t already doing.
“In fiduciaries I counsel, I don’t think there’s ever any doubt that the same standards apply anytime a plan purchases an annuity to pay benefits,” said Rosina Barker, a partner at Ivins Phillips & Barker, a law firm that specializes in tax and employee benefits.
Barker questioned the council’s recommendation that the Labor Department consider providing a set of factors fiduciaries should consider when selecting an annuity, which would serve as a safe harbor, limiting plan sponsors’ liability if they complied with them. “The fiduciary has to keep abreast of every piece of information that indicates a financial institution may not be safe,” she said. “In an era where a lot of people are thinking about what is the indication of a safe and sound financial institution, and their thinking changes as events change, I question whether a safe harbor would really enhance the process.” Barker also questioned whether the Labor Department has the authority to develop a safe harbor or to require the posting of a bond if a safe harbor requirement is not satisfied.
The other section of the recommendations, about disclosures for lump-sum offers, are “almost all current law,” Barker said, except for the recommendation that companies give a minimum 90-day notice for lump-sum buyouts, up from the current requirement for a minimum 30-day notice period.
“I think any additional look the Labor Department wants to take on the sufficiency and transparency of notifications would be welcome,” Barker added. “In my opinion, some of these notices are complex and could usefully be simplified.”
Jeffrey Capwell, leader of employee benefits and executive compensation at the law firm McGuire Woods, said he doesn’t expect the proposal for Labor Department guidance to discourage companies from undertaking de-risking transactions.
“Requiring the election period [for lump sums] to be at least 90 days would impact the design some people have been using, but that shouldn’t make it particularly more difficult to conduct one of these programs,” he said.
Capwell added that it’s not surprising that the Labor Department has concerns about lump-sum buyouts, since such transactions run counter to the emphasis Labor and the Obama administration have placed on encouraging the annuitization of retirement benefits. “There’s a general view in this administration that annuities make sense and lifetime payments make sense and there are risks associated with lump sum cash-outs of benefits,” he said, noting that the Labor Department has put forward a proposal for 401(k) plans to express participants’ benefits in the form of an annuity.