The federal government moved to limit pension de-risking last month when it prohibited companies from offering lump-sum buyouts to pension plan participants who already are receiving a pension.
While the announcement from the Internal Revenue Service put an end to that type of lump-sum offer, consultants said they still see a booming market for pension de-risking transactions. The IRS move leaves some question, though, as to whether the government might take additional steps to regulate this area.
Companies can use two kinds of transactions to reduce their pension obligations: the offer of lump-sum buyouts to plan participants or the purchase of an annuity from an insurance company, which effectively transfers responsibility for a certain portion of plan participants to the insurer.
Rick Jones, a senior partner in the retirement and investment practice of consultancy Aon Hewitt, said that an Aon Hewitt survey released a few months ago showed that 8% of corporate pension plan sponsors said they were “very likely” to offer lump sum buyouts to retirees in 2015, while 19% said they were “moderately likely” to do so.
“It’s not a strategy every plan was contemplating, but it was in place and in the works for a number of organizations,” he said. In the wake of the IRS’s limitation, which went into effect on July 9, the day it was announced, Jones predicted companies will consider the alternatives, which include lump-sum offers to former employees who are vested in the plan. Other consultants argued that the IRS limit will have little effect because companies’ lump-sum offers target former employees much more often than retirees.
“People who are retired typically are counting on the money, so there is some concern that one shouldn’t rock the board,” said Stewart Lawrence, senior vice president and national retirement practice leader at Sibson Consulting. “There’s also a concern about what’s known as anti-selection, that retirees in ill health are more likely to take the lump sums.”
Malcolm Hodge, a senior partner in the retirement business of consultancy Mercer, said that when Ford Motor offered lump sums to retirees in 2012, about a third accepted the offer.
“Likely the two-thirds that didn’t take it are going to have better longevity,” Hodge said, adding that those retirees’ longer lives could mean 5% to 10% in additional expense for the plan sponsor. “On the whole, you’ve just cost yourself money.”
Aon’s survey showed that 47% of companies said they were very likely or moderately likely to offer a lump-sum buyout to former employees this year, which is higher than the 27% likely to do a lump-sum offer to retirees. However, Jones said that the portion of pension plan liabilities that involve former employees is usually smaller than the portion involving retirees. “So plan sponsors were viewing the retiree lump sums as a way to de-risk fairly significant blocks of liabilities,” he said.
IRS and mortality tables
A separate, more recent IRS notice could have some effect on the timing of lump-sum offers over the remainder of the year. Lawrence, pictured at left, noted that in late July, the IRS announced that it will not adopt updated mortality tables the Society of Actuaries released last year for use in lump-sum calculations until 2017.
The new tables show that people are living longer, so when the IRS incorporates them, it will increase the cost of lump sums.
Some companies may have planned to do lump-sum offers this year because they expected the IRS to switch to the new mortality tables at the start of 2016, Lawrence said.
“Now they’re being told by the IRS the window will be open for a year and half,” he said. “Maybe they’re willing to sit tight until we see where interest rates are going. That might take a little bit of wind out of the sails for the remainder for 2015.”
Even if lump-sum activity slows later this year as a result, “all that will do is push it into 2016,” Lawrence added.
Annuitization still second place
Plan sponsors prefer lump-sum offers to annuity purchases because of the cost.
“An annuity in general is more expensive than the lump sums right now and with interest rates being as low as they are, annuities are particularly expensive,” Lawrence said. “They’re not happening as much in this country [as lump sums].”
Still, Mercer estimates that pension plan sponsors’ annuity transactions will total $10 billion this year, up from $8.5 billion in 2014 and $3.8 billion in 2013, and it predicts activity in coming years will range between $10 billion and $15 billion.
The IRS prohibition on lump-sum offers to retirees was unexpected, but consistent with the federal government’s concerns about lifetime income for retirees.
Additional regulation is seen as possible, especially in the area of lump-sum disclosures, after the Government Accountability Office released a report earlier this year that criticized the disclosures that companies provide to participants being offered lump sums.
“Regulatory groups are looking quite closely at disclosures,” Matt McDaniel, head of the U.S. defined-benefit risk practice at Mercer, said during a webcast last month. “It would not surprise me at all to see model disclosures.”