By Cindy Levering
There has been a lot of corporate defined benefit plan activity in the United States lately that has been labeled with a seemingly new term—“de-risking.” While there is no general definition of the term, de-risking can be broadly defined as actions taken by plan sponsors to reduce their exposure to risk through hedging, risk transfer, diminution or prevention. For defined benefit plans, some common areas where “de-risking” is being applied include:
- Governance — periodic review of roles and responsibilities of the plan’s governing body, including the identification of members who are fiduciaries; clear separation of operational and oversight functions; clear identification and separation of settlor and fiduciary decisions; and timely review and exploitation of risk management opportunities.
- Asset/Liability Management — hedging, immunization, annuity purchases, asset allocation/LDI
- Plan design — hard or soft plan freezes, lump sum options (including offers to former employees), cash balance conversion, variable annuities, plan termination
While some of this has been going on for years as employers have shifted from defined benefit to defined contribution plans, these changes have generally only affected current employees. Only 30 Fortune 100 companies offer defined benefit plans to new salaried employees compared to 90 in 1985. The asset and longevity de-risking that began in 2006 in the United Kingdom has moved recently to United States and is expected to become more prevalent in Canada in near future.
So why has de-risking become the mot du jour?
Each plan sponsor has its own issues but here are some very important concerns they all share.
High investment volatility has impacted balance sheets and increased the risk of unexpected plan contributions.
Plan sponsors are beginning to understand the impact longevity has on the cost of the plan.
Exposure to litigation and administrative costs are increasing.
PPA may encourage some plan sponsors to minimally fund their plans.
PBGC premiums are rising.
Sponsors do not perceive pension risks as worth holding.
Investors, lenders, and rating agencies may reward companies that reduce pension risk.
In 2012, the full phase-in of lump sum interest rates under PPA was completed. In addition, recent changes to the funding rules under MAP-21 decreased liabilities and contribution requirements making fewer plans subject to benefit restrictions. Together, these events have spawned a new movement toward paying lump sums to former employees, both deferred vested and retirees. GM, Ford, and Verizon are just a few of the firms that have made headlines in this year (See Appendix for a list of major firms that have done significant de-risking thus far in 2012).
While de-risking may lower the future cost for plan sponsors, it could be significantly increasing risk to former employees and retirees, who may be less able to deal with it.
There are many issues and questions for stakeholders to consider. Here are some of them (in no particular order):
Issues/questions for employers/plan sponsors:
- If the transaction is focused primarily on retirees, will it effectively support future volatility and plan cost goals?
- Considering the interest and market environment, is the timing for the transaction right? Are there opportunity costs that need to be considered?
- If early retirement subsidies are being eliminated, will this be easily understood by employees? Will it cause an unacceptable increase in litigation risk?
- Does the transaction trigger a partial plan termination?
- Will the transaction trigger settlement accounting?
- Will the transaction cause an unfavorable adjustment in the long term rate of return?
- Post transaction, will the plan funding surplus/deficiency be acceptable?
- Are the savings on recordkeeping, administration and PBGC premiums (which are scheduled to increase in 2014) significant enough to justify the transaction?
- If the transaction includes a temporary lump sum offer, will a private letter ruling be necessary to reduce regulatory and litigation risk?
- Is there any impact on workforce management?
- Are there any collective bargaining issues to be considered?
- If transferring liabilities or offering lump sums, will post transaction liquidity needs be adequate and should the asset allocation be adjusted?
- Will the “top 25” employees be affected by lump sum restrictions?
- Will anti-selection cause higher ultimate costs?
- For publicly traded companies, how will security analysts react to the transaction?
- If liabilities are being transferred, will the DOL’s safest annuity rules be satisfied?
Issues/questions individuals should consider:
- If you accept the lump sum offer, can you effectively manage the transfer of investment, longevity and early retirement risks? Note: A lump sum is probably not the best choice if you are healthy, expect a long lifetime, and have a limited amount of additional assets.
- Do you understand the Relative Value Notice well enough to recognize if early retirement subsidies have been eliminated as well as compare the value of optional forms of benefit you will be giving up for the lump sum?
- Will you be losing the right to receive future ad hoc retiree cost-of-living increases by choosing a lump sum or as a result of an annuity purchase?
- Is spousal consent required to receive the lump sum? Is the choice impacted by a QDRO?
- What is the financial strength and quality of the insurer if annuities are purchased and thus PBGC/Plan Sponsor guarantees are being traded for insurance company protection with state guarantees?
Issues for society/public policy:
- What is the capacity of the annuity/bond marketplace to handle a large volume of these transactions if they are not spread out over time?
- Do some de-risking transactions conflict with the goals of recent Treasury initiatives to allow partial lump sums, transfer defined contribution balances to defined benefit plans and otherwise encourage more lifetime income?
- Has MAP-21 accelerated this activity by lowering liabilities and eliminating benefit restrictions? Is this an unintended consequence of the law?
- In October, the Pension Rights Center asked Congress to issue a temporary moratorium on these transactions to look at the risk to individuals’ benefit security.
In conclusion, it will be interesting to see if the most recent wave of de-risking activity continues at the current pace, especially in light of the Pension Rights Center’s efforts to slow it down. It will also be interesting to assess the long term impact not only on plans and their ability to manage volatility but also on individuals and their ability to manage their retirement assets effectively. Finally, to the extent the information is made publically available; the actual elections that employees make will form the basis for many behavioral finance studies.
While most of us have heard that GM and Ford are de-risking their liabilities, here is a list of what they and 13 other large organizations are doing (taken from annual reports, SEC filings and press releases):
American Airlines – In March, American Airlines reversed its proposal to terminate its workers' pension plans and transfer them to the PBGC as part of its bankruptcy reorganization and decided to freeze the plans instead. The move, which must be approved by a judge, will reduce American's future contributions to the underfunded plans.
Ford – In April, Ford offered a voluntary lump-sum payment option to about 90,000 eligible retirees and former employees to reduce its future pension obligation by $1.8 billion. This is the first time a program of this type and magnitude has been offered by a U.S. company for ongoing pension plans. Payouts will start in late 2012 and will be funded from existing pension plan assets. This is in addition to the lump-sum pension payout option available to U.S. salaried future retirees as of July 1, 2012.
General Motors – In June, GM announced an expected $26 billion reduction in its U.S. pension obligation by offering lump sums to 42,000 salaried retirees and purchasing annuities from Prudential for most of its remaining salaried retirees in the largest annuity purchase ever in the U.S. There is no change to active employee benefits and affected retirees are still eligible for medical coverage. GM announced on October 31 that about 30 percent of the eligible salaried retires had accepted the lump sum option.
Bank of America – Bank of America froze their pension plan as of July 1, 2012 and will instead begin making an additional 2-3 percent annual contribution to employees' 401(k) accounts, on top of their existing program that matches employee contributions up to 5 percent.
NCR – On July 31, 2012, NCR announced that it expects to make $800 million in contributions and offer a voluntary lump sum payment option to approximately 23,000 former deferred vested employees. In April 2010, NCR began to increase the fixed income component of their plan from 39 percent at the end of 2009 to 80 percent in 2011, and is expected to be at 100 percent by year-end 2012. The total liability associated with the U.S. deferred vested participants is approximately 33 percent of the U.S. pension liability. The offer will include the choice of a lump sum or either an immediate or deferred annuity from the plan, and is “designed to provide greater flexibility in managing retirement savings.”
Verizon – In October 2012, Verizon announced it is purchasing a $7.5 billion group annuity contract from Prudential (the second largest only to GM) for 41,000 retired managers (many of them had a lump sum option at retirement). This represents about 25 percent of their total liability.
Sears – In September, Sears contributed $203 million to get to 80 percent funding so they could pay some lump sums. They are also planning to reduce their expected 2013 funding from $740 million to $350 million due to the provisions of MAP-21.
New York Times – On Sept. 14, 2012, New York Times informed 5,200 former employees that they intend to offer them the option of receiving a one-time lump sum payment or an immediate reduced monthly annuity from the plan. This represents approximately 15 percent of their total qualified pension plan liabilities, which was approximately $2 billion at the end of 2011. They hope to reduce the size of their pension obligations and the volatility in their overall financial condition.
Visteon Corporation – On Sept. 19, 2012, Visteon announced a one-time lump sum payment option from plan assets to certain former non-retired employees. The option will be offered to nearly 10,000 of the company's 20,000 total U.S. plan participants. Eligible participants who do not elect a lump sum payment will maintain their existing benefit.
Archer-Daniels-Midland (ADM) – On Sept. 20, 2012, ADM began notifying certain former non-retired employees of its one-time offer to pay their benefit in a voluntary lump sum. They estimate participation rates will be 50 percent to 75 percent which could reduce its global pension benefit obligation by approximately $140-$210 million and improve its pension underfunding by approximately $35-$55 million. They also expect ongoing pension expense to be reduced by $4-$5 million annually. Actual participation rates and payout amounts will not be known until December 2012.
Thomson Reuters – Eligible terminated participants who do not elect a lump sum or early annuity payment will receive annuity payments from the pension plan which had $1.5 billion in assets as of Dec. 31, 2010, according to its most recent Form 5500 filing.
Equifax – On Oct. 1, 2012, Equifax began notifying approximately 3,500 former employees of its offer to pay their pension benefits from the plan by the end of 2012 in either a lump sum or a reduced monthly annuity. This represents approximately 20 percent of their total qualified pension plan liabilities which were approximately $630 million as of Dec. 31, 2011.
Yum! Brands – On Oct. 9, 2012, Yum! began notifying certain former employees of a limited opportunity to voluntarily elect an early payout of their benefits to be paid from pension assets. As a result of this program, they anticipate recording an accounting charge between $25 million and $75 million in the fourth quarter of 2012.
A.H. Belo – They are offering, or will automatically distribute, lump sum payments to certain pension plan participants with a present value of $30,000. Approximately 1,500 participants, or 30 percent of total plan participants, will receive these offers. The number of actual participants selecting the voluntary opportunities will not be known until later in 2012.
Baxter International – Baxter is offering lump sums to 16,000 vested former employees to reduce administrative costs and investment volatility. They do not have estimates for how many participants will accept the offer and the effect it will have on pension liabilities. They had $3.67 billion in pension assets and $4.94 billion in liabilities for a funded status of 74.3 percent, as of the end of 2011.
Cindy Levering, ASA, MAAA, FA, is a retired actuary in Baltimore, Md. She can be reached at firstname.lastname@example.org