How To Derisk A Pension Plan

Transcription

1 Pension De-risking Strategies and Issues May 1, Presenters: Craig A. Bitman John G. Ferreira Azeez Hayne

2 Pension De-risking Significant pension settlement and de-risking activities occurred in 2012 and more activity on tap for 2013 Asset-based strategies Liability-driven investment strategies Funding policy Insurance annuity buy-ins Liability-based strategies Freeze of participation and/or benefit accruals Lump-sum payments to participants Insurance annuity buy-outs Ultimate strategy of plan termination 2

3 What Is Driving Pension De-risking? A number of factors are driving pension de-risking activity Law and regulatory changes Pension Protection Act of 2006 Ultimately will force employers to fully fund pension plans Results in calculation of smaller lump-sum payments than prior rules Moving Ahead for Progress in the 21 st Century (MAP-21) granted interest rate relief for funding, but also included steep increases in PBGC premium amounts Changes in accounting rules (in particular, FASB Statement No. 158) accentuate financial/accounting volatility of pension plan exposure Market conditions and volatility Strong balance sheets and access to inexpensive capital 3

4 Examples of De-risking Date Company Funded Ratio Liability Assets Notes 4/27/2012 Ford Motor Company (Salaried Plan Only) 80.7% $48.8 billion $39.4 billion Offering lump sums to retirees and terminated vested participants in US Salaried Plan 6/1/2012 General Motors (Salaried Plan Only) 92% $35.9 billion $33 billion Offering to retirees lump sums. If lump sum not elected, will receive annuity payments from Prudential Lump sums offered to terminated vested participants. 8/1/2012 NCR Corp. 67.9% $4.027 billion $2.733 billion Expect 70% take-up Offering lump sums. If lump sum not elected, will receive 8/9/2012 Energy Future Holdings Corp. 72.3% $3.3 billion $2.4 billion annuity payments from an insurance company 9/14/2012 New York Times 73.7% $1.987 billion $1.464 billion Offering lump sums to former employees 9/14/2012 Sears Holdings Corp. 66.3% $6.1 billion $4.1 billion Offering lump sums 9/19/2012 Visteon Corp. 77.7% $1.48 billion $1.15 billion Lump sums offered to deferred vesteds 9/21/2012 Archer Daniels Midland Co. 72.3% $3.1 billion $2.24 billion Lump sums offered to deferred vesteds. Expected 50-75% take-up 9/25/2012 Thompson Reuters $1.5 billion 10/1/2012 Equifax Inc. 78.1% $746.1 million $583 million Lump sums/reduced annuity offered to deferred vesteds Offering lump sums to deferred vesteds whose lump sum 10/5/2012 A.H. Belo Corp. 65.3% $420.9 million $274.9 million value is less than $30k 10/9/2012 Yum! Brands Inc. 72.3% $1.381 billion $0.998 billion Offering lump sums to former employees 10/19/2012 Baxter International Inc. 74.3% $4.94 billion $3.67 billion Offering lump sums to former employees 10/24/2012 Kimberly-Clark Corp. 91.6% $3.8 billion $3.48 billion Offering lump sums to former employees Offering lump sums. If lump sum not elected, will receive 10/26/2012 Kaydon Corp. 76.8% $142.8 million $109.7 million annuity payments 10/29/2012 J.C. Penny 97.7% $5.297 billion $5.176 billion Lump sums offered to deferred vesteds 10/17/2012 Verizon Communications Inc. 78.8% $30.6 billion $24.1 billion Annuity purchase from Prudential 10/19/2012 AT&T 81.8% $56.1 billion $45.9 billion Announced $9.5 billion contribution in preferred company stock 4

5 Asset-Based Strategies to De-risking Asset-based strategies to de-risking include: Asset liability driven investments Moving to hedged investments Dynamic or static Funding policy approaches Borrow to fund Annuity buy-ins Purchase of bulk annuity as a plan asset Guaranteed hedge against funding fluctuations 5

6 Asset-Based Strategies to De-risking (cont d) Advantages to LDI Strategies Can help reduce funding volatility Avoid settlement accounting Can help maintain funded status Disadvantages to LDI Strategies Must continue to administer the plan PBGC premiums Underfunding is locked in 6

7 Liability-Based Strategies to De-risking Four primary liability-based strategies Freeze of participation and/or benefit accruals Offering lump-sum payments to participants Insurance annuity buy-outs Ultimate strategy of plan termination 7

8 Liability-Based Strategies (cont d) Freeze of participation and/or benefit accruals Soft freeze of plan participation to new participants Hard freeze of benefit accruals for existing participants Some plan sponsors have evolved from earlier soft to more recent hard freeze Strategies slow or stop future increases in liabilities, but do not manage or reduce existing liabilities 8

9 Liability-Based Strategies (cont d) Offer lump-sum distributions to plan participants To date, by far the most common liability-based de-risking strategy for dealing with existing liabilities With notable exception of Verizon annuity buy-out, most plan sponsors have opted for a lump-sum de-risking strategy As with any de-risking approach, a thorough advance evaluation of cost, funding, and accounting consequences is necessary prior to adoption E.g., impact on plan funding and cash flow, company contribution obligations, savings from reduced administrative costs and PBGC premiums, financial reporting and accounting consequences, etc. 9

10 Liability-Based Strategies (cont d) Until recently, conventional wisdom was that offering a lump sum to retirees ran afoul of Code Section 401(a)(9) required minimum distribution rules 2012 private letter rulings concluded that offer of lump sum to retirees constituted a plan amendment increasing plan benefits and fit within regulatory exception Lump-sum window is a voluntary offer and participants can t be required to take it; creates some uncertainty regarding consequences ( take-up rates can vary) Lump-sum window design considerations Temporary vs. permanent most typically offered as a temporary window rather than an ongoing plan feature 10

11 Liability-Based Strategies (cont d) Terminated vested vs. retirees most typically offered to terminated vested participants, but notable exceptions (Ford and GM) include offer to retirees in pay status Sometimes offered with cap (e.g., offered to terminated vested participants with benefits less than $25,000) may help manage financial consequences of offer Decisions to make about how to calculate lump sums Under Code Section 417(e), certain interest rate and mortality assumption minimums must be used, but flexibility may exist in identifying 417(e) assumptions used for these purposes (i.e., how look-back and stability periods are defined) Whether the value of early retirement subsidies or other incentives should be included in calculating lump sums 11

12 Liability-Based Strategies (cont d) Lump-sum window compliance and implementation considerations are significant Compliance considerations include Code Section 436 benefit restriction rules that prevent plans below the 80% AFTAP funding level from offering full lump sums Possible nondiscrimination testing issues (particularly if lump sum is not offered to broad class of participants) Use of Code Section 417(e) assumptions Complex and detailed disclosure requirements including relative value disclosures, spousal consent requirements, etc. 12

13 Liability-Based Strategies (cont d) Implementation considerations include Data integrity issues a very significant consideration given the demands a lump-sum window will place on benefit calculation systems and processes Up-to-date participant information (death audits, missing participant considerations, locater searches, etc.) Communication process and strategy to address disclosure obligations and to ensure that plan participants have sufficient information to make informed decisions (important to manage fiduciary and legal risks as discussed below) Sufficient internal and external resources to manage project Collective bargaining considerations if union employees are involved 13

14 Liability-Based Strategies (cont d) An insurance annuity buy-out is another liability-based de-risking strategy Involves the transfer of assets and liabilities and all associated obligations and costs to a third-party insurance company The transaction is at the level of the plan and the insurance company and does not (directly) involve participants; no participant consent is required The Verizon buy-out is the most recent significant example transfer of $7.5B in pension liabilities to Prudential 14

15 Liability-Based Strategies (cont d) Although there are advantages to insurance buy-outs as a de-risking strategy (complete transition of liabilities, elimination of future costs like PBGC premiums, participant consent not necessary, etc.), there are potential draw-backs Costs (cash flow and insurance premium/profit margin) Accounting consequences settlement accounting Fiduciary issues and possible exposure relating to selection of insurance provider (discussed below) 15

16 Fiduciary Implementation of Pension De-risking Decision to undertake pension de-risking should be a settlor function, but implementation of the de-risking can raise fiduciary issues Participant communications Selection of annuity providers Investment strategy Fiduciaries should develop a strategy for communicating with participants Provide information relevant to participant decisions Information must not be misleading Purchase of annuities Selection of annuity providers is a fiduciary function DOL safe harbor for annuity selection (consider the extent to which it s really a safe harbor) Recent case law 16

17 Presenters Craig A. Bitman Partner, New York Azeez Hayne Partner, Philadelphia John G. Ferreira Partner, Pittsburgh

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