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Cash lump sums the next big thing in retiree payouts

Cash lump sums the next big thing in retiree payouts

Early on a Friday afternoon just over three years ago, Ford Motor Co. dropped a pension bombshell. The Dearborn, Michigan-based automaker disclosed a groundbreaking approach to “de-risk” one of its pension plans: 90,000 U.S. retirees and salaried employees were given the option to take their monthly pension benefit as a cash lump sum.

To be sure, annuity-to-lump-sum benefit offers were not new. Typically, such offers were made to employees at the time they left the company rather than to pension plan participants who were already drawing a benefit or to former employees who would draw a benefit when they reached retirement age.

But Ford was targeting the two latter groups.

“Historically, lump-sum distributions, which allow plan participants to exchange periodic annuity payments for a single payout, have been offered to participants only upon separation from active employment,” benefits consultant Towers Watson & Co. said at the time of Ford’s April 30, 2012, announcement.

Ford’s motivation for making the offer was spelled out by Bob Shanks, the company’s chief financial officer and executive vice president.

“Providing the option of a lump-sum payment to current salaried U.S. employees and former employees will reduce our pension obligations and balance sheet volatility,” Mr. Shanks said at the time.

How much of an impact Ford’s trailblazing approach would have in reducing pension plan liabilities became evident by the conclusion of the offer at the end of 2013: 35,000 of the pension plan’s 90,000 participants given the annuity-to-lump-sum benefit conversion offer accepted it, removing $4.2 billion in liabilities from the plan.

Three years after Ford’s pension bombshell, annuity-lump sum benefit conversion offers have become a mainstream corporate pension de-risking approach as employers seek to reduce their pension obligations and avoid equity market and interest rate volatility.

While there is no definitive survey reporting how many employers have given plan participants an offer to convert their annuities to lump sums, the number is considerable, experts say.

“It would be fair to say that several hundred plan sponsors have made such offers,” said Jason Richards, a Towers Watson senior retirement risk management consultant in St. Louis.

Some of the nation’s best-known corporations — including General Motors Co., Archer Daniels Midland Co., Hartford Financial Services Group Inc., McCormick & Co. Inc., The New York Times Co., NCR Corp. and Newell Rubbermaid Inc. — are among them.

A catalyst for the surge, experts say, was the Great Recession of 2008, which battered the funding levels of pension plans. The plans typically have a high percentage of assets invested in stocks, whose values plummeted.

Indeed, at the end of 2008, the average funding level of the 100 largest pension programs sponsored by publicly held companies sank to just under 80%, down dramatically from a year earlier when, on average, plans were well over 100% funded, according to Milliman Inc. surveys during those years.

That decline forced employers to pump more money into their pension plans at a time when many could least afford it.

“The 2008 plunge was a big driver,” triggering corporate interest in de-risking approaches such as annuity-to-lump-sum benefit offers, said Jack Abraham, a principal with PricewaterhouseCoopers L.L.P. in Chicago. The economy’s plunge also was a catalyst for other approaches, including shifting plan liabilities to insurers through the purchase of group annuities.

Yet another driver was a 2006 federal law, which took effect in 2008, that accelerated the amount of time employers had to fund pension liabilities. Sharp and sudden swings in equities markets could result in big increases in employer contributions to their pension plans.

“Pension plan funding became a lot more volatile,” said Matt McDaniel, a partner at Mercer L.L.C. in Philadelphia.

PBGC mandates

Another factor in pension de-risking approaches were congressionally mandated increases in the insurance premiums employers with pension plans must pay the Pension Benefit Guaranty Corp. — the federal agency that guarantees pension plan participants’ vested benefits.

“Those rates have been a key driver, making it a lot more expensive to offer a pension plan,” Mr. McDaniel said.

When Congress created the PBGC as a key part of the Employee Retirement Income Security Act of 1974, lawmakers set the premium at just $1 per plan participant. Big increases in the agency’s deficit — racked up by its takeover of massively underfunded pension plans from employers that ran into financial difficulty or went out of business — has fueled premium hikes. Next year, the base PBGC premium will rise to $64 per plan participant from $57 this year and $42 in 2013.

Reducing the number of participants in an employer’s pension plan through a lump-sum benefit conversion immediately cuts the employer’s PBGC premiums.

Rulings from federal agencies also increased employer interest in making those offers by ending some lingering uncertainties about their legality.

In 2012, the Internal Revenue Service issued two private-letter rulings making clear that the approach passed legal muster.

Before the rulings — widely believed to have been requested by Ford and GM — there had been uncertainty about whether such offers could be made to retirees already receiving benefits.

With the reasons for making lump-sum offers clear, the growing number of employers doing so is creating a credible database of acceptance rates.

At Hartford, for example, about 40% of its 13,500 former employees accepted the offer to convert their future annuity to a cash lump-sum benefit late last year, a spokesman said.

In addition, Kimberly-Clark Corp. reported that about one-third of its 10,000 former employees given the lump-sum benefit offer in 2012 took it, while nearly 40% of Ford participants accepted their offers.

In all, acceptance rates typically will range from about 40% to 60%, with a key factor being how well the offer is communicated, Mr. McDaniel said.

In most cases, the offers are made to former employees who have accrued a pension benefit but have not reached the age at which they can begin collecting it.

The fear of adverse selection is a key

reason employers typically have not extended the offers to retirees, Mr. Abraham said.

For example, an ailing 80-year-old widower with a terminal illness would be more apt to take the lump sum rather than continue with a monthly annuity, which would end when the individual died.

Another decision employers have to make is how much time they will give participants to decide whether to accept the annuity-to-lump-sum benefit offer.

“One month is too quick, and six months is too long. Sixty to 90 days is where employers are leaning. You want to give participants enough time to make a decision, but not so much time that they forget it,” Mr. Abraham said.

Participants aren’t the only ones who have to be notified of the offers. Rules laid down by the PBGC this year require employers making conversion offers to answer four questions on a PBGC form: How many plan participants not in pay status, such as retirees, were offered the option? How many of those participants took it? How many plan participants in pay status were offered the option? And how many of those employees took it?

The PBGC made clear why it wants the data: a fear that as pension plans shrink in size, the agency will collect less in premium income, money it uses to pay guaranteed benefits to participants in failed plans the agency has taken over.

“Premium losses have the potential to degrade PBGC’s ability to carry out its mandate” to guarantee benefits, the agency said in a filing with the federal Office of Management and Budget.

Still, while the PBGC may see its premium income decline, its exposure to losses as pension plans shrink also decreases when participants accept lump-sum benefits offers, said Ari Jacobs, global retirement solutions leader with Aon Hewitt in Norwalk, Connecticut.

“Lump sums permanently eliminate the PBGC’s exposure and risk related to those benefits,” Mr. Jacobs said.

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