New Report Analyzes Important Step Taken by More than A Dozen Major US Companies Last Year

With the huge cost of legacy defined benefit pension plans burdening many companies across the United States, lump-sum offers are gaining in popularity. A new report, Lump-Sum Buyouts Gain Traction Among U.S. Pension Plans, from Greenwich Associates explores the drivers of this trend and analyzes its impact on companies and the employees and retirees who rely on corporate pension plans for financial security. Included in the report is a case study of one major U.S. company that undertook a lump-sum buyout of DB plan participants in 2012, complete with lessons for other companies considering a similar initiative.

Lump-sum buyouts not only offer the opportunity to de-risk and remove liabilities from balance sheets, but they can also help reduce funding gaps, which represent another major concern for many U.S. corporations. A recent Greenwich Associates study shows average corporate plan funding ratios fell from 89% in 2011 to 81% in 2012, driven mainly by declining interest rates. More than 60% of plans currently have funding ratios of 85% or less. These funding gaps represent the highest ever, according to Mercer Investment Consulting, and are projected to negatively affect the balance sheets and 2013 earnings of some corporations.

However, more than a dozen major companies took preemptive action in 2012, extending lump-sum offers to current and/or former employees in an attempt to shed liabilities and minimize the impact of volatility on balance sheets. Companies such as Lockheed Martin, J.C. Penney and NCR launched their lump-sum programs after Ford and GM kicked off the buyout blitz in the first half of the year. Ford made its offer in April 2012 to 95,000 salaried retirees and former employees. GM followed with a similar offer to its employees in June, extending lump-sum options to salaried retirees unprotected by union contracts. Ford and GM remain in the minority with their offers to current employees. Most companies have limited their buyouts to former employees whose pensions have vested.

Regulatory Changes Open the Door
The 2006 Pension Protection Act (PPA) changed the interest rate basis for lump-sum calculations to one tied to investment-grade corporate bond yields—a move that reduced the cost of pension plans’ future liabilities and made lump sums a more cost-effective risk transfer strategy. Although the PPA also prohibited plans funded at less than 60% from offering lump-sum buyouts and placed restrictions on other low-funded plans, the new law helped open the door to last year’s spate of buyouts. Provisions of the 2012 Moving Ahead for Progress in the 21st Century (MAP-21) Act also encouraged companies to consider lump-sum buyouts.

Challenges for Companies Considering Buyouts
Adverse selection represents a key concern for companies considering buyouts. The healthiest participants in a plan may take an annuity while those who don’t expect to survive take the lump; so the older the population, the higher the adverse risk for plan sponsors. Lump-sum buyouts also carry high administrative and execution costs. Much depends on the size of the population and the funding status of the plan. Although underfunded plans have a greater need to reduce their liabilities, better-funded plans, which meet regulatory requirements and can afford the upfront costs, are more likely to be attracted to lump sums.

From a logistical standpoint, plan administrators must be able to track down and follow up with participants. This may be difficult when it comes to past employees, who, unlike retirees, are not in regular touch with the company. They are generally younger –– in their 40s and 50s — making them apt to be more mobile than older participants. Since most offers give participants between 30 and 90 days to decide whether to take the lump sum, well-written materials and communications are imperative. Administrators also need well-staffed hotlines to answer questions during that period.

In addition, successful buyout execution requires plenty of lead-time for the fund’s investment strategy, which must be able to provide the cash to pay lump sums when they fall due. Companies need to understand in advance the future liability characteristics of the population so they can plan appropriately for liquidity needs.