Pension Plan De-Risking: Good for Employers, Bad for Retirement Policy?

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More large defined benefit plans are trying to limit their pension liability through “de-risking” by offering lump-sum distributions to retirees instead of the more typical annuity distributions. The years 2009 through 2013 saw a flurry of pension plan de-risking and a new report from the Pension Benefit Guaranty Corporation tallies the number of plan participants affected by this activity.

The report, issued Dec. 10, suggests that more than a million participants in large plans were affected by de-risking from 2009-2013. More than half of them (621,169) were affected in 2012 when Verizon Communications Inc. and General Motors Co. announced major de-risking moves.

Of the approximately 3,590 plans with more than 1,000 participants included in the report, 534 had engaged in “risk transfer activities,” which include lump-sum distributions and group annuity purchases. Of these, 381 involved lump-sum payments.

The report may provide additional fodder for the ongoing debate in the retirement plan community over giving participants in pay status the choice to elect a lump-sum payment over their current annuity.

In a Dec. 15 telephone interview with Bloomberg BNA, former PBGC director Joshua Gotbaum said that the report’s findings reflect federal pension law and regulatory practices that incentivize employers to offload their pension liabilities through use of lump-sum offers. Gotbaum served as PBGC director from 2010 to 2014, during four of the years encompassed in the report.

“It’s been clear for many years that some employers would choose lump sum offers as a way to get out of their defined benefit pension obligations,” said Gotbaum, currently Guest Scholar in the Economic Studies Program at The Brookings Institution. “What is unfortunate is that federal policy has for the most part encouraged this development rather than discouraged it.”

“For example, the federal regulation originally intended to protect workers’ rights by specifying how lump sums should be calculated doesn’t take market factors into account and as a result employers are “required” to offer lump sums at a discount to their true cost—and then pray that the employee accepts them,” he said.

How lump-sum benefits are calculated under current regulation also works to employers’ advantage, he said.

“First, the law said that in calculating the lump sum you use the mortality table published by the IRS, which always lag mortality by some period of time. In effect you are calculating based on less longevity than people have,” he said.

“Second, the regulation permits employers to pick and choose from a range of possible discount rates,” Gotbaum said. “So if you have low discount rate and a high discount rate in the last six months, employers can pick the one that reduces the cost of the buyout. So in effect the federal government is offering a 15 or 20 percent incentive to employers to get rid of their pension obligations. And so it is not surprising that employers are responding.”

“Unfortunately, neither the Treasury nor the Labor Dept. has seen fit to require disclosure of the fact that employers are saving money when employees choose a lump sum option,” Gotbaum said.

Gotbaum noted that Treasury had taken some steps to limit the offer of lump sums to people who have already retired, but said that overall the effects of federal policy were to accelerate the use of lumps sums rather than to limit them.

Andrew L. Oringer, a partner and the co-chair of the Employee Benefits and Executive Compensation Group at Dechert LLP, said that employer efforts to shift, reduce or eliminate pension risk should be viewed in light of the fact that the “pension system is fundamentally a voluntary one.”

Offloading obligations to insurers raises a number of policy questions, as the funding vehicle becomes an insurance contract and moves away from the employer,” he told BBNA in a Dec. 15 e-mail. “Understandably, the government wants to monitor fiduciary considerations here closely.”

“Offering lump sums would seem at first blush simply to be the offering of additional choices to participants,” Oringer said. “But some have expressed a concern that participants won't know what's best for themselves and, indeed, may be affirmatively misled by those seeking to encourage distributions. It is by no means clear to me that participants are broadly incapable of understanding information and making informed decisions, or that those describing the alternatives to participants are in some way unscrupulous. Those kinds of suggestions should be backed up by objective and balanced empirical evidence before being credited as factual. In addition, it seems that the technical analysis surrounding whether adding lump sums is permissible is being backed into depending on the policy drivers for those who may not like lump sums in defined benefit plans. Again, as employers are increasingly constrained, is it any wonder why defined benefit plans are out of favor as new plans and, indeed, at risk for a wave of plan terminations? Be careful for what you wish.”

See related story, 1 Million Participants Affected by De-Risking Over 5 Years, PBGC Says in Report, and BBNA Insight, Recent IRS Guidance Prohibits Lump-Sum Windows for Pension Retirees, Updates Pension Mortality Tables for 2016.

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