Time & Attendance
By Patty Kujawa
Mar. 17, 2015
Defined benefit plan sponsors can bank on one thing: uncertainty. They know it can’t be eliminated, but are fighting back by taking what they owe some participants off their balance sheets and having insurance companies take care of the payments.
The strategy is called an annuity buyout, and it’s becoming a popular way to strengthen what’s left of private employers’ $3.2 trillion defined benefit system — commonly known as pension plans. In February, Kimberly Clark Corp. announced its intent to purchase pension annuity contracts to reduce what it projects to owe 21,000 retirees by about $2.5 billion. Other large employers purchasing annuity contracts in the past three years include Bristol-Myers Squibb Co., General Motors Co., Motorola Solutions Inc. and Verizon Communications.
“There’s an element of fatigue and plan sponsors have had it,” said Richard McEvoy, leader of Mercer consulting’s Dynamic De-risking Solution group. “There are a number of factors combining to increase pension obligations.”
An annuity buyout is when a pension plan shifts its obligations (or what it has promised to pay a participant) to an insurance company. The insurance company then provides annuities for the participants affected. It’s called de-risking because by pulling participants and their pension promise out of company plans, sponsors no longer bear the risk of having to fund those obligations and are able to create smaller, more manageable plans.
The five mega-deals that have been completed since 2012 have totaled $40.5 billion in obligations transferred to various insurers covering 218,000 participants. Each deal involved a portion of each company’s pension plan participants, typically those who have already retired.
Annuity buyouts are not so much about cost savings as they are about decreasing the size of the company pension plan to reduce the number of participants and assets plan sponsors have to manage, consultants say.
“Everyone is looking to reduce risk, and they’re looking at all the tools in their tool kit to do it,” said Stephen Marshall, managing director at investment consulting firm Wilshire Associates.
For years, pension plans have had a problem: what they owed participants has grown relative to the amount of money they have held. In January, pension plans were only 79.6 percent funded compared to 84.9 percent a year ago, according to consulting firm Milliman.
Funding ratios are affected by several factors including longer lifespans for U.S. workers, increased payments to the federal insurance company that backstops pension plans and swings in interest rates. It can be quite the rollercoaster ride for plan sponsors. For example, Milliman data show that 2013 was a historic year for pension funds. Robust investment performance and other positive factors produced a historic $198.3 billion improvement in funding status over the previous year.
Things were looking good at the end of 2013, but market shifts and new mortality estimates introduced in October 2014 helped drive down funded status by more than 5 percentage points. It may not seem like much, but that difference can mean millions in contributions that sponsors needed to make in order to keep plans afloat.
“Sponsors face a challenge between managing volatility through investments and/or transferring risks entirely,” McEvoy said. “If they do what they can to match assets to liabilities, they still have a big plan, and it can seriously unravel when there’s a financial crisis.”
While there are a number of strategies available, about 21 percent of 183 defined benefit plan sponsors said they are considering annuity buyouts in 2015 for some of their participants, a February survey by Aon Hewitt showed.
“A growing number of plan sponsors anticipate increasing pension plan costs,” said Ari Jacobs, global retirement solutions leader for Aon Hewitt, in a written statement. “Settlement strategies may be an appropriate approach for well-funded DB plans so that pension plan sponsors are able to honor the retirement benefits promised to participants while also considering the long-term financial outlook of the plan.”
In February, personal care company Kimberly-Clark announced its plan to purchase annuity contracts from Massachusetts Mutual Life Insurance Co. and Prudential Insurance Co. for about 21,000 U.S. retirees. The deal, when complete, is expected to reduce Kimberly-Clark’s pension promises by about $2.5 billion.
In a buyout like this, participants receive annuity checks from the insurance company, and the obligation is no longer covered by the Pension Benefit Guaranty Corp. — the federal insurance agency for defined benefit plans.
It was the first mega-deal for 2015, and many observers expect more to follow. Last year, the annuity purchase market was valued at $8.7 billion compared with $4 billion in 2013, according to Towers Watson & Co. data.
While the retirement industry has seen the massive shift to 401(k) and other defined contribution plans, consultants say de-risking strategies like annuity buyouts are helping companies strengthen and sustain their defined benefit plans.
“It’s responsible risk management,” McEvoy said. “It’s a way to bring down the size of the plan and focus on employees.”
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