Senior Investment Research Analyst | Consulting Research Group
Is now the right time to de-risk? To terminate or not to terminate? What do I do now?
The burgeoning level of pension risk transfer (PRT) activity for traditional defined benefit plans demonstrates that plan sponsors have been grappling with these questions with increased frequency over the past several years. PRT is the settlement of defined benefit plan benefit obligations either directly with participants or by outsourcing the risk to a third-party insurer. In 2014, U.S. group pension buy-outs reached $8.5 billion across 280 plans, a staggering 120 percent increase over $3.8 billion in 2013. Annuity transaction activity continued in 2015 with 195 plans placing more than $8 billion by the third quarter. We anticipate these numbers could be even higher in 2016.
General Motors and Verizon grabbed headlines in 2012 by publicly confirming details of their PRT activities. Since that time, plan terminations and PRT activity levels have remained at the forefront of industry publications in large part due to recent market and legislative changes. This activity is a direct result of the changing pension landscape, including market conditions, legislative initiatives, economic influences, and company-specific drivers. Corporate pension plan sponsors are facing rising costs associated with managing plans, heightened regulatory oversight, and market conditions that could decrease plan funding status and increase funding status volatility. Additionally, organizations no longer view traditional pension plans as a recruiting or employee retention tool.
These factors have driven a considerable decline in the number of active pension plans over the past several decades. In fact, from 1980 to 2014 the Pension Benefit Guaranty Corporation (PBGC) covered almost 80 percent fewer plans. Of the remaining plans, approximately 44 percent had fully or partially frozen benefits in 2014, pointing toward the likelihood of future plan termination.
Managing the Moving Parts
PRT continues to be a hotly discussed topic that involves and affects numerous parties: participants, plan sponsor stakeholders, regulators, service providers, and insurance companies. When terminating a plan, pension plan sponsors must develop and execute a strategy with many overlapping stages lasting up to 24 months. Similar to the broader market statistics, many of our plan sponsor clients have a stated objective of terminating their frozen pension plans. These clients are seeking to eliminate unrewarded risk while fulfilling promises to their employees by pursuing various forms of PRT.
Many variables impact the pension market landscape and as many motivations lead corporations to pension risk transfer or termination. Reducing risk by eliminating or decreasing the size of the plan is the primary goal of any pension risk transfer or termination, regardless of the motivation. A successful plan termination or risk transfer protects participants at every phase of the process while balancing the plan sponsor’s economic considerations with the organization’s goals and objectives. In a practical sense, a successful PRT transaction requires monitoring all the steps in plan termination and managing the regulatory agencies and their respective requirements, filings, and approvals while keeping an eye on any changes within the PRT market.
Fiduciary vs. Settlor Roles
The plan sponsor has duties and obligations under the Employee Retirement Income Security Act of 1974 (ERISA) in addition to managing the many moving parts. Plan sponsor decisions fall into two functional categories: settlor and fiduciary. Committee members may find it difficult to differentiate between these roles and responsibilities since they wear both settlor and fiduciary hats at various times.
There are differing opinions about where settlor decisions end and fiduciary decisions begin. The most commonly accepted interpretation is that a plan sponsor’s decision to terminate a pension plan and to offer an annuity contract is a settlor function and, thus, is not subject to fiduciary requirements. However, the implementation of this termination strategy, including the selection of annuity providers, may be a fiduciary act and subject to fiduciary oversight.
A fine line exists between these two functions, and experts sometimes differ on the classification. For example, implementing a settlor decision may exercise discretion in plan administration and thereby become a fiduciary function. When the same party is both settlor and fiduciary, courts will closely scrutinize actions.
Regardless of whether the courts determine a given decision is a settlor or fiduciary function, CAPTRUST is concerned the lines are gray enough that plan sponsors should have a process in place, follow the plan documents (unless inconsistent with ERISA), and document the process. The class action lawsuit targeting Verizon’s PRT activity demonstrates PRT actions are heavily scrutinized by the participants. While multiple arguments in this case were ultimately dismissed, defending legal action is a costly proposition, and fiduciary violations can lead to personal liability. CAPTRUST recommends that plan sponsors consult with their ERISA attorneys when issues surrounding these roles arise.
Through Interpretive Bulletin 95-1 (DOL 95-1), the Department of Labor mandated certain criteria in selection of an annuity provider in connection with a plan termination and the purchase of the “safest annuity.” This bulletin helps protect participants and plan sponsors by defining criteria for consideration when balancing the safest vs. most affordable annuity selection. This mandate requires a plan sponsor to rely upon extensive research of insurance companies’ creditworthiness, diversification, and capital requirements of the insurers participating in this market, among other things. Plan sponsors should document their determination of the safest annuity, as defined in DOL 95-1, as part of their fiduciary process.
Evaluating PRT Service Providers
PRT is a complicated business transaction due to the nature of annuity placements and many moving parts of plan termination. This process will likely require expert third-party advice. CAPTRUST evaluated the landscape of PRT service providers to ensure our clients have access to the advice needed to accomplish their objectives. Our due diligence process identified BCG Terminal Funding as a superior provider of PRT services for our pension clients. BCG Terminal Funding has been in the pension risk transfer and annuitization market since 1983 and has advised on more than 2,000 transactions.
We have included insights from Mike Devlin, a partner at BCG, below as we continue to explore the PRT environment.
CAPTRUST: Can you describe the market landscape and the recent changes impacting plan sponsors?
Devlin: 2015 was an interesting year. First, capacity issues were tested from two standpoints. One, insurance carriers had record years, which made them rethink the type of liability they want to quote. With the demand for PRT at a record high, insurance carriers have the luxury to be picky. That is not good for plan sponsors, since instead of having five to seven carriers compete on pricing, they potentially have two or three, and in some scenarios, only one carrier participating.
Carriers also have to onboard all of the participants after being awarded the pension liability. When the market explodes like it did this year, carriers may slow down what they quote on as they absorb recent placements. For example, one carrier targeted $1 billion in placements for 2015. It hit that number by the end of the second quarter, which means the onboarding unit was working on a full year of placements that were placed in just two quarters.
CAPTRUST: What other changes impact plan sponsors? In particular, what does this mean for plan sponsors looking to terminate in the near term?
Devlin: The Internal Revenue Service halted the ability to offer lump sums to retirees in July 2015. Most were surprised that this option was available in the first place. We know people are living longer and not saving enough, which may lead to outliving your savings. Offering retirees the ability to opt out and take a lump sum seems to go against everything we are reading from the government. With this announcement, the demand for PRT will only increase.
The other change is the realization that the new mortality table is on the horizon (if the plan sponsor has not already implemented it). This will bring the plan liability calculation for the retiree block closer to the annuity cost, which will further increase demand in the PRT market in 2017.
CAPTRUST: Plan sponsors often underestimate the complexity and cost associated with plan termination and PRT. How would you suggest plan sponsors prepare for termination and pension risk transfer?
Devlin: Terminating a pension plan is an expensive process. That is why we highly recommend plan sponsors conduct a PRT analysis, which will illustrate exactly what their funding level is on a termination basis. We find that some plan sponsors are caught off guard when we show them that the cost to terminate is higher than they expected. Part of the disconnect is that there are various ways to measure your liability—from minimum funding level to accounting to termination.
Before they embark on a long and costly termination, we want to make sure they understand all aspects of termination including obstacles and costs. PRT analysis can help answer most of these questions. We recommend that the analysis be done in advance of deciding to terminate so that you can understand all options you have, including de-risking before termination. Questions that would be answered include:
- Should we annuitize retirees in advance of termination? If we do, what implications will this have if we choose to annuitize the remaining population later?
- Should we implement a lump sum for terminated vested participants if termination is not within reach?
BCG advises plan sponsors, makes the final recommendation, and acts in a fiduciary capacity in evaluating and selecting the safest annuity in a plan termination. While CAPTRUST has an understanding of the pension risk transfer process, the steps involved in a plan termination, the regulatory requirements, and the fiduciary considerations, we also recognize expert assistance in this process is in the best interest of our clients.
Having completed a significant number of plan terminations and advised on de-risking strategies, Devlin advises “… this became a year that you needed guidance from a PRT specialist who understands the existing obstacles as well as the new obstacles on the horizon.” Regardless of the PRT service provider you choose to collaborate with, CAPTRUST recommends engaging a PRT specialist early in the decision-making process. This will lead to better outcomes for participants and organizational stakeholders.
 LIMRA Security Retirement Institute survey results published by AnnuityNews.com. LIMRA, Accessed December 3, 2015, http://www.limra.com/Posts/PR/News_Releases/LIMRA_Secure_Retirement_Institute Third_Quarter_2015_U_S_Pension_Buy-out_Sales_top_$3_Billion_for_Second_Consecutive_Quarter.aspx?cid=RSSNewsCenter.
 PBGC 2013 Pension Insurance Data Tables, Accessed November 22, 2015, http://library.captrust.com/Institutional/DB%20Spotlights/DB_Topical%20Spotlight_Q3-2015%20(border).pdf.
 “ERISA: The Distinction between Settlor, Fiduciary and Corporate Functions.” ERISA Benefits Consulting, Inc., Accessed November 19, 2015, http://www.hg.org/article.asp?id=5138.
 David F. Jones, Kathleen Ziga, and Sumi C. Chong. “ERISA Fiduciary Responsibility and Liability.” Accessed November 19, 2015 https://www.dechert.com/files/Publication/ee304282-37b8-45eb-b765-07b7f39613a7/Presentation/PublicationAttachment/b8d46e10-6060-4a9f-8354-0fdfc5f7f71a/D.%20Jones,%20K.%20Ziga%20-%20ERISA%20Fiduciary%20Responsibility%20and%20Liability.pdf.