Letter from the US: De-risking threatened
Corporate America is looking at the impact of the Pundt, Edward vs Verizon Communications case after the Supreme Court awarded victory to the retirees. They were not happy with Verizon’s decision to transfer defined benefit (DB) pension liabilities to Prudential, a New Jersey-based insurance company. The case may have implications for de-risking.
Pension experts such as the American Association of Retired Persons and the Pension Rights Center hope that de-risking will now stop. But consultants say it is irreversible because of the funding status of DB pension plans. The current funding level is only 79% according to consulting firm Mercer. Last May, the estimated aggregate assets of pension plans sponsored by S&P 1500 companies were $1.82trn (€1.61trn), with liabilities of $2.32trn: the aggregate deficit was up $94bn from the $404bn at the end of 2015.
De-risking involves transferring benefits, and their associated assets and liabilities, from a DB plan and its sponsor to participants or insurance companies. An increasingly common move is transferring the company’s pension obligations to an insurer by buying a group annuity for employees. Between 2007 and 2015, 500 US companies transferred $67bn to insurers. Last year, $13.8bn was transferred, up from $8.7bn in 2014.
In 2012, there were a few mega deals including Verizon’s, a $7.5bn spin-off transaction, affecting 41,000 retirees and totalling a quarter of the company’s then $30.6bn in pension liabilities.
Two groups of retirees filed class actions to block the transaction. The retirees transferred to Prudential argue that they did not get adequate notice and were not asked for consent. Moreover, they are concerned about having lost the guaranteed federal Pension Board Guaranty Corporation protection. They are afraid that if Prudential or a successor experiences an asset shortfall, the insurance industry guaranty associations will not be able to save their benefits.
The other retirees – still in the company’s pension plan – claim that Verizon breached its fiduciary duty when it paid a $1bn fee to Prudential for the annuity, using money out of plan assets rather than the company’s revenue: they argue that the $1bn should have been used in favour of their benefits.
So far, nobody has lost any benefits. But waiting for proof of harm will be too late, Verizon retirees argue. A lower court ruled against them, while the Supreme Court gave them the right to sue even though their benefits have not yet been hurt, and sent the case back to be re-evaluated.
“That is a huge vindication of our argument,” said Jack Cohen, the chairman of the Association of BellTel Retirees, one of the two groups of plaintiffs. “The court has sent a powerful message that Verizon retirees – and, by extension, millions of others whose pensions have been de-risked – cannot simply be dismissed. On behalf of our 134,000 members, we will not stop the fight for our retirement security.”
However, Jason Richards, a pension de-risking consultant at Willis Towers Watson, does not see any slowdown in de-risking. “Pension plan sponsors are very aware of their fiduciary duties and of the legal problems, especially regarding annuity purchases,” he explains. “When we advise clients about this matter, we stress that you can never eliminate the chance of being sued. What’s crucial is to follow a very clear process and due diligence while making settlor decisions – in the interest of the company, such as freezing the pension plan – or fiduciary decisions in the interest of the pension plan’s members, such as investing the assets.”
It is too early to know how many billions in obligations will be transferred in 2016, because usually companies wait until year end to make decisions.
“But, with interest rates still falling and equity markets still very volatile, funding problems are not going to get better for pension plans,” says Richards. “So, we think that de-risking with group annuities will go on.”