De-risking strategies are likely to become more popular with US corporate pension funds now they have reached their healthiest state since the crisis. This trend has been ongoing for the last couple of years but may substantially accelerate in 2014, says consultancy Towers Watson.
The firm examined pensions data for the 418 Fortune 1000 companies that sponsor US defined benefit (DB) pension plans and found that the pension funded status of the nation’s largest sponsors increased from 77% at the end of 2012 to 93% end-2013, the highest levels since 2008.
A similar study by Milliman focusing on the 100 largest corporate DB pension plans (the Milliman 100 Pension Funding index) revealed even better results – the funded ratio was 95.2% as of end-2013 against 77.2% the previous year. This dramatic improvement was attributed to rising interest rates, which lowered liabilities, and a strong stock market.
The discount rate for the December 2013 funded status surged 87 basis points to 4.83% from 3.96% at the end of 2012, causing a 7.4% decrease of the projected benefit obligations for the 100 DB pension plans analysed by Milliman. Their cumulative investment return was 11.%, higher that the 7.5% median expected return. If this improvement continues, Milliman reckons that many companies could attain fully funded status for their plans in 2014.
But other “intriguing opportunities for 2014” are open to pension plan sponsors thanks to the improved funding environment, says Dave Suchsland, a senior retirement consultant at Towers Watson. “We expect the actions we’ve seen among companies to de-risk their pension plans over the past several years will accelerate, especially in light of increases in PBGC [pension benefit guaranty corporation] premiums.”
The effect of the premium hikes, according to Aon Hewitt, could increase the carrying costs of unfunded pension liabilities by more than 3%.
De-risking strategies – other than finance strategies – involve the transfer of benefits, and their associated assets and liabilities, from a DB plan and its sponsor to participants or insurance companies. The most common move is paying lump sums to terminated vested participants – Verizon Communications has taken this approach. The alternative – adopted by The New York Times and Thomson Reuters – is to transfer pension obligations to an insurer through a group annuity at a price that includes a premium. Ford and General Motors have offered both options to their plans’ participants.
The lump sum option has become more convenient for sponsors following a change in the rules by the Pension Protection Act of 2006, effective in 2012. The lump sum is now more or less equal to the value of the benefit carried on the sponsor’s books and could be paid out without sustaining a loss, according to October Three Consulting. On the contrary, paying out an annuity costs 105-110% of the book value of a retiree’s benefits, because of the insurer’s regulatory and administrative costs, differences in underwriting criteria, and profit margins. This is why 28% of respondents to a recent Towers Watson survey of 180 US DB plan sponsors said they are either planning to offer lump-sum payments next year or are considering doing so. A further 39% did this in 2012 or were doing so in 2013. Only 11% were considering a group annuity deal.
Participant advocates, such as the American Association of Retired Persons and the Pension Rights Center, are concerned about such de-risking strategies. They think that due to provider fees and regulatory costs, participants are unlikely to be able to reproduce their DB benefits by using the lump sum to buy a retail annuity. Annuities are also problematic because they are not protected by the PBGC.
These concerns were heard by the ERISA Advisory Council, which has issued summary findings and recommendations about the need to disclose pros and cons of lump sums and annuities to plan participants who can choose whether to accept them or not.
The US Department of Labor is considering new regulations, but there are no deadlines.