Is DB Plan Annuitization More Costly Than Maintaining the Plan?

SEI contends most companies can handle maintaining a DB plan for less than the cost of offloading it, but there are individual factors to consider.

By Rebecca Moore | September 28, 2016
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Tom Harvey, director of the Advisory Team within SEI’s Institutional Group, in Oaks, Pennsylvania, says  conversations with defined benefit (DB) plan sponsors show they are fatigued because they’ve put assets in their plans and the investments have performed well since the financial crisis—but their funded status is no better than five years ago.

“Annuitization is appealing because they want to get out of managing money,” he says.

In addition to the appeal of offloading the tedious work of running the pension, employers are also commonly presented with a picture of pension annuitizaiton that makes strong financial sense. However, one problem with this process, Harvey contends in a recent Q&A, is that the costs of implementing an annuitization strategy are often quoted by insurers in terms of a premium over the pension benefit obligation (PBO) liabilities—and that premium right now is at historically low levels. 

Harvey explains to PLANSPONSOR that many real-life plans have actually performed much better than PBO projections might indicate—implying that just because the snap-shot PBO-derived premium calculation looks attractive today, this does not mean that over the projected lifetime of the pension assets and liabilities the economic picture could not very well shift. And so, for many employers, it may be more prudent in the end financially speaking to keep the pension assets and liability in house. 

Harvey suggests the PBO accounting measure indicates funded status is the same or lower than five years ago, but measuring actual liabilities shows most plan sponsors are in fact better off than five years ago. “For an individual employer, it will be about considering what the liability looks like and whether you can manage it. Many payments are due 50 years out, so plan sponsors can pay out of cash flow quite easily with the proper planning,” he says.

The ultimate measure that will settle the debate for many employers is total liability, Harvey says. He cautions plan sponsors not to worry about a fluctuating PBO projection year over year, and just to invest prudently against the true liability. “Discount rates dropped 40% this year; no one’s benefits went up. PBO drove liability higher, but no plan sponsor’s liability changed as a factual matter. PBO is not a reason to change strategy,” he adds.

Harvey also notes that in today’s low-yield environment, “it takes a lot of bond to feed liability.” It is thus not very easy for the insurers to turn a profit on pension assets, and so the cost of annuitizing must reflect this. He says it may also not be as complete or total a solution as some plan sponsors may expect. He contends some plan sponsors may be able to eliminate only one-third to half of liabilities, leaving a money management problem that could be meaningful.

Lastly, Harvey points out that pension payments are part of a whole range of commitments employers have, to be weighed carefully alongside other debt and capital expenditures. “There’s no place else that company’s feel like they have to get the commitments off the balance sheet because of funded status calculation. Pensions are pre-funded more so than other liabilities,” he notes.

NEXT: Individual company considerations