A Plan Sponsor Transfers Nonqualified DB Plan Risks

Many plan sponsors have used annuity purchases for their qualified DB plans to ensure participants’ benefits are protected from market volatility; a similar strategy can be used for nonqualified DBs.

When Ralph Balestriere, CFO of the Red Wing Shoe Company in Red Wing Minnesota, came to the company in 2010, he found its qualified defined benefit (DB) plan assets were mismanaged in the recessionary period.

The wrong investment vehicles were used; the plans were banking on interest rates rising, which didn’t happen. “I said, this is enough, let’s get out of our DB plans,” he tells PLANSPONSOR. “We are not in the pension business, and we don’t have a lot of resources to manage investment strategy in our DBs.” The company offers three qualified DB plans as well as a nonqualified DB plan—the Supplemental Executive Retirement Plan (SERP)—and a nonqualified deferred compensation plan.

According to Balestriere, the company has had a de-risking strategy for its DB plans for the last three years. It’s using a de-risking glide path for investments; has offered a lump-sum window for vested, terminated participants; and has received a prohibited transaction exemption from the Department of Labor (DOL) to contribute some shares of the company into its plans.

With the end goal of making sure the DB plans were not subject to market volatility, once the SERP became 100% funded, Red Wing decided to do an annuity buy-in. Balestriere says he presented the decision to the company’s board in December 2015 and they were enthusiastic about it—three of the board members are participants in the plan.

The task of finding the right annuity provider was given to Red Wing’s adviser since 1995, Mesirow Financial. Greg Giles, president of the compensation and executive benefit strategies group and senior managing director at Mesirow in Chicago, says Mesirow vetted insurance companies and interviewed them. “The approach we took was to use DOL Interpretive Bulletin 95-1 guidance for annuity selection for qualified plans,” he tells PLANSPONSOR. “We recognized we were not being held to that fiduciary standard, but it made sense to hold insurance companies to standards and evaluate pricing.” Pacific Life was chosen as the annuity buy-in provider in 2016.

NEXT: The buy-in and its benefits

Giles adds, “This was one of most fun, creative, exciting things we’ve worked on in a long time. This forced us to think outside the box, to take strategies used in qualified plans and use them for nonqualified plans.”

While the complete plan de-risking process took years, once Pacific Life was selected, the transaction was closed within 30 days. The SERP has about $26 million in assets and 20 participants, 15 of whom are retired. The difference between a pension buy-out and buy-in is that, with a buy-in, the company still keeps responsibility for the plan payments and communications with participants. The transaction was seamless to participants. According to Giles, it was a corporate finance transaction to secure the plan’s balance sheet from longevity risk and invisible to participants.

So, the buy-in has eliminated the market volatility risk for the plan. “We don’t have to worry about another recession anymore,” Balestriere says. But, it also has addressed longevity risk.

Giles explains that the SERP does not offer lump-sums, but offers lifetime annuities to participants and surviving spouses. “When we looked at potential payouts, we were betting on the mortality of not only participants, but spouses. So how much do we fund the rabbi trust assuming mortality when some outliers could live to 103?” The buy-in makes sure payments will be provided.

Balestriere says he would tell other nonqualified DB plan sponsors it was a very simple, logical, easy process, and he felt comfortable with the transaction. “It was a no-brainer, and it helps you sleep better at night.” But, he says plan sponsors should realize it is not cheap. There is an expense and it has to be recorded on profit/loss statements. Plan sponsors should be ready to accept that.