Considerations for Settling Pension Obligations

October 26, 2012 ( - For today’s frozen defined benefit (DB) plans, the question is not if they will settle—it’s more about “how” or “when.”

“We think 2012 is sort of the beginning of a tipping point [for the settlement market],” Jay Dinunzio, senior consultant at Dietrich & Associates, said during a webinar titled “The Next Big Thing in the Pension Market—Liability Settlements.”

The “how” of a pension settlement—discharging all or a portion of an employer’s pension benefit obligation—is the decision to offer participants either a lump sum they elect to receive, or an annuity. The “when” has become complex because of factors including the low interest rate environment and many underfunded plans. In order to settle obligations, plan sponsors must also recognize the significant added costs associated with it, Dinunzio said.

The decision to settle is a deviation of “business as usual,” so plan sponsors must overcome the psychological hurdle of breaking out of their routine, he added.

This summer, General Motors Co. announced it would offer lump-sum payments to select retirees and monthly pension payments to others administered by The Prudential Insurance Company of America. The retirement plan actions resulted in an expected $26 billion reduction of G.M.’s U.S. salaried pension obligation, the largest insured annuity settlement in U.S history (see “GM Transfers Some Pension Risk”). Trailing behind it is Verizon Communications Inc., which announced in October it had signed a partial pension buyout deal to transfer approximately $7.5 billion of the Verizon Management Pension Plan obligations to Prudential (see “Verizon Signs Partial Pension Buyout Deal”).

When deciding between lump sum and annuity, Dinunzio said the following should be considered: 

For lump sums: 

  •  Large one-time payment
  •  Flexibility to invest
  •  Preference of non-retired participants
  •  Must be actively elected
  •  Interest rate basis fixed annually
  •  Attractive option for unhealthy people
  •  Distribution from plan trust
  •  Sponsor focused on bottom line
  •  Election process complexity


 For annuities: 

  •  Smaller monthly payments
  •  Guaranteed income for life
  •  Preference of current retirees
  •  Required default option if lump sum settlement (LSS) is not elected
  •  Interest rate basis varies daily
  •  Attractive option for healthy people
  •  Plan assets used to purchase group annuity contract
  •  Paternalistic sponsor


Most participants do not want a lump sum because they have budgeted around monthly income in the past, Dinunzio said. The risk remains, he added, that healthy people will all choose the annuity while unhealthy people will elect to have a lump sum.

Dinunzio concluded that several things are driving settlements: Aside from technical factors such as the Moving Ahead for Progress in the 21st Century Act (MAP-21), he said in general CEOs are becoming more informed and there is an increased corporate value to eliminating pension debt. “They want to move the obligation off their books,” he said.