Greenwich Associates has released a new report, “Lump-Sum Buyouts Gain Traction Among U.S. Pension Plans,” that explores why pension plans have begun to favor this course of action, as well as the possible effects this trend may have on the companies and employees that rely on these plans for their financial security. The report includes a case study of one U.S. company that undertook a lump-sum buyout of DB plan participants in 2012.
Lump sums may help companies to de-risk and remove liabilities from balance sheets—a hope that more than a dozen corporations embraced in 2012, Greenwich Associates claimed, by offering lump-sum options to current and/or former employees. Ford and GM led the charge in April and June of 2012. Ford made the offer to 95,000 salaried retirees and former employees, and GM extended lump-sum options to salaried retirees unprotected by union contracts. According to Greenwich associates, most companies have limited their buyout offers to former employees whose pensions have vested.
Greenwich Associates contends that companies may reduce their funding gaps by making lump-sum options available. A recent study by the data provider found that the average corporate plan funding ratio fell from 89% in 2011 to 81% in 2012, largely due to declining interest rates. More than six in ten plans are currently 85% funded or less, the largest-ever funding gaps, according to Mercer Investment Consulting.
The passage of the Pension Protection Act (PPA) in 2006 changed the basis for lump-sum calculations from interest rates to investment-grade corporate bond yields—effectively reducing the cost of pension plans’ future liabilities and making lump sums a more cost-effective risk transfer strategy.
But buyout options can also carry high administrative and execution costs. Plans that meet their regulatory requirements, are better funded and can afford the initial expenses will be more qualified to offer lump sums, but underfunded plans have the greater need to de-risk in this way, Greenwich Associates reported.
When considering whether to offer a lump-sum option, take into account the overall health and predicted longevity of your participant population, Greenwich Associates advised. A participant who expects a longer life may favor an annuity option, but an older participant population may present higher adverse risk to plan sponsors, the report claimed.
Greenwich Associates warns plan sponsors that a successful buyout requires plenty of lead-time for the fund’s investment strategy, which must be able to provide the cash to pay lump sums when they are due. Clear communication with participants is imperative, Greenwich Associates added, especially for past employees who may be more difficult to contact than current workers or retirees.
The report is available for request at Greenwich Associates’ website.