Preparations for Pension Buyouts and Lump Sums

April 5, 2013 ( - Plan sponsors considering pension risk transfers should take steps ahead of time.

A thorough communications plan should be put in place to deliver the right messages and prepare the targeted population for the transaction–whether a buyout or pension lump sums–so participants have time to make a decision. “It’s always best to let the facts speak for themselves,” Jerry Levy, principal and consulting actuary for Mercer, as well as author of Mercer’s Retirement Perspective, “Pension Risk Transfers Revisited,” told PLANSPONSOR.

Levy suggested plan sponsors inform participants why they are undertaking the transaction, and explain what it means for participants. If participants are asked to make a choice of a lump sum or annuity, plan sponsors may want to consider providing them with access to independent financial counseling. “Providing these tools is a great opportunity for employees if the organization wants to do that,” Levy said.

In light of a buyout transaction, the investment policy statement should be reviewed, Levy said. This is because the pension plan may have a significantly different liability structure after blocks of inactive participants are cashed out or annuity contracts are purchased.

A large transaction may affect the mix of stocks and bonds, and the duration of liabilities may change, Levy said. Plan sponsors may want to look at further de-risking and reducing the assets invested in equities, and they may want to rearrange liabilities and assets to facilitate total plan termination, he added.

Before jumping into a bulk annuity purchase, it may be useful to implement a phased de-risking approach over more than one fiscal year, according to Levy. This longer timeline can allow a plan sponsor to avoid significant settlement expense, or take advantage of a year in which there is a significant charge to earnings from an unrelated source. Mercer’s paper suggests plan sponsors discuss these options with human resources, accounting, finance representatives and legal counsel to avoid pension and age discrimination issues.

Plan sponsors should plan carefully for de-risking activity and avoid “busy” seasons or annual health care enrollment times.

Interest rates are another factor for when to de-risk. Plan sponsors may be hesitant about buying annuities or cashing out deferred benefits in a low interest rate environment. However, Mercer suggests the plan sponsor could use a portion of the existing bond portfolio to pay the lump sums or purchase annuities, which would reduce some concern about timing because the value of the bonds would fall as interest rates rose.

A plan sponsor can also consider the attractiveness of the after-tax cost of borrowing. The loan proceeds could be used to fund the pension plan and would be available for cash-outs, annuity purchases and to raise the plan’s funded status if needed to avoid benefit restrictions or eliminate Pension Benefit Guaranty Corporation (PBGC) variable premiums, the paper said. That “borrow-to-fund” strategy was used recently by some large employers and can be used by companies that can borrow at the current low interest rates.