Will your defined benefit pension be the next to be “derisked” and then dumped? Clorox froze its defined benefit pension plan in 2011, and now it’s taking steps to prep the plan in case the fiduciary committee decides to offload it onto an insurer, according to a Clorox executive who spoke at a recent Mercer webcast on pension derisking.
What does pension derisking mean for workers? Employers might offer to pay current retirees and former employees lump sums in lieu of promised monthly pension payments. Or they might replace former employees’ pensions with equivalent annuities purchased from an insurer. In some cases, employers who intend to keep running their plans in-house are changing investments to less risky ones to make the plans more stable. But there are outside risks–increasing PBGC premiums and increasing longevity–that are making it a costlier and a tougher case to keep the pension liabilities on the books.
“There’s obviously going to be an upward pressure on maintaining even a frozen plan,” said Chip Conrad, treasurer and vice president of tax at Clorox. “We need to work with our fiduciary committee to educate themselves and ourselves on the trade-offs and opportunities so that we’re ready for the day that we’re fully funded and may wish to offload liabilities—so we’re poised to execute—but I quickly add that the key focus will be on the best interest of plan participants.”
U.S. pension plans sponsored by S&P 500 companies were fully funded (meaning they had enough banked to meet future obligations to retirees) in 2007 but got hammered in the Great Recession when stock values dropped and interest rates declined. They hit a low point at the end of July 2012 at only 69.5% funded—a deficit of $689 billion. But then by December 2013, thanks to rising equity markets and higher interest rates these same plans were at nearly 95% funded.
That’s important because being fully funded is a prerequisite to transferring pension risk onto an insurer.
“There’s a real window of opportunity available now,” said Geoff Manville, who monitors the latest legislative developments from Washington, D.C. for Mercer, a global benefits consulting firm.
Mercer, a Marsh & McLennan company, is spreading the word about how the improved funding levels create an opening for employers to “derisk” their pension plans. That includes strategies to reduce volatility, offloading pension liabilities onto insurers, and offering lump sum cashouts to plan participants or buyouts to retirees already receiving monthly checks.
Conrad described to fellow corporate tax execs how Mercer helped Clorox derisk its defined benefit plan by using a glide path to move into fixed income as certain funding triggers were hit. The theory is to take risk off the table as funding status improves. Gordon Fletcher, a Mercer pension risk expert, showed how lump sum offers (the Internal Revenue Service mandates the dollar amount of the offer) generally cost an employer much less than what it would cost to keep the pension on the books or to transfer it to an insurer.
There are two big cost factors to keeping pensions that are motivating employers to consider dropping them. First, there’s a dramatic rise in Pension Benefit Guaranty Corporation premiums on the horizon starting in 2015; employers have to pay a premium into the PBGC pot for each plan participant each year. Second, longevity is a factor: new IRS-mandated mortality tables will make keeping pensions on the books more costly.
Also, taking a pension plan off the corporate books removes volatility from the balance sheet; it’s a trend that appears to be accelerating. More insurers are entering the market, according to LIMRA, an insurance and financial services company trade group. Sales of pension risk buy-out products topped $3.8 billion in 2013, the best sales year since 1999 with the exception of 2012 when General Motors and Verizon transferred their group pension obligations to Prudential and the tally for the year was $35.9 billion. LIMRA analysts predict that 2014 pension buy-outs will eclipse 2013 and grow for several years to come.
Another issue companies are toying with is whether to make additional contributions to their pension plans to mitigate higher PBGC premiums; there’s essentially a 3% return on cash available because accelerated contributions can reduce the PBGC variable rate premiums by close to 3%. Conrad said that while Clorox is mindful of the ability to prefund its pension to take advantage of “the PBGC arbitrage,” the company has chosen not to because “we guard our uses of cash.”
The Pension Rights Center maintains a list here of some of the dozens of employers who have frozen their plans (Boeing is the most recent addition to the list) in the last few years and another list here of those that have offered lump sum pension buyouts.