By Mark Miller
CHICAGO, Nov 19 (Reuters) - A growing number of employers are making plans to “de-risk” their pension plans. That’s jargon for reducing the financial risk posed to corporate balance sheets by pension plans - but if you have a defined-benefit pension and you start hearing that term tossed around, pay careful attention. Less risk for employers can mean more risk for you.
A survey of 180 pension plan sponsors by Towers Watson, the benefits consulting firm, found that 75 percent have implemented or are planning de-risking maneuvers. Their motive is to reduce risk posed by unfunded pension liabilities, which must be carried on the books as debt and hurt a company’s ratings from debt agencies.
De-risking strategies can vary from reducing exposure to risky equities in pension portfolios to offering lump sum buyouts to retirees and former workers. In some cases, plan sponsors have transferred pension obligations to private insurance companies by purchasing huge group annuities to pay out benefits.
“Plan sponsors are in a better position than they have been in a long time to think about a wide range of options,” says Matt Herrmann, head of the retirement risk-management group at consulting firm Towers Watson.
Traditional pensions have been in decline for years as more sponsors froze or terminated their plans. Just one-third of private-sector workers have them, down from 88 percent in 1975, according to the National Institute on Retirement Security.
If you’re already receiving a pension, or expect one in the future, the lump sum buyout trend bears especially careful watching. Two big companies, Ford Motor Co. and General Motors, made news last year with lump sum offers to large groups of retirees.
The Towers Watson survey finds that employers’ interest in lump sum offers is gaining momentum - fueled by two improvements in financial conditions that make these deals less expensive for them.
First, the stock market’s gains have sharply improved the funded status of pension plans. Plans sponsored by S&P 1500 companies stood at 91 percent in October, the highest since the same month in 2008, according to data compiled by Mercer, the consulting firm. (If a plan is underfunded, it needs to find the cash to make whole a retiree who takes a buyout.)
The second factor is higher prevailing interest rates. Lump sums are calculated using an interest rate pegged to corporate bond rates; the lower the rate, the higher the lump sum payout.
Towers Watson found that 28 percent of respondents are either planning to offer lump-sum payments to former employees next year or in 2015. That’s in addition to the 39 percent of respondents that made lump sum offers in 2012 or 2013.
While de-risking may help corporate balance sheets, it’s unnerving for retirees. “It’s frightening for a retiree - here you thought you were set for the rest of your life with a pension, and suddenly the rules change,” says Karen Friedman, executive vice president and policy director for the Pension Rights Center, a non-profit pension advocacy rights group.
A lump sum may sound attractive, especially if it’s a sizable amount, but determining whether it’s a good deal depends on these factors:
- Life expectancy. If you’re in good health and have a family history of longevity, the pension likely will pay out more to you over time than you could make taking the lump sum and investing it.
- Other income sources. If you have substantial savings or other sources of guaranteed income - Social Security or other pensions - a lump sum may make sense if you have an immediate need for the cash.
- Size of the lump sum. If the offer is coming from an employer for which you didn’t work long, it’s going to be small. Taking the offer may be attractive simply because it makes managing your various retirement accounts easier.
- Interest rates. The lump sum is a good deal only if you are certain you can beat the rate of return (referred to by the numbers folks as the “discount rate”) used to calculate what your pension is worth as a lump sum. The interest rates vary by age; the current rate for a 50-year-old terminated vested participant is 5 percent, Herrmann says. But since future pension payments are guaranteed, you need to compare that to what you could get on risk-free investments, like certificates of deposit or Treasuries - and there are no risk-free investments in today’s market that match or beat 5 percent.
Towers Watson also queried plan sponsors about their interest in buying group annuities for workers as a way to get pension liabilities off the books. General Motors’ de-risking plan also included a plan to buy a group annuity from Prudential for a large group of retirees who opted not to accept the lump sum offer. In these deals, pensioners continue to receive their full benefits, but the annuities lack the protection provided by the Pension Benefit Guarantee Corp, which takes over a plan and its benefit obligations if a sponsor goes belly-up.
Just 11 percent of survey respondents said they were considering a group annuity deal, suggesting GM hasn’t set a major trend in motion - at least not yet.