Concept of taking over frozen plans makes inroads in U.S.

Managing the assets and liabilities of frozen defined benefit plans might be the next frontier for financial firms.

Retiree Benefits LLC, New York, is the first firm to jump into the arena in the United States, and its executives hope that running frozen plans will become a major source of new business.

The new firm offers to acquire frozen defined benefit plans from corporate plan sponsors, assuming fiduciary responsibility for the plans and ensuring full benefit payments to the participants. Retiree Benefits and its investors will put up capital equaling 10% of the assets of the plans they acquire in order to ensure those full benefit payments, said Paul Palmer, chief executive of Retiree Benefits.

The new firm is being funded by three private equity firms: Amaranth Group Inc., New York; Cerberus Capital Management LP, New York; and Lightyear Capital Inc., New York. It will consult with Hewitt Associates, Lincolnshire, Ill., on human resource issues, and Groom Law Group, Washington, on the legal aspects of assuming fiduciary responsibility for the frozen pension plans.

Many companies are expected to close plans to new workers or freeze or cut benefit accruals for existing participants in their defined benefit plans. The process has already started for companies such as E.I. du Pont de Nemours & Co., Wilmington, Del., which announced Aug. 28 that it will freeze its $15.9 billion pension plan to new employees at the beginning of 2007 and reduce the accrual rate for existing participants to one-third the current level a year later.

Observers think officials at some companies will be eager to rid themselves of the responsibility of their plans, handing over both assets and liabilities to outside firms.

Companies that freeze their plans sometimes turn to an insurance company — such as MetLife Inc., New York, or Prudential Financial Inc., Newark, N.J. — by purchasing annuities in order to ensure benefit payments.

"Historically it's been the case that companies that freeze their plans sometimes purchase annuities," said Mr. Palmer. "Whether they do this depends on the price of the annuities relative to the asset yield of the frozen pension plan. When markets are good, many companies decide against purchasing annuities. For example, if the price of an annuity is LIBOR minus 50 basis points (currently about 5%), but your assets are earning 8% annually, then there's no way a company would purchase annuities."

Mr. Palmer said Retiree Benefits could notch a return over bond yields (the typical return a plan gets when it purchases annuities) and ensure full benefit payments without having to go to an insurance company because of the 10% in capital it will put up.

Creating a line of business by managing assets and liabilities of frozen pension plans is new in the United States, but has been occurring in the United Kingdom for two years. There, mark-to-market accounting has encouraged some companies with big asset-liability mismatches to freeze their pension plans and sell them. UBS Global Asset Management, Chicago, and MetLife are among the firms already offering their services to U.K. companies.

Many industry experts agree the new Pension Protection Act will lead scores of U.S. companies to freeze their plans, and possibly sell frozen pension plans to insurance companies that would match assets to liabilities in order to provide benefit payments for the life of the plan.

Mr. Palmer said the firm and its investors are not worried about ensuring full benefit payments to participants of frozen pension plans without partnering with an insurance company. "We're not an insurance company. In essence, when we acquire a frozen pension plan, we become the new plan sponsor and assume the fiduciary responsibility of that plan. We back up our work by putting up capital in case the markets don't do well. Typically, it's 10% of the plan assets." When asked if the company could afford to put up the 10% of assets as capital, he said, "We're not capital-constrained."

Mr. Palmer added that the key to success for his firm is that it won't just match assets to liabilities in a frozen pension plan; it also will invest the assets in a mix of stocks, bonds and alternatives in search of a return above liabilities.

"When you simply match assets to liabilities, you're missing out on the upside when the market does well," said Mr. Palmer. "Our approach is to get a return above a simple, long-duration bond coupon."

Mr. Palmer also noted his firm will make money based on the performance of the pension plans it takes over. "When the plans lose money, we lose money."

So far, Retiree Benefits doesn't have any clients, he said.

Executives at money management firms that are considering launching businesses similar to the one Retiree Benefits is offering said acquiring a pension plan is easier said than done.

Aaron Meder, associate director of the global investment solutions group at UBS Global Asset Management, said 10% of the $2.5 trillion in U.S. defined benefit assets is in frozen pension plans. "Our projection is that number will go to 20% to 30% in the next few years," he said.

UBS doesn't offer to acquire frozen U.S. pension plans, although it will manage the assets of frozen pension plans for plan sponsors.

Andrew Wozniak, director of research and analysis at Mellon Asset Management, Pittsburgh, said his firm is looking into the possibility of acquiring frozen plans; right now, he said, Mellon Asset will manage the assets in a liability-driven investment framework. "There are significant legal ramifications and other hurdles to doing so (acquiring the assets and liabilities frozen plans), so we're just examining those."

"When you have situations where you acquire a plan's assets, liabilities, mortality risk and expense risk, you need to have a lot of experience in doing so," said Cynthia Mallett, vice president of corporate benefit funding at MetLife, commenting on what it takes to manage the assets of a frozen plan. The firm is one of the largest managers of frozen pension plans, with $20.1 billion in assets from closed U.S. and overseas plans, managing those assets in annuities.