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June 26, 2013 01:00 AM

Pension buyouts might increase risk for plan, report finds

Kevin Olsen
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    Karin Franceries said she knew it was an expensive solution to getting pension liabilities off balance sheets, but was surprised by the outcome showing the plan actually became riskier.

    Purchasing a pension buyout for retirees might increase risk for the pension fund and result in greater costs to the company than the premium paid to an insurer, according to a report from J.P. Morgan Asset Management.

    JPMAM's most recent “Pension Pulse” report runs through a case study of a closed pension fund that is 80% funded with about $1.2 billion in assets. Karin Franceries, executive director of JPMAM, said it represented a typical corporate pension fund.

    “We (reached) conclusions that were quite different from what we had been hearing from people,” Ms. Franceries said in a telephone interview. “It's just not necessarily the most optimal solution at any state (of the plan).”

    Ms. Franceries said the firm decided to study the issue because of the surge in interest from companies since General Motors Co. purchased a pension buyout last June from Prudential Insurance Co. of America. Ms. Franceries said she knew it was an expensive solution to getting pension liabilities off balance sheets, but was surprised by the outcome showing the plan actually became riskier.

    The report cites a 2012 study that showed 44% of pension fund executives surveyed said they were likely to engage in risk transfers like buyouts over the next two years. The fiscal environment has improved as well; the aggregate funded status of Russell 3000 companies improved to 86% at the end of May from 77% at the end of 2012.

    The report concluded the post-buyout downside risk is larger because the liabilities remaining have a longer duration, the service cost compounds the effect and the funded status is lower because additional assets need to be transferred to an insurer as a premium for taking on the liabilities. While the risk would be greater, including longevity risk, a buyout would also provide more freedom for companies to take on more investment risk for higher returns since the remaining participants would be active employees and not receiving benefits until years down the line.

    The two factors that make a buyout attractive are if the plan is frozen and fully funded, Ms. Franceries said. However, the report did not delve into behavioral factors of pursuing a buyout, such as the market reaction, as analysts tend to prefer to see smaller pension liabilities compared to a company's market capitalization.

    In the case study, expected pension contributions by a company in the 10 years following a buyout are actually greater than just keeping all the pension assets.

    The reduction in administrative costs and Pension Benefit Guaranty Corp. premiums that come with a buyout “honestly doesn't make that much of a difference,” Ms. Franceries said. While there would be fewer members in a plan, premiums would increase because the plan would have a lower funded status.

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