Transfer strategies on the fast track

U.S. corporate executives, in their zeal to cull the risk of holding traditional defined benefit plan liabilities, have in the past several years increased the frequency of pension risk transfer transactions in a trend that is only expected to accelerate.

Hundreds of U.S. companies with defined benefit plans have transferred their pension liabilities to participants via lump sums or by purchasing group annuities from insurance companies since the beginning of 2012.

It is one of the profound turning points in the transformation of the U.S. retirement plan landscape, and it has only begun. Aon Hewitt, Lincolnshire, Ill., completed a survey last fall of 183 mostly large corporate DB plans that showed almost half anticipate taking some kind of settlement action in 2015.

Twenty-two percent of surveyed employers foresee offering lump-sums to terminated vested participants and 21% are considering purchasing group annuities from insurance companies.

“Pension plan risk has certainly come to the forefront in the last 10 years,” said Joseph Nankof, founder and partner at Rocaton Investment Advisors LLC, Norwalk, Conn.

It is an evolution that began with a funding crisis in the early years of the 21st century following the tech bubble and the recession that followed, a crisis that culminated with the passage of the Pension Protection Act of 2006 and the adoption of new Financial Accounting Statement 158 standards that same year moving pension plan liabilities to the corporate balance sheet.

The final phase of the PPA went into effect on Jan. 1, 2012, bringing new corporate bond rates to replace 30-year Treasuries, the spread between which was generally 125 to 150 basis points, to determine the size of lump-sum payments.

Those events led to companies not only reducing risk through liability-driven investing strategies, but dispensing with their risk entirely, the most common method of which has been offering lump sums to terminated vested participants who have yet to retire.

Between 400 and 500 companies have offered a lump-sum payment to those participants — by far the most common pension risk transfer method — since the adoption of the corporate bond rate, said Matt Herrmann, St. Louis-based leader of Towers Watson & Co.'s retirement risk management group.

Until then, lump-sum offers generally were deemed too expensive.

In April 2012, the floodgates officially opened when Ford Motor Co., Dearborn, Mich., announced a lump-sum offer to 90,000 retirees and former employees who had yet to retire. It was by leaps and bounds the largest such offer ever announced.

“It's a helpful and useful tool to control the size of the plan. Part of the problem is these plans have become materially larger than they anticipated,” Mr. Herrmann said.

An additional hurdle, however, is the requirement that a plan reach an 80% funding ratio before such a lump-sum offer to terminated vested participants can be made. Significant pension contributions are usually the first step in the pension risk transfer process, followed by lump sums to terminated vested participants, then often a group annuity purchase from an insurance company.

Lump-sum offers to retirees are the most rare of all PRT transactions because those require private letter rulings from the IRS.

Dan Susik, senior vice president, finance, and treasurer, at Ryder System Inc., Miami, said the company's move in October to offer lump sums to terminated vested employees made sense as a way to deal with administrative costs as well as Pension Benefit Guaranty Corp. premiums. The company had frozen its defined benefit plan in 2008.

“We offered the (terminated vested) lump sum to somewhere in the 10,000 to 11,000 number range,” Mr. Susik said. “We were very pleased to find about 62% (accepted the offer), which is a good response.”

Many of those former employees' lump sums were very small and reduced pension liabilities about 12%, or roughly $250 million.

“From an administrative perspective, it made a lot of sense,” Mr. Susik said. “It also was a material reduction in our PBGC premium.”

The premium that defined benefit plans must pay to the PBGC is in part calculated by measuring the number of participants in a plan. The fewer the participants, the smaller the premium.

“We constantly are studying ways to lower risk in the plan,” said Robin Diamonte, chief investment officer at United Technologies Corp., Hartford, Conn. “It's an ongoing process constantly, so we're always talking to insurance companies and trying to understand pension risk transfer.”

United Technologies has an open union defined benefit plan and a frozen salaried traditional defined benefit plan, from which participants were moved to a cash balance plan in 2014.

That same year, in an effort to reduce administrative costs, the company offered lump sums to terminated vested participants who had yet to retire and had very small balances, and thus would be more likely in theory to accept the offer.

“We decided to increase it to people that had $30,000 or less of terminated vested (benefits),” Ms. Diamonte said, “Only the one that are not in any kind of status, for $30,000 benefit or less, and ended up expanding it to $50,000 or less.”

“We did a first wave and the take rate was in line what we were expecting,” she said. “We offered it to about 36,000 participants and we had 17,600 actually take it, so it was a 49% ... hit rate.”

Ms. Diamonte said the savings overall were about $400 million in pension liabilities, the loss of which isn't affecting the plan's investment plans, since it's a small slice of the more than $32 billion in assets the company oversees.

What affects more of the company's derisking plans is the seemingly logic-defying ability of interest rates to stick to record lows, as well as new mortality tables recently released by the Society of Actuaries.

“It is interesting (that) we were about 88% funded at the end of last year. We were closer to 100% the year before,” Ms. Diamonte said. “It was those two things that took us down. We had good investment returns. It really makes you rethink your derisking model.”

“We're holding steady on the (derisking) glidepath. We're going to look at these derisking possibilities. We think with interest rates like this, it's really hard to put more of a hedge in this market,” she added.

John Boudreau, Duluth, Ga.-based treasurer at NCR Corp., said the first phase of the company's pension transformation strategy, which began in 2010, was primarily a response to the financial crisis.

“(The crisis) sensitized the company to the enterprise risk of how large this liability was in relation to the size of the company,” Mr. Boudreau said.

The first phase of NCR's strategy was moving all of its assets to fixed income. The second phase, in August 2012, included a voluntary lump-sum offer to about 23,000 former employees who were vested in the company's frozen U.S. defined benefit plan but had yet to receive benefits. The company said that offer had reduced its liabilities by about $240 million for its then $2.7 billion plan.

In June 2014, another lump-sum offer, this time to U.S. retirees who began receiving benefits between Jan. 1, 1994, and April 1, 2014, was announced; and in December, in the latest phase of NCR's pension transformation strategy the company agreed to partial buyout with Principal Life Insurance for retirees who had started receiving benefits before Jan. 1, 1994.

It was the second buyout for the company, which in November entered into an annuity buyout agreement with Pension Insurance Corp. for the defined benefit pension fund for NCR Ltd., its U.K. subsidiary.

Buyout activity also has made headlines since 2012.

In June of that year, General Motors Co., Detroit, made the unprecedented announcement it would offer a lump-sum payment to 42,000 retirees in its U.S. salaried pension plan, about 30% of which accepted it, and also had purchased a group annuity contract from Prudential Life Insurance Co. under which Prudential agreed to pay and administer future benefit payments to another 76,000 U.S. salaried retirees, transferring about $29 billion in liabilities.

The latter deal is the largest such transaction in U.S. history and underscored the reality that the amount some companies held in pension liabilities was greater or equal to the company's market capitalization, and it made economic sense to move those liabilities off the company's books.

GM's market cap at the time of the Prudential transaction was about $34.5 billion compared to pension liabilities of $109 billion as of Dec. 31, 2011.

Motorola Solutions Inc., Schaumburg, Ill., which completed the third largest annuity transaction in U.S. history in September, transferred its risk for similar reasons. The transaction reduced liabilities by about $3 billion. As of Dec. 31, after the annuity transactions in tandem with lump-sum offers, U.S. plan assets totaled $3.3 billion and projected benefit obligations totaled $4.5 billion, according to the company's recently released 10-K filing.

“This is a company that has gotten smaller over the last decade and a half, so if you rewind 15 years, the company had $45 billion in sales, six major businesses, (and) 150,000 employees. What we're going to be left with after the divestiture ... is a monoline business with about $6 billion in revenue and about 15,000 employees. And this business is still saddled with a legacy pension,” Robert O'Keef, Motorola Solutions' corporate vice president and treasurer, said in an interview at the time.

“You look at Kimberly-Clark (which announced a buyout Feb. 23) and Verizon a year or two ago, these are not companies that felt like they had to do something, I think they looked at the economics and they thought this made sense to do,” Mr. Boudreau said.

Additionally, with pension liabilities now making an impact on balance sheets, companies also have come to the realization that they don't possess the expertise they believe necessary to manage those plans.

“Pension accounting can create a fair amount of variability and volatility into our financial results. For us, we looked at it from the standpoint of, how can we address this liability and transfer it to an insurance company?” said Philip Fracassa, executive vice president and chief financial officer at The Timken Co., Canton, Ohio.

Timken purchased a group annuity contract from Prudential in January, reducing its pension liabilities by $600 million. Global plan assets had totaled about $2.1 billion at the end of 2014.

“We're not money managers by trade,” Mr. Fracassa said. “We make bearings and power transmission components.”

After the unprecedented activity of the past three years, even more activity in the arena of lump-sum offers and group annuity buyouts is expected.

Brad Howard, New York-based senior manager at Deloitte Consulting LLP, said that an expected update in the IRS mortality tables to determine lump sums, possibly coming as early as 2016, would give corporate plans a “very big impetus to act in 2015 if you're considering a lump-sum change.”

“Even those that have done one since 2012, a number of those will actually operate another window in an attempt to get ahead of the assumed IRS change,” Mr. Howard added.

Low interest rates continue to hamper companies' ability to keep liabilities under control, and while updated mortality tables compound that, they provide an appeal to choosing a group annuity buyout, said Sean Brennan, New York-based partner in the financial strategy group at Mercer LLC.

“On the relative perspective, the fact that many plan sponsors have adopted updated mortality tables, the pension liabilities look a whole lot more like insurance liabilities so annuity buyouts are relatively more attractive,” Mr. Brennan said.

With so many companies interested in transferring risk, there might be other issues, said Ari Jacobs, Aon Hewitt's global retirement solutions leader.

“There are limitations to the market,” he said. “So, for example, if (there are) tons of deals, there's not enough administrative capacity to run through the market, meaning we would have limitations of how many deals could be run at a time. That's just people resources.”

“There are capacity limitations against particular types of liabilities,” Mr. Jacobs added. “What I mean by that is, certain liabilities may have more potential insurance bidders than others, so if you're placing a standard retiree-only deal of a big size, you'll have bidders there. If you're looking for something very specialized, very unique with the more complex type of liabilities, you might have problems finding multiple insurers.” n