Tom Harvey, director of the
Advisory Team within SEI’s Institutional Group, in Oaks, Pennsylvania,
says conversations with defined benefit (DB) plan sponsors show they
are fatigued because they’ve put assets in their plans and the
investments have performed well since the financial crisis—but their
funded status is no better than five years ago.
“Annuitization is appealing because they want to get out of managing money,” he says.
In
addition to the appeal of offloading the tedious work of running the
pension, employers are also commonly presented with a picture of pension
annuitizaiton that makes strong financial sense. However, one problem
with this process, Harvey contends in a recent Q&A,
is that the costs of implementing an annuitization strategy are often
quoted by insurers in terms of a premium over the pension benefit
obligation (PBO) liabilities—and that premium right now is at
historically low levels.
Harvey explains to PLANADVISER that many
real-life plans have actually performed much better than PBO
projections might indicate—implying that just because the snap-shot
PBO-derived premium calculation looks attractive today, this does not
mean that over the projected lifetime of the pension assets and
liabilities the economic picture could not very well shift. And so, for
many employers, it may be more prudent in the end financially speaking
to keep the pension assets and liability in house.
Harvey
suggests the PBO accounting measure indicates funded status is the same
or lower than five years ago, but measuring actual liabilities shows
most plan sponsors are in fact better off than five years ago. “For an
individual employer, it will be about considering what the liability
looks like and whether you can manage it. Many payments are due 50 years
out, so plan sponsors can pay out of cash flow quite easily with the
proper planning,” he says.
The ultimate measure that will settle
the debate for many employers is total liability, Harvey says. He
cautions plan sponsors not to worry about a fluctuating PBO projection
year over year, and just to invest prudently against the true liability.
“Discount rates dropped 40% this year; no one’s benefits went up. PBO
drove liability higher, but no plan sponsor’s liability changed as a
factual matter. PBO is not a reason to change strategy,” he adds.
Harvey
also notes that in today’s low-yield environment, “it takes a lot of
bond to feed liability.” It is thus not very easy for the insurers to
turn a profit on pension assets, and so the cost of annuitizing must
reflect this. He says it may also not be as complete or total a solution
as some plan sponsors may expect. He contends some plan sponsors may be
able to eliminate only one-third to half of liabilities, leaving a
money management problem that could be meaningful.
Lastly, Harvey
points out that pension payments are part of a whole range of
commitments employers have, to be weighed carefully alongside other debt
and capital expenditures. “There’s no place else that company’s feel
like they have to get the commitments off the balance sheet because of
funded status calculation. Pensions are pre-funded more so than other
liabilities,” he notes.
NEXT: Individual company considerationsWhile SEI contends maintaining the
DB plan is cheaper than annuitization for most DB plan sponsors, Jim
Kais, senior vice president and national retirement practice leader for
Transamerica Retirement Solutions in Miami, says the answer is not so
black and white.
He tells PLANADVISER there are a lot of factors
plans sponsors must weigh. He agrees annuitization can be expensive. For
one thing, the plan must be fully funded before annuitization will make
financial sense in many cases, so a cash infusion from the employer is
often needed, and it’s usually not a small amount. Kais says plan
sponsors should determine whether that cash outlay and annuitization
will provide more revenue and return for the company. “It’s not uncommon
today for plan sponsors to borrow to fund. Interest rates are low, so it can make sense to bridge that gap if plans are going to annuitize,” Kais says.
He
adds that right now demand is higher than supply—there’s a small group
of companies taking on pension risk—discount rates are around 2%, and
premiums are high.
There are so many factors that go into making
the decision to do an annuity buyout and terminate the plan—looking at
the market, where the company is in its life cycle, company goals and
how risk-averse it is. “Look at a plan with a liability of $11 million.
It will see an increase in liability with the new mortality tables. If
it has assets of $10 million, the unfunded liability of $1 million will
double just because of the change in mortality tables. This could be
tough head wind for companies that may not be cash rich,” Kais says.
On
a related note, Kais says DB plan sponsors need to modernize their
data; processes are still very manual. They need data to analyze and run
models to see if market returns will generate enough to keep the plan
going, he suggests.
Finally, according to Kais, DB plan sponsors
should not forget about the human resources (HR) aspect of terminating
the plan and annuitizing. “It’s really important for HR to have a seat
at the table with CFOs to discuss the impact for retention and
retirement readiness for future workers. With no DB, will employees be
able to retire?”
Even SEI concedes there are situations in which
DB plan annuitization makes sense. “If the pension is so large, such as
three times market capitalization, it can be unmanageable for the plan
sponsor. Small plans can create administrative and disclosure burdens on
the company,” Harvey says.
“We suggest looking carefully at
long-term cost and whether the DB plan is really a liability the plan
sponsor cannot manage; is benefit of annuitization worth it?” he adds.
“But, for most plan sponsors, they need to explore the all-in cost and
benefits rather than grab for a life preserver for something with which
they’re frustrated.”