In many cases misconceptions about offering lump-sum cashout windows for DB plans are the main reason why plan sponsors decide not to move forward, the firm contends. In a Point of View paper, “Terminated Vested Cashouts: Overcoming Common Misconceptions,” Mercer says the advantages of such a cashout can be numerous and the economics of such an exercise very compelling, pointing out that increases in interest rates and improvements in funded status during 2013 may make 2014 an “opportune time to capitalize on these advantages.” Mercer research indicates lump-sum cashout windows also tend to be popular with participants, with many using the opportunity to consolidate their retirement assets and take more control over their retirement planning.
The paper examines the reasons DB plan sponsors give for not going ahead with such cashouts and address how these challenges might be overcome.Interest rates are currently too low.
Plan sponsors note that a lower interest rate leads to a higher lump sum value and worry that the cashout amounts will be too high. If a plan sponsor is looking to profit from the expectation of higher interest rates though, the paper notes there are generally more efficient ways of doing that than carrying terminated vested liabilities.Incurring an opportunity cost in their asset portfolio.
Some plan sponsors express concern that by paying out lump sums, they lose the opportunity to generate returns in excess of the liability growth rate, which could impact their profit-and-loss expenses. Whether or not this is true depends on which assets are used to pay out lump sums, notes the paper, pointing out there is a way of paying out of fixed income assets that would preserve the same level of asset growth.
Funded status deteriorating if plan is already underfunded.
The paper points out that a plan’s funded status may understate the true economic cost of carrying liability, as it does not include costs of holding the liability such as administrative and Pension Benefit Guaranty Corporation (PBGC) costs. If plan sponsors capture tactical opportunities, lump sums paid may be less than the liability released.Triggering a profit-and-loss settlement charge and impacting share price.
If settlement accounting is undesirable, the paper points out that lump sum windows can be constructed in tranches so that the settlement accounting threshold is not breached in any year. Such tranches can be constructed by lump sum value, business unit or other methods that maximize the value of a cashout window while eliminating settlement recognition.
Employer contributions increasing.
The paper observes that such contribution acceleration is small relative to the potential costs savings of removing participants from the plan. In addition, to the extent that lump sums paid out are less than the economic liability, Mercer expects long-term contributions to decrease.
Not wanting employees to squander pensions.
While some plan sponsors have concerns that participants will be left with less retirement income by taking a lump-sum cashout, the paper notes that terminated, vested participants were not career employees with their company to begin with and therefore the lump sum may only make up a small part of their total retirement savings.
Intentions to terminate the plan anyway.
The paper observes that paying out lump sums now may reduce risk and costs over the extended period (one to two years) it can take to terminate a plan. In addition, paying lump sums while the plan is still in operation can be less complex and less costly.
Participant data is not clean enough.
Since many plan sponsors are challenged by maintaining accurate data for terminated, vested participants that may have left the company years before, the paper notes that doing a lump-sum window now could be beneficial in that the data for such participants would be more current and accurate.
Cashout programs require too many resources and are too expensive.
Mercer research finds plan sponsors receive fewer inquiries from participants doing a lump-sum window now rather than later. The paper notes that the cost of a cashout is equivalent or less than the cost of doing benefit calculations ad hoc as participants retire.
Mortality table changes will not be effective till 2016.
Given the decrease in interest rates over the first quarter of 2014, paying out lump sums may actually cost less than the obligation released. Going forward into 2015, this may no longer be the case as it is likely that auditors may start to make use of the new mortality tables, released by the Society of Actuaries, in advance of the projected 2016 adoption date.
“We believe that for plan sponsors that can get past these misconceptions, the benefits of a lump sum window may be compelling, though each organization’s specific circumstances need to be considered when making a decision,” conclude the authors of the paper.
The paper suggests plan sponsors perform a formal review that includes: quantifying the specific level of potential expense savings, both annual and present value; reviewing the cost of executing a cashout project and determining the specific implementation steps; determining if the return on investment is compelling enough; and launching a clean-up project to make sure that complete and accurate calculations exist for former employees.
Information about how to download the paper can be found here.