According to survey results provided in "Pension Plan De-Risking, North America 2015" (published by Clear Path Analysis and sponsored by Prudential Retirement), "pension risk management remains a principal concern for many plan sponsors." This should come as no surprise. Low interest rates, longer lifespans and anemic funding levels are a few of the concerns cited by the fifty-one senior professionals who answered questions. Half of the respondents agree that implementing a risk management strategy sooner than later makes sense, with one out of four individuals indicating an intent to transfer risk to an outside insurance company in 2015. Three out of four survey-takers "believe that movement in interest rates will impact their decisions to implement a liability driven investment strategy, or to execute a bulk annuity transaction." When asked about the use of alternatives such as hedge funds, fourteen percent replied that they currently use and seek to increase. One third currently allocates to alternatives and two percent look to introduce. Assuming that a respondent can only answer this question once and that there is one survey-taker per pension fund, this means that there is roughly a fifty-fifty split when it comes to including alternatives as part of a defined benefit plan investment portfolio.
If true that lower interest rates may discourage some plan sponsors from fully transferring risk to a third party insurer via a buy-out but they nevertheless seek to more actively manage pension risks, one could logically expect a greater use of a strategy such as Liability-Driven Investing ("LDI"). To the extent that LDI frequently entails the use of derivatives, those plan sponsors in favor of LDI may want to take note of a recent move by the U.S. Securities and Exchange Commission ("SEC"). As I just posted to my investment risk governance blog, certain registered funds could soon be asked to publish a considerable bounty of data about how they price securities, characteristics of trading counterparties and the specific use of derivative instruments. See "SEC and Asset Manager Disclosures About Use of Derivatives" (May 21, 2015). Sometimes an LDI strategy can include an allocation to alternatives. Post Dodd-Frank, lots of alternative fund managers are registering with the SEC. Connecting the dots, plan sponsors that use LDI and/or invest in alternatives are likely to benefit from enhanced disclosures made by asset managers.
Even those sponsors that decide on a risk transfer of some type other than LDI will soon be impacted by reporting mandates. In "Employers must disclose pension de-risking efforts to PBGC," Business Insurance contributor Jerry Geisel explains that data regarding lump sump arrangements will have to include answers to questions such as those listed below:
- How many plan participants "not in pay status" were offered a chance to switch from a monthly annuity to the lump sum payout?
- How many plan participants "in pay status" were given a choice?
- What was the number of participants who made the choice to take a lump sum?
In its filing with the Office of Management and Budget ("OMB"), the Pension Benefit Guaranty Corporation ("PBGC") writes that "de-risking" or "risk transfer" events "deserve PBGC's attention because (among other things) they lower the participant count and thus reduce the flat-rate premium and potentially the variable rate premium." Fewer dollars being paid for this last-resort insurance "have the potential to degrade PBGC's ability to carry out its mandate..."
Given the complexities of managing pension risks and the regulatory changes underway, you may want to attend the May 27, 2015 educational webinar entitled "Pension De-Risking for Employee Benefit Sponsors: Avoiding Litigation and Enforcement Action." I hope you can join us for a lively and topical event.
If you are looking for a few hours of musical fun and a good rags to riches story, I recommend Jersey Boys. I had the pleasure of seeing the stage production in Las Vegas last year. I liked it so much that I am seeing the Broadway show later this summer. The movie is equally fine although a theatrical aficionado may find the drama with music less exciting than music with a bit of drama. Besides the entertainment factor (and I give the film a thumbs up), the original endeavor and global touring companies continue to spin foot-thumping sounds into commercial gold. According to "'Jersey Boys' has been a windfall for all involved" by L.A. Times writer David Ng (June 21, 2014), worldwide grosses exceeded $1.7 billion in March with more than "20 million people in 10 countries," counting themselves as lucky audience members.
What you may find notable is that some of the talented contributors passed twenty-one a long time ago and yet demonstrate that one can keep working, if desired, for many years. Clint Eastwood was both a producer and director of the movie. He is eighty-four years old. Frankie Valli was an executive producer of the movie, helped to develop the stage deliverable and is still singing live at the age of eighty. Christopher Walken does a marvelous job as a celluloid version of Valli mentor, Gyp DeCarlo. He is seventy-one years old. Bob Gaudio, the magical hit-maker for the Four Seasons and member of the Songwriters Hall of Fame, has been front and center in the making of the play and movie. He is seventy-two years old.
These individuals are not alone in continuing their presence in the work force. Forbes staffer Halah Touryalai cited a Wells Fargo study that 30% of polled "middle-class American[s] believe they will need to work until they are at least 80-years-old in order to retire comfortably" but may not have the okay from employers. See "More American Say 80 Is The New Retirement Age" (October 23, 2012). New York Daily News reporter Heidi Evans refers to 80 as the "new 50." NBC News recently reported that creative seniors are setting up consulting practices, starting businesses, seeking jobs with non-profits or working part-time. See "Retirees Keep One Foot in the Workforce" by Shelly Schwartz (April 8, 2014). Great Jobs for Everyone 50+ by Kerry Hannon addresses opportunities by category such as snowbirds or retired teachers as does the AARP in its 2011 guidance for those who head south for sun when bad weather in winter looms.
Some say that age is an illusion in terms of what one can do. Famed wit George Burns is quoted as saying that "You can't help getting older, but you don't have to get old." Sadly Mr. Burns did not appear for his famed booking at London's Palladium to celebrate 100. A bad fall led to its cancellation and he celebrated this marker elsewhere. In "Curtain Falls: George Burns Dies at 100" (Seattle Times, March 10, 1996), reporter Howard Reich writes that Burns extolled the virtues of passion about what one does, adding that "If you can fall in love with what you're going to do for a living, you got it made." Hear, hear for the motivational cue.
From an economic perspective, global demographics open the door wide to tremendous business opportunities for financial service companies. Providing advice to seniors as well as employers that want gray matter is one promising area. Restructuring existing retirement plans is yet another. Consider the recent announcement that BT Retirement Saving Scheme has arranged for longevity insurance and reinsurance "to provide long term protection to the Scheme against costs associated with potential increases in life expectancy of members." The 16 billion GBP is "the largest ever in the UK and involved the creation of the BT Pension Scheme's own insurance company." See "BT Adds Longevity Insurance to Limit Risks of Pension Plan" by Amy Thomson and Sarah Jones (Bloomberg, July 4, 2014).
Enjoy the popcorn, watch the summer flick and then ponder what you intend to do with the rest of your life. If that means putting together your business plan for creating value-add services to companies and individuals in this new era, go for it. There are lots of ideas for profit.
People in my family buy things to last. It doesn't always work out the way we want. For example, we can't watch internet movies through our television set because we have yet to upgrade to a newer box that has the technology to allow this to happen. However, sometimes it is better to upgrade, even if there is a short-term incremental cost to do so. I learned this lesson the hard way in recent weeks. Sick of an old laptop that constantly froze on pages with too many graphics and a printer that only worked when I cleaned the print head (and that became a frequent occurrence), I made a beeline to Staples. During my discussion with the technology salesperson, he agreed with me that the immediate outlay of buying new productivity tools would be a lot cheaper than upgrading with the purchase of a few parts. The speed, storage and ability to use newer versions of software were a few of the advantages we discussed.
Change can be a good thing or not. The concept of evaluating when to tweak plan design or asset allocation mix (or a host of other decisions), as compared to carrying out a complete overhaul, applies to retirement plans. Of course this assumes that it is even possible to modify. For a defined benefit plan that is grossly underfunded or a defined contribution plan that is set up to keep workers happy by offering a particular group of investments, reversing course could be problematic. On the flip side, a sponsor that can effect change that would be deemed advantageous by participants but does not take action could be accused of bad practices or worse. Keep in mind that lots of ERISA lawsuits allege actions that a fiduciary committee could have taken. The important thing is to be vigilant about what has to be done on an ongoing basis and respond accordingly,
At least some plan sponsors are taking heed of the need to review where things stand. According to a recent Aon Hewitt survey, 62 percent of polled 220 U.S. companies with traditional pension benefit offerings vowed to "adjust their plan's investments to better match the liabilities in the year ahead." Some respondents affirmed their intent to consider increased allocations to fixed income securities and hedging strategies, once their funding status improves. One out of eight companies queried are evaluating plan funding status as often as once per day. Click to download "2014 Hot Topics in Retirement: Building a Strategic Focus."
I have a t-shirt that reads "Change is good. You go first." It always makes me chuckle. Even when change is not warranted, it is important to demonstrate that at least someone has thought about risk factors and alternative ways to mitigate those identified uncertainties.Maybe the t-shirt should instead read "Assessing whether change makes sense is an important part of a fiduciary's responsibilities."
In case you missed our December 10, 2013 presentation about pension de-risking, sponsored by Continuing Legal Education ("CLE") provider, Strafford Publications, click to download slides for "Pension De-Risking for Employee Benefit Sponsors." It was a lively and informative discussion about the reasons to consider some type of pension risk management, considerations for doing a deal and the role of the independent fiduciary. The transaction and governance commentary was then followed with a detailed look at ERISA litigation that involves questions about Liability Driven Investing ("LDI"), lump sum distributions and annuity purchases.
Some of the issues I mentioned that are encouraging sponsors to quit their defined benefit plans in some way include, but are not limited to, the following:
- Equity performance "catch up" from the credit crisis years and the related impact on funding levels, leading some plans to report a deficit;
- Need for cash to make required contributions;
- Low interest rates which, for some firms, has ballooned their IOUs;
- Increased regulation;
- Higher PBGC premiums;
- Rise in ERISA fiduciary breach lawsuits;
- Desire to avoid a failed merger, acquisition, spin-off, carve-out, security issuance or other type of corporate finance deal that, if not achieved, could lessen available cash that is needed to finance growth; and
- Difficulty in fully managing longevity risk that is pushing benefit costs upward as people live longer.
While true that numerous executives have fiduciary fatigue and want to spend their time and energies on something other than benefits management, it is not always a given that restructuring or extinguishing a defined benefit plan is the right way to go. Indeed, some sponsors have reinstated their pension offerings in order to retain and attract talented individuals who select employers on the basis of what benefits are offered.
Given what some predict as a worrisome shortage of talented and skilled workers, the links among HR strategy, employee satisfaction and the bottom line cannot be ignored. For those companies that depend on highly trained employees to design, produce, market and distribute products, the potential costs of losing clients to better staffed competitors is a real problem. According to the "2013 Talent Shortage Survey," conducted by the Manpower Group, "Business performance is most likely to be impacted by talent shortages in terms of reduced client service capability and reduced competitiveness..." A report about the findings states that "Of the 38,618 employers who participated in the 2013 survey, more than one in three reported difficulty filling positions as a result of a lack of suitable candidates; the 35% who report shortages represents the highest proportion since 2007, just prior to the global recession."
As relates to the well-documented shift by companies and governments to a defined contribution plan(s), I recently spoke to a senior ERISA attorney who suggested a possible re-thinking of the DB-DC array, based on discussions with his clients. The conclusion is that a 401(k) plan is sometimes much more expensive to offer than anticipated. For employees who lost money in 2008 and beyond and cannot afford to retire, they will keep working. The longer they stay with their respective employer, the more money that employer has to pay in the form of administration, matching contributions, etc.
A plan sponsor has a lot to consider when deciding what benefits to offer, keep, substitute or augment. Dollars spent on benefits could reap rewards in the form of a productive and complete labor force. With full attribution to the seven fellas in Disney Studio's Snow White, will your employees be singing "Heigh-ho, heigh-ho, it's off to work we go" or will they instead bemoan their stingy boss and search for a new work home, with better economic lollipops, thereby leaving a business deprived of precious human capital?
According to "Balancing Costs, Risks, and Rewards: The Retirement and Employee Benefits Landscape in 2013" (CFO Research and Prudential Financial, Inc. - July 2013), numerous changes are underway. The opinions of senior financial executive survey takers validate the continued twin interest in expanding defined contribution plan offerings and managing the liability risk of existing defined benefit ("DB") plans. The strategic import of benefits as a way to attract and retain talent is recognized by "nearly all respondents in this year's survey." Regarding the restructuring of traditional pension plans, this report states that nearly four out of every ten leaders have frozen one or more DB plans yet recognize the need to manage risk for those plans as well as for active plans. Liability-driven investing ("LDI") programs are being adopted by "many companies". Transfer solutions are being "seriously" considered by roughly forty percent of companies represented in the survey. Almost one half of respondents agree that a return to managing its core business could be enhanced by doing something to address pension risk.
None of these results are particularly surprising but it always helpful to take the pulse of corporate America with respect to ERISA and employee benefit programs. I have long maintained that the role of treasury staff will accelerate. There are numerous corporate finance implications associated with the offering of non-wage compensation. As I have added in various speeches and articles echoing what numerous ERISA attorneys cite (and I am not an attorney), plan sponsors must carefully weigh their fiduciary responsibilities to participants against those of shareholders in arriving at a particular decision.
For a copy of the study, click here.
Interested readers may also want to check out the reference items listed below:
- "Applied to Pensions, Risk is a Four Letter Word" by Dr. Susan Mangiero and Nancy Ross, Esquire (CFO, November 8, 2012);
- "Pension De-Risking for Employee Benefit Plan Sponsors" (Strafford Continuing Legal Education, January 16, 2013); and
- "Pension Plans: The $20 Trillion Elephant in the (Valuation) Room" (Business Valuation Update, Vol. 19, No. 7, July 2013).
If you have further comments or questions, click to email Dr. Susan Mangiero.
I am delighted to join the roster of multi-disciplinary speakers for this exciting October 24-25, 2013 New York City event. Designed for and by attorneys, the American Conference Institute's 6th National Forum on ERISA Litigation will include comments from renowned judges, in-house counsel, insurance experts, economic consultants and practicing litigators in the ERISA arena. According to the conference flyer, attendees will learn about the following:
- Emerging trends in multiple facets of ERISA litigation;
- Understanding new theories of liability arising from investment decisions, including alternative investments and the trend towards de-risking;
- 401(k) fee case considerations and a discussion about evolving defense strategies, the issue of service providers and the viability of float claims;
- ESOP litigation to include an overview of DOL investigations and settlements;
- Benefits claims litigation
- ERISA fiduciary litigation and ways to minimize liability exposure:
- Class action update; and
- Ethical issues that arise in ERISA litigation.
Having spoken and attended prior ERISA litigation conferences sponsored by the American Conference Institute, I always learned a lot. In particular, the discussions among jurists, the plaintiffs' bar and defense counsel makes for a collection of timely and lively debates. I hope you will be similarly satisfied if you decide to attend.
As a courtesy to readers of this blog, the American Conference Institute has activated a discount code of $200 for anyone who registers for the conference. Simply type "PRM200" when prompted. Click here to register. Click to download the agenda.
On January 16, 2013, this blogger - Dr. Susan Mangiero - had the pleasure of speaking with (a) Attorney Anthony A. Dreyspool (Senior Managing Director, Brock Fiduciary Services) (b) Attorney David Hartman (General Counsel and Vice President, General Motors Asset Management) and (c) Attorney Sam Myler (McDermott Will & Emery) about compliance "must do" items and litigation vulnerabilities. Sponsored by Strafford Publications, "Pension De-Risking for Employee Benefit Sponsors" attracted a large audience of general counsel, outside ERISA counsel and financial professionals. In addition to numerous talking points shared by all of us presenting, we had lots of attendee questions about issues such as balance sheet impact, case law and annuity regulations.
Click to download the slides for "Pension De-Risking for Employee Benefit Sponsors."
In my opening comments, I described some of the factors that are being discussed as part of conversations relating to whether a plan sponsor should de-risk or not. These include, but are not limited to, the following:
- Low interest rates;
- Higher life expectancies;
- Increased PBGC premiums;
- Company's debt capacity;
- Intent to go public or sell to an acquirer;
- Available cash; and
- Knowledge and experience of in-house ERISA fiduciaries.
Attorney Hartman urged anyone interested in de-risking to allow ample time of between six to eighteen months in order to file documents, research and create or modify policies and procedures as needed. He also advised companies to make sure that participants are fully apprised of their rights and to explain the merits of any particular transaction. For companies that may want to redesign a plan(s) for hourly workers, more time may be needed, especially if collective bargaining agreements are impacted. His suggestion is to inform plan participants about state guarantees that apply in the event of an insurance company default. When retirees are emotionally attached to getting a check from their employer, care must be taken to allay any concerns that future monies will come from an outside third party. Keep in mind that the market may be moving at the same time that a deal is being put together. Regarding the transfer of assets, Attorney Hartman stated the importance of finding out early on what an insurance company is willing to accept. An independent appraiser may be required to determine the appropriate value of certain assets.
I talked about the various risks that can be mitigated via de-risking versus those that are introduced as the result of some type of defined benefit plan transfer or derivatives overlay strategy. The point was made that there is no perfect solution and that facts and circumstances must be taken into account. I added that litigation may arise if a plaintiff (or class of plaintiffs) question any or all of the following items:
- Whether executives are unduly compensated as the result of an earnings or balance sheet boost due to de-risking;
- Timing of a transaction and whether interest rates are "too low" at the time of a deal;
- Completeness (or lack thereof) of information that is provided to participants;
- Amount of fees paid to vendors;
- Use of an independent fiduciary;
- Level of asset valuations;
- Use of an independent appraiser;
- Extent to which due diligence was conducted on the structure of deal; and/or
- Level of vetting of "safest available" annuity provider.
Attorney Dreyspool emphasized that ERISA fiduciaries must demonstrate procedural prudence. This could entail an assessment of factors that include but are not limited to:
- Amount of cash out;
- Which participants will be impacted;
- How the plan is to be terminated; and/or
- Alternative transactions that a plan sponsor might have adopted instead.
He gave a long laundry list of items that must be considered when vetting an insurance company, should a transaction involve an insurer. While not exhaustive, factors to review include the following:
- Quality and diversification of insurer's investment portfolio;
- Size of insurer relative to proposed contract;
- Level of insurer's capital and surplus;
- Lines of business of the insurer and other indications of its exposure to risk;
- Structure of the annuity contract;
- Guarantees supporting the annuities, like separate accounts;
- Availability of protection through state associations; and/or
- Size of the guarantee.
The audience was encouraged to review DOL Advisory Opinion 2002-14A (dated December 18, 2002) and ERISA Section 404(a).
Attorney Myler presented litigation slides prepared in part by senior ERISA litigator Nancy G. Ross (also with McDermott Will & Emery). He explained the civil enforcement law relating to contract claims, asserting that a lawsuit could focus on what a participant was promised versus what they received. He differentiated between settlor functions and fiduciary acts as a cornerstone of any lawsuit that could be brought against a member of a company's investment committee and/or any of the service providers involved in a particular de-risking transaction.
There seems to be no shortage of case precedents with respect to disputes already making their way through the court system. Attorney Myler discussed Kuntz v. Reese, Call v. Ameritech Management Pension Plan, Laurenzano v. Blue Cross/Blue Shield and Lee v. Verizon Communications Inc., inter alia.
Indeed, it is worthwhile listening to review the in-depth comments made by all speakers. The topic is broad and important with no doubt more activity to occur in the U.S. and elsewhere.
According to its Fall 2012 issue of Pension Pulse, published by the J.P. Morgan Asset Management Strategy Group, 2013 is going to be "grim" for pension funds after a less than jovial 2012. Citing a drop in funded status for many U.S. plans this year, "despite a 14% stock market rally," trouble spots are unlikely to disappear any time soon, putting continued pressure on the size of liabilities.
To tame the beasts in the form of "funded status volatility, unfavorable changes in the index used to value pension liabilities and longevity assumptions that increase liability values," employers continue to explore de-risking transactions such as offering lump sums and buyouts. Contrary to popular belief, the authors point out that even companies with underfunded plans like lump sum arrangements. The appeal is in part motivated by tax rules that allow "certain plans to use backdated discount rates to value lump sum payouts" that are higher than current discount rates.
Although the evidence suggests an increased demand on the part of plan sponsors to de-risk, J.P. Morgan professionals reference a ceiling of about $70 billion more over the next four or five years before industry capacity is reached for pension risk transfers. Of course, any time that demand increases and supply remains static, prices will rise as a result. At the margin, that could encourage some organizations from de-risking.
The report goes on to describe a "surreal discount rate" situation as the result of some bank securities being downgraded below AA in June of 2012. The net effect - a change in the discount rate curve that "reduced the weight of financials" - left only ten issuers to make up 75% of the market value of the index. Arguably, this increases the "inherent concentration risk" which in turn could increase the volatility of the index, thereby sending employers off on a measurement roller coaster ride. Shareholders could then feel the pinch if companies have to add cash to a plan as funding levels sink.
Adding insult to injury, the authors describe a change in actuarial assumptions that could significantly push the costs upward for companies that sponsor pension and Other Post Employment Benefits ("OPEB") programs. Their assertions are that (1) "changing actuarial assumptions are likely to increase pension liabilities by 2% to 5%" and (2) uncapped post-retirement health care benefits could go up by 6% to 9%.
Taken individually or together, the various pressures on retirement plan liabilities suggest a busy year ahead for ERISA fiduciaries and their support staff.