Pension De-Risking Gets Political

I have long maintained that retirement plan issues receive considerable attention whenever politicians enter the fray. Certainly that is the case with the U.S. debate about fiduciary standard rules among lawmakers, industry and regulators. Now it seems that de-risking is the next topic du jour for Congress.

According to "2 senators call for derisking rules" by Hazel Bradford (Pensions & Investments, October 23, 2014), U.S. Senate Finance Committee Chairman Ron Wyden (a Democrat from Oregon) and the Chairman of the Health, Education, Labor and Pensions Committee, Tom Harkin (a Democrat from Iowa) have asked government officials at various agencies to "consider developing guidance on procedures and the fiduciary duties of plan sponsors." The article describes their letter to the U.S. Department of Labor, the U.S. Department of Treasury, the Pension Benefit Guaranty Corporation ("PBGC") and the Consumer Financial Protection Bureau as emphasizing the involvement of insurance companies for lump-sum and risk transfer transactions.

Nick Thornton wrote in "Lawmakers urge clearer rules for de-risking" (Benefits Pro, October 23, 2014) that said letter cited concerns such as the following:

  • Loss of PBGC protection in the event of a plan takeover;
  • Risk of persons "self-directing their retirement savings over the course of their retirement";
  • Possible reduced rights for spouses when a lump sum settlement is involved; and/or
  • Loss of ERISA's protection.

There is nothing wrong with clarifying legal and economic rights but one worries that past may be prologue when it comes to imposing mandates. Too many times, overly simplistic regulation induces a perverse outcome. (Read "Unintended Consequences" by Rob Norton (Library of Economics and Liberty) for a discussion of this concept.) Given the often complex array of facts and circumstances for every ERISA plan and its sponsor, a "one size fits all" is ill-advised.

A silver lining is that national conversations can (hopefully) generate changes that encourage further saving for retirement. In "Combating a Flood of Early 401(k) Withdrawals" (New York Times, October 24, 2014), Ron Lieber paints a bleak picture. He points out that a recent announcement by the Internal Revenue Service that allows more money to be set aside as an official contribution will be of little consequence to non-savers. He describes a large number of workers who "pulled out $60 billion" of the $294 billion in employee contributions and employer matches that went into the accounts." Statistics show that about forty percent of persons in flux "took out part or all of the money in their workplace retirement plans when leaving a job in 2013."

Speaking of planning ahead, visit the Art of Saving website to learn more about an effort to make November 5 a U.S. National Savings Day. The Consumer Federation of America is promoting thrift as part of its America Saves National Savings Forum on May 20, 2015 in Washington, DC.

Get out the balloons for satisfied piggybanks.

Pension De-Risking For ERISA Plan Sponsors

I am delighted to join the speaker faculty for a December 10, 2013 webinar entitled "Pension De-Risking for Employee Benefit Sponsors: Minimizing Risks and Ensuring ERISA Compliance When Transferring Pension Obligations to Other Parties." If this topic is of interest to you, send me an email. I can make ten (10) guest passes available on a complimentary, first come, first served basis. Otherwise, you and your colleagues can register by visiting the Strafford Continuing Legal Education site. This topic is important and timely. I look forward to having you join us on December 10, 2013.

As U.S. pension plans face record deficits, options for transferring some or all of a sponsor's plan risk make sense for many companies. General Motors, NCR and Verizon are a few companies that have chosen de-risking options in 2012.

De-risking transactions take many forms, from transferring company obligations to third parties, to offering payouts to plan participants, to undertaking liability-driven investing and other strategies. Counsel and companies must tread carefully to avoid ERISA-based litigation or enforcement actions.

Prudent de-risking requires thorough financial analysis and clear demonstrations that ERISA fiduciary standards are met. Counsel should guide companies on how to establish the reasonableness of decisions and prepare to defend against possible court challenges.

Susan Mangiero, Managing Member at Fiduciary Leadership; Sam Myler at McDermott Will & Emery; Anthony A. Dreyspool, Senior Managing Director at Brock Fiduciary Services and David Hartman, General Counsel and Vice President at General Motors Asset Management, will provide benefits counsel with a review of pension de-risking approaches used by companies to reduce some of the risks involved with employee retirement benefits.  The panel will offer best practices for leveraging the precautions to prevent ERISA fiduciary law violations when making transfers.

The panel will review these and other key questions:

  • How can pension providers demonstrate they have met their ERISA standards of prudence, care and loyalty to plan participants?
  • What steps should be taken in preparation for termination of a pension plan?
  • What are the grounds for the various challenges to de-risking techniques and what are the techniques to avoid those challenges?

Following the speaker presentations, you'll have an opportunity to get answers to your specific questions during the interactive Q&A.

 

Pensions Going Postal

Pension issues are hard to miss these days. What is notable is that pension plans influence corporate finance activity in several ways. First, they are collectively and, in some cases, individually, large and hard-to-ignore investors. Second, benefit economics can sometimes mean the difference between a deal such as a restructuring or merger or acquisition moving forward or getting stalled.

The over subscribed Initial Public Offering ("IPO") of the venerable postal system organization known as the Royal Mail Group, Ltd. ("Royal Mail") is a good example of pension plan sway.

Listed on the London Stock Exchange and trading under the ticker of RMG.L, Bloomberg reports that Royal Mail equity climbed nearly forty percent on its first day of trading with active volume early on. (See "Royal Mail Stock Jumps 38% on First Trading Day After IPO" by Kari Lundgren and Thomas Penny, Bloomberg, October 11, 2013). As a result of what most market participants call a successful launch, critics reiterated their plaint that Royal Mail should have gone for much more. Certainly the topic of pricing surfaced only to be met with concern about whether institutional investors would support the equity issue at a higher price. (See "Government tried to raise Royal Mail IPO price" by Himanshu Singh, CityWire Money, October 12, 2013). As it turned out, interest was strong and fears about a weak debut were ill-founded. According to Chief Business Correspondent for The Telegraph, Louise Armitstead, only 300 out of 800 pension fund and life insurance companies were able to get shares in Royal Mail with "the institutional offer [being] 20 times oversubscribed." (See "Royal Mail: 500 institutions miss out on shares amid record demand," October 10, 2013).

A few days later, those buyside squeaky wheels must be happy indeed. According to "Landsdowne grabs huge stake in Royal Mail sell-off" (October 11, 2013) by CNBC business editor, Helia Ebrahimi, sovereign wealth funds and hedge funds were each allocated about 50 million GBP and "that not enough stock was given to U.K. pension fund managers." Moreover, union workers continue to have questions about the economics of a proposal to limit Royal Mail employee benefits. In "Unite members vote against Royal Mail pensions cap," Professional Pensions reporter Taha Lokhandwala writes that the "announcement outraged unions as the scheme was in surplus at the time." Keep in mind that, the Royal Mail pension assets of 27 billion GBP and liabilities of 37.5 billion GBP were transferred to the U.K. treasury in 2012 in order allow Royal Mail a chance to better compete. See "Government to take over Royal Mail pension scheme deficit from next month," Out-Law.com, Pinsent Masons, March 23, 2012.

In contrast to the appearance of a financial home run for the Royal Mail deal, with respect to excess demand for stock and a clean-up of the nearly 10 billion GBP unfunded pension deficit, The Deal reports a third missed contribution to the U.S. federal mail system's pension plan as it falls "behind by another $5.6 billion." In "U.S. Postal Service skips third pension payment" (October 6, 2013), author Lisa Allen quotes union representative Sally Davidow as blaming the 2006 Postal Accountability and Enhancement Act for "an onerous requirement that the service prefund 75 years' worth of retiree health benefits in 10 years, without allowing the agency to increase postage rates above inflation or offer new services to offset the added costs." With the price of a first class stamp soon to rise to 46 cents, and another hike for three cents more in the works, one wonders if the American mail service should look to its English counterpart and consider a pension transfer and privatization that might, if well structured, advantage employees and taxpayers alike.

Pension De-Risking: Compliance and ERISA Litigation Considerations

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.

J.P. Morgan Predicts Gloomy Year Ahead For Pension Plans

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.

CFO Magazine Article About Pension De-Risking

In case you missed the launch of "Applied to Pensions, Risk is a Four-Letter Word" by Dr. Susan Mangiero and ERISA attorney Nancy Ross (CFO Magazine, November 8, 2012), experts conclude that Chief Financial Officers need to do their homework before entering into a particular deal. "Beyond the obvious number-crunching needed to vet what's often a large dollar transaction, the decision to de-risk should minimally include:

  • A thorough evaluation of the financial, operational, and legal strength of the annuity provider as required by the U.S. Department of Labor Interpretative Bulletin 95-1.
  • Independent pricing of any hard-to-value assets that will be contributed as part of a de-risking deal.
  • Economic assessment of opportunity costs in a low interest rate environment and whether it is better to delay a transaction or close immediately.
  • Review of vendor and counterparty contracts that may need to be unwound in the event of a full transfer of pension assets and liabilities to a third party.
  • Review of direct and indirect fee amounts to be paid by a plan sponsor as the result of a de-risking transaction.
  • Assessment of litigation risk associated with plan participants asserting that they've been unfairly treated as the result of a pension de-risking arrangement.
  • Creation of a strategic communications action plan to ensure that plan participants, shareholders, and other relevant constituencies are provided with adequate information."

In a related commentary, ERISA Stephen Rosenberg describes the chaos in the defined benefit plan market that continues to give plan sponsors pause about staying with the status quo. Click to read "On Getting Out of the Pension Business."

Global Pension Assets: Another Tough Year

Hot off the press, the OECD's September 2012 issue of "Pension Markets In Focus" includes some notable statistics about pension schemes around the world. While aggregate assets increased to over $20 trillion (as of December 2011), post-fee real rates of return were miniscule at best. With an average annual rate of return of -1.7%, few winners bested the market at large. The award for the highest performing pension system went to Denmark with an annual return of 12.1% in 2011, followed by the Netherlands (8.2%), Australia (4.1%) and Iceland and New Zealand, each turning in a modest 2.3%. Turkey, Italy, Spain, Japan, the United Kingdom and the United States realized negative returns.

The news is not all grim.

According to André Laboul, OECD Head of the Financial Affairs Division Directorate for Financial and Enterprise Affairs, assessments of performance that consider many years show that the traditional 60% equity and 40% long-term sovereign bond mix have generated positive returns that range from 2.8% in Japan to 5.8% in the United Kingdom. Of course, many factors are at play, not the least of which is how much latitude an investment committee or policy-making body has to allocate monies locally versus internationally, the rate at which assets grow (and can be put to work) and the fees that are paid to various service providers.

Regarding asset class exposure, OECD researchers note that pension funds' allocation to "public equities declined significantly compared to past years." This trend is likewise noted in the "Global Pension Assets Study 2012." Published by Towers Watson in January, this compilation of interesting data points shows that the Netherlands and Japan have a "higher than average" allocation to bonds. In contrast, "in 2011, Australia, the UK and the US retained above average equity allocations." Apportioning more monies to alternatives is an undeniable reality for retirement plans in multiple countries

Since more than a few people posit that asset allocation decisions dominate portfolio returns, it is critical to track who is investing in what. Pension de-risking activity will likely have an impact on defined benefit plan portfolio mix going forward if, as experts suggest, more companies decide to exit or modify their exposure to the "pension business" by freezing a plan, using derivatives, offering lump sum payouts, entering into group annuities and so on.

Pension restructuring and adding more alternatives are factors that are changing the governance landscape in numerous ways. For one thing, the need for investigative due diligence and independent valuation services arguably becomes more acute. Second, the regulatory focus on holdings disclosure and compensation paid to service providers could inhibit the use of private funds at the same time that yield-seekers are writing checks.

The "push-pull" dynamic is holding everyone's attention since so much money is at stake.