A retired client is on the line seeking your advice about a letter she just received from her previous employer’s pension plan administrator. The letter states that the employer is terminating the pension plan that pays her monthly retirement benefit. Once regulators have approved termination, the plan will transfer its obligation to pay her benefits to a yet undetermined insurance company. “What should I do?” she asks.
If you haven’t encountered a pension buyout yet, the odds are increasing you will. According to a March 5, 2015 LIMRA Secure Retirement Institute press release: “Group pension buy-out sales reached $8.5 billion in 2014, a 120 percent increase over the 2013 total of $3.8 billion.”
Buyout activity levels can be difficult to interpret because a few large deals can make the market look more active; nonetheless, the quantity of transactions is growing. LIMRA Secure Retirement Institute reports that the number of buyout contracts grew to 277 in 2014 from the previous year’s 217. The number of insurers offering buyouts also grew by two to 11.
Companies’ pullback from defined benefit pension plans has been widely reported for years. That trend is understandable, according to Lynn Esenwine, distribution vice president for Prudential’s Pension Risk Transfer business. Managing a large pension plan has started to resemble managing an insurance company portfolio, she notes.
Company executives must deal with volatile financial markets while monitoring benefit funding levels and their impact on financial statements. Additionally, mortality assumptions recently changed while insurance premiums and underfunding penalties from the Pension Benefit Guarantee Corp. (PBGC) have increased steadily.
“If you are the CFO or treasurer of an organization and looking at cash flows and managing a pension plan, you’re starting to wonder, is this a good business for me to be in, trying to understand how long people are going to live?” she asks.
There are two primary buyout trends in the industry, Esenwine says. In one model, the plan offers a lump sum cash-out to its deferred vested employee population. The other model, which Prudential uses, uses group annuity contracts to fund the benefits.
At the risk of oversimplifying the process, in a traditional buyout the employer transfers its fully funded pension plan, i.e., assets and liabilities, to the insurer. With Prudential, for instance, the insurer’s general account subsequently guarantees benefits and makes payments directly to the participants.
In a protected portfolio buyout, Prudential places the assets in an account separate from the general account for an added level of protection. Both methods allow the employer to walk away from the pension plan’s administration and expense.
So what should your client do? She really can’t do anything until the plan provides more specific details on the transfer options: lump sum, annuity or a choice between them. From a pension income perspective, nothing will change before the transfer.
If the client is offered and opts for a lump sum option, then you need to review the pros and cons of lump sums versus annuities as they apply to the client’s situation. I discussed this topic in a previous blog post.
If she decides to, or must continue with an annuity from the insurer, the form and amount of her pension will remain the same. That raises another key consideration, though: the loss of PBGC insurance. I won’t debate the value of that coverage — the writers at BenefitsPro.com do an excellent job covering the agency and its finances. The National Organization of Life & Health Insurance Guaranty Associations provides details on state guarantee funds. At a minimum, you can review applicable state-level coverage and the insurance company’s financial strength and share that information with the client.