Sponsors of defined benefit pension plans face many risks. Low interest rates and volatile markets can make managing and funding pension plans very challenging. The only way to truly relieve your company of the long-term risks is to terminate the plan. However, a plan termination is a long, complicated process subject to many rules and regulations. It is also expensive, particularly for plans that are not well funded, and many companies may face a significant negative impact to their financial statements upon plan termination.
Even if you cannot afford plan termination, there may be several ways to mitigate your risk by reducing size, cost or volatility associated with your pension plan. One common strategy in recent years is a risk transfer transaction through the purchase of annuities for retirees:
- Annuity Buy-In – you can purchase a group annuity contract from an insurance company to pay benefits for some or all plan participants.
- Annuity Buy-Out – you can transfer plan assets and liabilities to an insurance company, a common strategy in recent years for certain terminated participants.
Weighing the Pros and Cons
Annuity purchases are categorized as a risk transfer - they transfer the risk to someone else, such as the insurance company. In an annuity buy-in, the group annuity contract becomes an asset of the plan and guarantees some or all of the cash flow needs for the identified participants, which may help to offset some of the plan’s investment risk and longevity risk. In an annuity buy-out, the insurance company assumes the financial and administrative responsibilities of paying the benefits to retirees, which relieves your company of its obligation and removes participants from the plan. In addition to these benefits, purchasing annuities via the annuity buy-out can generate annual Pension Benefit Guaranty Corporation (PBGC) premium savings.
There are some considerations to make before settling on this de-risking strategy. First, you will most likely need to pay a premium to the insurance carrier since they now assume the financial and administrative responsibilities of paying the benefits to these retirees. However, this premium is also a cost that will be assumed if the plan terminates in the future. In addition to paying a premium, there may be a slight reduction to the plan’s funded status since the cost of annuitizing these obligations may be higher than your current financial statement obligations and funding liabilities. Because of this, the size and structure of the annuity purchase needs to be carefully designed to eliminate any undesirable results.
Higher interest rates have helped many defined benefit plans improve their funded status, along with strong asset performance but current market conditions remain uncertain. Today’s current environment shows very attractive annuity pricing opportunities, and many plan sponsors are electing to incur premium costs now rather than wait for those costs when the plan eventually terminates. An annuity purchase strategy can be tailored to your organization’s specific goals, objectives and risk profile. However, be aware that there are specific rules that must be followed.
For More Information
For plan sponsors who are considering implementing a de-risking strategy or terminating their pension plan, the decision requires significant research and due diligence to assure that an informed decision is made. Before moving forward, you should work with a trusted professional to understand the key considerations, prepare, and receive guidance throughout the complex process. The CBIZ team of administrators, actuaries, and advisors can help you and your retirement committee better understand how these decisions may impact the future of your plan.