Administration July 30, 2014

Reducing DB Costs, Risk via Lump-Sum Windows

July 30, 2014 (PLANSPONSOR.com) – There is a spectrum of de-risking strategies defined benefit (DB) plan sponsors can use.
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During a recent webinar hosted by PwC, “Reducing Pension Cost and Risk Using a Lump Sum Buyout Strategy,” Jim McHale, a principal with PwC, and David Ehr, a manager with PwC, defined de-risking as taking action to reduce or eliminate a company’s pension benefit obligations, resulting in a reduction in future volatility of cash contributions and financial statement impacts.

Ehr pointed out that de-risking strategies on the “benefit design and investment” end of the spectrum include plan redesign, asset liability modeling/liability-driven investing, implementing hedging and investment strategies, and fully or partially freezing DB plans. Those on the “liability settlement” end of the spectrum include a lump-sum window for terminated, vested participants, and a buy-in annuity contract or buy-out annuity contract settlement of obligations for retired participants.

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Ehr observed that the strategies under the “benefit design and investment” part of the spectrum are easier and less expensive to accomplish, while those on the other end of the spectrum, “liability settlement,” are more difficult and more expensive to accomplish. “There is a tradeoff with de-risking,” said McHale. “Plan sponsors want to reduce risk, but there is a cost to it. The question is how much risk can be eliminated for what cost. With de-risking, plan sponsors need to look at the full range of options for their plan.”

Lump-sum windows are the offering of a lump-sum optional form of benefit to former employees who are vested in their DB benefits but have not yet commenced payments, and are often available only for a set period of time. Ehr said accepted lump sums fully settle the participant’s benefit, so plan liabilities and assets are reduced by the transaction.

McHale noted that new mortality tables are under review by the Internal Revenue Service, and during this review process, more lump-sum windows are likely to be offered by companies, since offering them after the tables are approved will cost the plan more, as benefit calculations will reflect a longer life expectancy of participants.

McHale pointed out that using a lump-sum window can offer plan sponsors the advantage of “reducing risk and plan size, which can improve the credit rating of a company.”

According to Ehr, “A company should have solid reasons and a clear business case for using a lump sum buyout. They need to ask themselves how this approach will impact the company in terms of administrative expenses and other factors.” Ehr noted one consideration: Companies need to ask whether the required interest rates for lump sums favorably compare to discount rates used for DB funding and accounting obligations.

In terms of what makes a lump-sum window a success, Ehr said having clear communication with participants is important. Plan sponsors should make sure participants understand their options and what forms need to be completed as part of the process. Sponsors need to walk a fine line between informing participants and influencing them, he warned, providing participants with materials that allow them to make an educated decision in a timely manner.

Maintaining strong project management over the process is also important. Plan sponsors need to create a detailed project plan and establish a definitive time frame for the lump-sum window, as well as coordinate with relevant stakeholders such as their finance and human resources departments, as well as legal trustees, investment advisers and other consultants.

Participant data quality is also an important consideration, said Ehr. Plan sponsors need to be able locate participants well after they leave the company and retire. Sponsors also need to have a process in place for seeking out lost participants and, after performing due diligence steps, may need to consider removing these lost participants from their plan census data.

De-risking is part of a broader movement that is changing retirement plans, said McHale, with more and more companies moving away from DB plans. He noted that it is loosely following the physics principle that nothing can be created or destroyed, simply changed in form. By de-risking, he said, plan sponsors are looking to transfer their risk elsewhere.

Compliance July 30, 2014

ERIC Disagrees with Court About Vested Retiree Health Benefits

July 30, 2014 (PLANSPONSOR.com) - The ERISA Industry Committee (ERIC) is urging the U.S. Supreme Court to reverse a federal court ruling that one company’s collectively bargained retiree health benefits are vested for life.
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In an amicus brief filed with the U.S. Supreme Court, ERIC asks the high court to reverse a decision by the 6th U.S. Circuit Court of Appeals in M&G Polymers v. Tackett. The appellate court reached the conclusion that retirees had a vested right to health care benefits and, in the absence of evidence to the contrary, a vested right to contribution-free health care benefits. Those benefits could not be bargained away without retiree permission.

ERIC argues that courts should not presume that silence regarding the duration of retiree health benefits in collective bargain agreements (CBAs) means the parties intended those benefits to vest for life. ERIC notes that other circuits have adopted a variety of approaches for evaluating the vesting issue, but none has applied the 6th Circuit approach, and the 3rd Circuit has essentially adopted a presumption that the benefit is not vested. 

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The brief specifically argues that vesting should not be held to exist unless there is clear and unambiguous language providing for such, emphasizing that no reasonable employer can be deemed by implication to have unalterably committed itself to provide such uncertain and costly benefits for life.

“If the parties wish to negotiate lifetime health care benefits for retirees and their families, they are free to do so. But such lifetime benefits should not be a ‘gotcha’ sprung by the judiciary on employers who never intended to assume such costly and unpredictable burdens,” the brief argues. “Thus, unless clearly stated otherwise, the terms of a collective bargaining agreement pertaining to retiree health care benefits should apply only to those employees who retire during the term of the agreement and only for the duration of the agreement.”

The brief explains that requiring parties to state their intentions clearly is all the more appropriate because Congress, in enacting the Employee Retirement Income Security Act (ERISA), consciously imposed a vesting standard for pension benefits but not health care benefits. In distinguishing between the two types of benefits, Congress recognized that it is easier for employers to anticipate the costs of pension plans, but health care costs, by contrast, are inherently uncertain, as new treatments, technologies and drugs are always emerging, ERIC says.  

Moreover, the brief urges the Supreme Court to expressly reject the “flawed rules” of contract interpretation applied by the 6th Circuit in the case. In finding that retiree health care benefits had vested for life, as it has done in prior cases, the 6th Circuit relied on a series of special rules of contract interpretation that it has created in this context, the brief explains. “Applying traditional rules of contract interpretation, the judgment … must be reversed because the collective bargaining agreements at issue here do not include a clear and unambiguous statement (or, indeed, any statement at all) of an intent to vest benefits,” the brief maintains.

Finally, the brief contends that, even assuming for the sake of argument that it was appropriate for the 6th Circuit to have relied on non-legal policy considerations to support its presumption favoring vesting based on the 1983 ruling in UAW v. Yard-Man, Inc., such policy considerations have changed dramatically since then. Since Yard-Man was decided, a number of changes have significantly expanded the availability and affordability of health care benefits for both pre-65 and post-65 retirees. Expansions in Medicare coverage, as well as the enactment of the Affordable Care Act and other “pathmarking” health care-related legislation, have created health care options that did not exist in 1983. Those changes have dramatically shifted the landscape for post-employment health care benefits and undermined the policy considerations (if any) that the 6th Circuit may have originally relied upon in fashioning the so-called Yard-Man presumption, the brief stresses. 

“These options ensure that retirees and their families will have access to affordable, comprehensive healthcare coverage even in the absence of the Sixth Circuit’s artificial rule that unilaterally imposes lifetime health care obligations on employers,” despite the lack of clear agreement and intent to do so, the brief concludes.

The case will be heard and decided by the court in its upcoming term which commences in October.

ERIC’s brief is here.

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