No matter what role pension plans play in a company’s total compensation offering, it is vital to effectively communicate with employees on defined benefit plan de-risking.
As companies use de-risking strategies to minimize the impact of increasingly volatile markets, employers should explain their company’s choices and options clearly and candidly to affected employees.
What is pension plan de-risking? It is the transfer of defined benefit pension plan liabilities and assets from the employer to someone else. Often, that is to an insurance company in the form of an annuity purchase. Another example is to offer a lump-sum payment to plan participants in exchange for their giving up the right to guaranteed monthly benefits.
From a best-practices standpoint, decision and implementation teams should involve HR as an indispensable partner on retirement and benefit issues.
Human resources employees do not just focus on recruiting anymore; they are liaisons between employees and company executives. HR should be directly involved in communicating with employees about all the considerations for making this decision.
Determining pension strategy
Pension plans should be managed the same as any line of business — with budgets, forecasts and objectives. This approach is even more important if the pension plan is frozen, causing it to take on characteristics of a discontinued operation. Without careful planning, negative financial and employee ramifications seep into the core of the business.
The strategy needs to be evaluated not just from profit and loss, cash flow and balance sheet perspectives — but also from the potential impact on employees. Working together, finance and HR departments can better align their workforce strategy with business goals, determine the best way to successfully deliver benefits and ultimately increase ROI.
Increase in de-risking strategies
A recent Mercer/CFO survey found 84% of plan sponsors are either employing or planning a dynamic de-risking strategy. The survey also found:
- Over half of plan sponsors intend to take further steps in this direction, including increasing exposure to fixed income, extending duration and hibernation.
- More than 75% of respondents said it was likely or very likely they will offer a lump sum cash-out option buyout of their pension benefit in 2019 or 2020.
De-risking involves paying out the present value of a participant’s benefit as a lump sum. The interest rates used to calculate that present value are a part of the Pension Protection Act (PPA) “spot” first, second, and third segment rates for a designated month.
Deferred vested participants are former employees who separated from service and would otherwise have to wait until retirement eligibility to receive their benefits. A recent IRS ruling now permits the lump-sum buyout option for current retirees who are already receiving monthly distributions.
Skeptics deride lump-sum payments as a way for employers to “dump” pension responsibilities. Some people mistakenly think that if a company moves forward with this strategy, then the windfall to them must be significant. This, of course, is absolutely not true.
Lump-sum payouts gain popularity
Employees cannot be forced to make this election, although lump-sum pension payouts are gaining in popularity for two major reasons:
- Receiving a lump sum today removes any risk associated with a company’s inability of making good on its promise.
- Lower interest rates. The lower the interest rate, the larger the lump-sum payment. It may be too good of a number to pass up, even though the recipient takes on the investment risk.
Many sponsors set the lump-sum rate at the beginning of the calendar year based on the spot rates in a prior year “lookback” month. This allows participants to know what rate will be used to calculate their lump sum for the entire year.
When left to their own conclusions, employees may fear the company is pursuing a de-risking strategy because it is in trouble. It also is extremely important to emphasize that this is a 100 percent voluntary option and the company is not offering any incentives or enticements. The law provisions require rigid standards to compute the lump-sum equivalent, so a plan sponsor has no subjective opportunities to alter factors in a favorable way.
As companies use de-risking strategies to minimize the result of increasingly volatile markets, employers should detail their choices and options clearly to affected employees. Failure to recognize and deal with the outcome of de-risking strategies could harm to the company’s reputation while causing mistrust an anxiety among employees.