As defined benefit pension plan sponsors seek to transfer pension risk, offering lump sum pension cashouts for terminated vested participants has been an attractive option to consider. Many plan sponsors embarked on such cashout projects beginning in 2012 and Mercer expects this trend to intensify in 2014.
Mercer has just published a point of view, “Terminated Vested Cashouts, Overcoming Common Misconceptions” to help plan sponsors evaluate whether a cashout should be considered.
“Among the attractions to the plan sponsor are reduced pension liability, leading to lower plan financial risk and volatility,” observed Matt McDaniel, a senior consultant at Mercer. “Other advantages include eliminating PBGC premiums, investment and administrative costs, and making payments before updated mortality tables come into effect. However, the business case for pension cashouts is driven by the unique circumstances of the plan sponsor and a cashout will not make sense in every situation.”
“These programs also tend to be popular with eligible participants,” Mr. McDaniel observed. “Take-up rates for an effectively executed lump sum exercise can be upwards of 50%.”
Some sponsors for whom a cashout might be appealing are waiting on the sidelines, hesitant because of concerns that can in fact be addressed. In its report, Mercer identifies ten of these misconceptions and outlines how they may be addressed to allow for a successful risk transfer project.
Mercer’s point of view addresses all ten misconceptions in detail, but the three most important concerns, according to Mercer, are:
“Interest rates are too low right now.”
Waiting for a rise in interest rates to take action is a bet on the direction of interest rates. If a plan sponsor is looking to profit from the expectation of a rise in interest rates, Mercer believes there are more efficient ways to achieve that than carrying terminated vested liabilities.
“Paying lump sums will trigger a P&L settlement charge and impact our share price.”
Sponsors who wish to avoid settlement accounting can structure the lump sum program to do so. Even if settlement accounting were triggered, the market has become more savvy about adjusting earnings for pension expense and is less likely to penalize an organization for taking prudent steps to manage risk within its pension plan.
“I don’t want my employees to squander their pensions.”
Mercer’s experience has been that over 80% of lump sums over $50,000 are rolled over into an IRA or other tax-qualified vehicle. While participants may lose the longevity protection of an annuity benefit, a lump sum payment provides participants with the flexibility to make individualized decisions based on their financial goals and preferences. Finally, a lump sum program is voluntary and participants who prefer the security of a lifetime annuity can keep it.
Mercer is a global leader in talent, health, retirement, and investments. Mercer helps clients around the world advance the health, wealth, and performance of their most vital asset – their people. Mercer’s more than 20,000 employees are based in more than 40 countries and the firm operates in over 130 countries. Mercer is a wholly owned subsidiary of Marsh & McLennan Companies (NYSE: MMC), a global team of professional services companies offering clients advice and solutions in the areas of risk, strategy, and human capital. With over 55,000 employees worldwide and annual revenue exceeding $12 billion, Marsh & McLennan Companies is also the parent company of Marsh, a global leader in insurance broking and risk management; Guy Carpenter, a global leader in providing risk and reinsurance intermediary services; and Oliver Wyman, a global leader in management consulting. For more information, visit www.mercer.com. Follow Mercer on Twitter @MercerInsights.