As more pension plans enjoy surpluses, they consider derisking strategies including hibernation vs. termination.
Participants at a recent meeting of NeuGroup for Pensions and Benefits sponsored by Insight Investment voiced concerns about pursuing buyouts of their pension plans by insurers and leaned more toward hibernating plans, although they left room for exceptions.
- Hibernation occurs with so-called frozen plans that are no longer accruing future benefits and are usually well-funded or overfunded. It involves managing risk to reduce volatility by adopting a liability-driven investment strategy and letting the payout of benefits shrink the plan.
- Buyouts are still an option, and participants acknowledged selling pieces of their plan liabilities and finding reasonable prices. In particular, selling low-balance participant liabilities can have straightforward economic benefits because an insurance company, unlike a corporate, is not charged PBGC fees for pension liabilities.
- The rising funded status of corporate pensions has made both hibernation and plan terminations more feasible. And pension funding will likely remain strong as the positive impact of rising interest rates partially offsets recent sell-offs in stocks and other equity-like investments.
Split objectives. Sweta Vaidya, head of LDI Solution Design at Insight Investment, said that as plans approach and exceed fully funded status, the firm’s clients have differing end-state objectives.
- Some intend to continue selling parts of their pension liabilities and taking risk off their books, pursuing a full plan termination eventually.
- Others want to keep their plan open for employees and manage the risk going forward, targeting funding of 110% to 120% to account for future service costs and minimize cash contributions and volatility in the income statement.
- One member said that under hibernation, the rigid and costly asset-liability matching of insurance companies can be avoided while still organizing assets to provide liquidity for upcoming benefit payments. “So we do a kind of cash flow matching on coupon payments,” he said.
Buyout concerns. Defined benefit plan participants may not be happy when their pension is involuntarily transferred to an insurance company and the company is no longer on the hook. And there can be indirect costs.
- A participant said his company’s defined benefit and 401(k) plans share the same manager and other retirement plan-related service providers, so selling off the former could end up raising fees on the latter and also impact revolving credit availability from the financial institution.
- That said, one member said his team has looked at selling a portion of the company’s plan over the last few years and executed a buyout piece earlier in 2021. Pricing was favorable—not below the accounting value of the liability, but “less than we’ve seen in the past and better than expected,” he said.
- However, Ms. Vaidya at Insight notes that selling off the most attractive and least costly portions of a pension liability means a company is holding riskier, more difficult-to-manage liabilities. Those may have been naturally hedged previously by the liabilities the corporate sold.
Surplus benefits. Companies sponsoring pensions pay significant financial penalties if they return surpluses accrued under the hibernation strategy to the corporation. Instead, the corporate may be able to:
- Transfer money to other post-employment benefit plans, such as health and life insurance, as permitted under Section 420 of the US tax code, albeit with some residual penalties.
- Apply surpluses to other employee benefits such as 401(k) matches—a possible alternative to wage increases.
- Fund other sponsored pensions, such as those taken on as part of an acquisition.