Woman taking notesPrivate sector employers have been retreating from the defined benefit (DB) pension model for decades. This is largely motivated by a desire to “de-risk” the company from a financial obligation that’s as variable as financial market behavior. More recently, holdouts on that trend have been given new motivation to depart from the DB design: escalating Pension Benefit Guaranty Corporation (PBGC) premiums. 2015 legislation set the stage for annual increases through 2019, after which the increases will be indexed for inflation.

De-Risking by Lifting Out

A path to wind down a DB — short of immediate termination — is a “risk transfer” in which responsibility for making good on obligations to a segment of the plan’s beneficiary base, typically retirees, is turned over to an insurance company. A “lift-out,” as this process is also called, is also somewhat common to settle liabilities for vested benefits of active employees, particularly if the DB plan is frozen.

To start a lift-out risk transfer strategy, the company must pick an insurance carrier from which to purchase a jumbo annuity contract. That process must conform to selection criteria laid out by the U.S. Department of Labor (DOL) in Interpretive Bulletin 95-1. That document dictates that plan sponsors pick the “safest available annuity,” although that isn’t always an easy call. It’s not enough just to look at a carrier’s ratings by rating agencies, the DOL warns.

The document also acknowledges that sometimes “the interest of the plan participants and beneficiaries may require the selecting fiduciary to consider the cost of the annuity (to the extent that the cost is borne by the participants and beneficiaries) in addition to the annuity provider’s claims-paying ability.” Even so, it adds, “cost considerations may not justify the purchase of an unsafe annuity.”

In addition to eliminating financial uncertainty, a lift-out strategy can generate savings if the annuity provider can, without the regulatory necessity of paying PBGC premiums, manage the annuity liability it’s assuming more cost-effectively than the plan sponsor. A recent survey of DB sponsors by an investment consulting firm found that about one-third were actively considering pursuing a lift-out strategy, more than double the percentage from the prior year.

Talking About It

If you decide to go with a lift-out, communicate this clearly to plan participants. Provide them with information about why you’re making the change and what they can expect.

Coordinate with the insurer to develop a communication strategy explaining the process to plan participants, being careful not to release nonpublic information during the process. This should include information regarding customer support for participants. If the buyout is part of a plan termination, make sure that required termination notices are provided to participants.

Final Steps

Additional tasks for plan sponsors in picking an annuity provider include establishing the administrative process for the shift of operational responsibilities to an annuity provider, and negotiating contract terms. Be sure to build safeguards into the contract to allow for last-minute shifts or corrections to your retiree census data. If you’re looking at options to wind down your DB plan, contact your benefits advisor, actuary and an attorney to clarify your de-risking objectives and ensure you are in compliance with all requirements.


Headshot of Jenise Gaskin.

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