Retiree Lump Sum Window Webinar Q&A

Following the Retiree Lump Sum Windows Back on the Table - Navigating Risk Management Options webinar, Aon’s industry experts answered questions and provided additional context regarding litigation risk, adverse selection, new benefit elections, the annuity market and more.

Q1: How long does it take to run a retiree lump sum window program? Is that something a plan sponsor can accomplish in 2019 to shed some balance sheet liability before the end of the year?

Yes, we believe plan sponsors can execute a window this year; however, they would need to begin the process soon. Retiree lump sum windows can be longer than those for terminated vested participants and longer than an annuity purchased process.

There are many items to consider for implementation, such as program design, strategy, and stakeholder involvement. Additionally, compiling a large amount of data is critical for these types of transactions. It is a good idea to begin the data compilation process early if your organization is considering the establishment of a lump sum window or annuity purchase to further prepare for a successful transaction. Retiree lump sum windows can take anywhere between seven and nine months to execute, so it is essential to plan.

Q2: How can plan sponsors work with their legal counsels to manage litigation risk?

To some extent, it is difficult to avoid litigation risk completely, but a good starting point is to ensure that the organization has a strong governance process in place. Teams should align closely with their legal counsel, particularly when moving forward with any sort of transaction. It is also essential to partner with legal counsel throughout the planning, documentation, and communication processes. Additionally, all procedures should be consistent and fair with clear guidelines for making elections.

Q3: What kind of variability and assumptions are there with the cost of retiree lump sums by population? 

The webinar features an illustrative pricing chart on page seven (7) of the presentation. Aon compiled data from 2018 and compared discount rates for accounting liability to create the chart. The chart shows the projected benefit obligation (PBO), which is expected to be daily versus anticipated lump sum payments under the same date. It also compares current rates on the lump sums (which are mandated by the IRS) versus accounting liability market discount rates. Data indicates where one would have expected the lump sums to land relative to the liability portion over 2018. Pricing will not necessarily hold forever, which is the case for every population.

Aon has made some assumptions regarding population type, industry type (blue collar, white collar, or mixed collar) and gender-based composition. These assumptions were based on market rates from 2018. With lump sum distribution, organizations have the potential to lock in rates up to 16 months before the transaction is executed. For example, lump sums can be paid on December 1, 2019, with rates based on November 2018.

Q4: How are insurers thinking about adverse selection?

Adverse selection is an important concept as organizations think about retiree lump sum offers in the context of a plan termination or in conjunction with an annuity purchase. There is a school of thought that when lump sums are offered to retirees, there are always those in the population who might have some insight into their mortality.

For example, an 80-year-old retiree with cancer who is offered a lump sum might be more likely to select this option given their condition. From a financial standpoint, it is a better choice for an individual to choose the lump sum in this case. This option would potentially enable the retiree to bequeath their heirs the full value of the lump sum or have needed funds for any health-related expenses.

Q5: What are the rules for spousal content and new benefit elections?

Lump sum retirees must consent to all new benefit elections. Existing rules around the qualified joint and survivor annuities and disclosures also require that spouses must consent to a distribution when retirees are married. Spousal consents are usually related to specific content at the time of job commencement; therefore, additional spousal consent must be obtained if any changes are made.

Q6: What factors does an employer need to weigh when considering a potential lump sum retiree buyout?

In Aon’s experience, administrative expenses, Pension Benefit Guaranty Corporation (PBGC) premiums, potential volatility, and reduction of volatility all factor into an appropriate analysis for program design. Some plan sponsors may choose not to launch a program based on the impact on the income statement and the interplay of the actual assumptions that drive the income statement. Also, funding levels might not be sufficient to support a lump sum retiree buyout. Other organizations may also choose to wait until a full plan termination can be executed.

Q7: With the recent press of retirees forgoing guaranteed lifetime income payments over a lump sum distribution, what financial security considerations do employers need to make?

Choosing a lump sum distribution is a voluntary option that can be positive for both the employer and participant. First, a lump sum option allows participants to customize their retirement spending patterns. It also gives retirees the option to select an alternate form of payment if for some reason, they did not make the best choice at retirement. Some participants may also prefer to receive a larger chunk of retirement income and choose to retire early. This potentially enables retirees to travel and lead a more active lifestyle in an earlier phase of their lives than at a later retirement date.

There could also be situations where both a participant and a spouse have monthly retirement checks. This allows one of them to have a lump sum and the other a guaranteed lifetime income, which could be beneficial. There are also some participants that look to pursue investment or business opportunities. Lump sum payments provide an additional option that enables more customization for the participants.

Aon recommends providing the right tools and extensive communication so that retirees receive the appropriate level of support to help guide their experience.

Q8: If a retiree lump sum program is offered to some eligible participants or in an early lift out, that leaves the remainder of the pension plan in a different funded status. What potential issues are there?

With either of these strategies – when an organization is transferring a premium to the insurance carrier for the participants that are annuitizing or paying out certain participants with a lump sum – the plan is effectively fully funding the liability for those participants. If a plan is underfunded and a portion is transferred out, that portion is effectively fully funded. It is natural that the portion of the plan that gets left behind is going to be less well funded. Essentially, assets are being taken from one portion to fully fund the other in anticipation of the program.

Q9: How has the annuity market changed over time in terms of the participants playing in the annuity lift out and annuity purchase environment?

The number of insurers participating in the pension risk transfer market has grown. When an organization looks to undertake a buyout process, it is standard practice to go to all of the insurance carriers participating in the market to obtain the best pricing and fit.

The market is bifurcated in a couple of ways as different insurers participate in various segments of the market. Relative to size, an organization must first consider the placement that they will be making. Some insurance carriers, including the largest and the biggest insurance carriers in America may be more inclined to take on the largest transactions in the pension risk transfer market. It is well understood that not every insurance carrier is going to be equipped to take on the liability of a billion-dollar annuity purchase.

On the lower end of the market, there are other insurance carriers that look at volumes— with the goal of taking on and managing smaller transactions. Size is one big factor. The other factor is structural and related to whether an organization is undertaking a retiree-only transaction or a full plan termination. Insurers have different views on whether or not they want to manage the different risks that are inherent in these different transactions.

To learn more about lump sum options and pension risk transfer options, please each out to your Aon consultant. Your consultant can also provide more information on the specific insurers participating in the market and discuss participation levels throughout various segments and plan populations.