On the Path to
the DB Plan?
TERMINATING
Plan sponsors have become
fatigued
managing a plan that is continually underfunded and generating ever-growing PBGC premiums.
BIGGEST
(with accompanying boring analysis)
5
Understandably,
when your actuary
(aka white knight) presents a
favorable-appearing solution
to end the pension, you jump at the chance.
We feel your pain
but after evaluating more than 50 of these proposals for our clients, we strongly encourage you to
take a closer look before running for the exit.
Here are the 5 biggest
Start here
MYTHS ABOUT ANNUITIZING YOUR PLAN
Check it out, you might be surprised
Check it out, you might be surprised!
1
Myth 1
They almost always
and cost less than maintaining the pension plan.
above the cost of simply maintaining the plan.
Current assets are $225 M
$13 M
$275 M
At a 5.5% discount rate, your PBO liability is $235 M
At a 5.5% discount rate, your PBO liability is $235 M
Now, the cost to annuitize is reduced to about $11 M
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A rise in interest rates can impact the cost of annuitizing...
what if the discount rate went from 4% to 5.5%?
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Current assets are $225 M
At a 4% discount rate, the PBO liability is $275 M
The cost to annuitize is estimated at 5% or $13 M
The cost to annuitize is estimated at 5% or $13 M
For a total funding gap of $63 million
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Current assets are $225 M
At a 4% discount rate, the PBO liability is $275 M
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PBO liabilitiy based on a 3.75%
$275 M
in assets
$225 M
82%
Projected Benefit Obligation (PBO)
A plan with...
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BACK
Many actuarial firm
analyses of plan termination
are seriously flawed
Annuitization strategies are
In Reality
After evaluating more than 50 of these proposals for our clients, we have found common errors include:
and present value of liabilities to determine transaction “returns”
Comparing nominal assets
with the cost of capital, understating the opportunity cost of funding
Confusing the cost of debt
to justify annuitization transactions, ignoring the timing of the payments—the critical aspect of pension economics
Using IRR calculations
on assets as the funding mechanism for liabilities, ignoring the availability of principal for benefit payments
Focusing on return
by focusing on how they are calculated (percentage of funding shortfall) rather than how they are paid (percentage of total assets) and projecting those premiums forever
Overstating the “cost” of variable rate PBGC premiums
of assets used for annuitization—in effect comparing two investment strategies while not including the investment returns of one of those strategies
Ignoring the projected investment returns
Consider this example
For a total funding gap of $63 million vs.
$22 million
$40 M savings
The increase in rates resulted in a
The cost to annuitize declines aproximately
rise in discount rates
$13.5 M with each 50bp rise
in discount rates
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Myth 2
financially favorable transactions
carry considerable financial cost
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Click here to go to next myth
Source: SEI analysis. For illustrative purposes only.
2
funded status
discount rate
and should not be a key driver of pension strategy.
as significant as you might think
In Reality
for the pension plan sponsor, and contributions that reduce those costs are positive uses of capital.
PBGC premiums are a
Myth 2
$1.1 M
$2 M
This contribution reduces PBGC premiums by almost $1 M
and that “return” may well be limited in duration, as the variable rate premium shrinks as the plan’s funded status improved over time.
4.3% return on investment which
providing at least a
seems significant, but
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$25 million
A plan with $225 M in assest and $275 M in liabilities makes a $25M contribution
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makes a $25 M contribution to the plan
$25 M
in liabilities
$275 M
$225 M
in assets
A plan with...
Check out this example
Myth 3
large financial burden
PBGC premiums may not be
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that is actually below the cost of capital for most U.S. corporations
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Assumes 1800 participants. Source: SEI analysis. PBGC premium is based on rates in effect as of 12/31/2018. For illustrative purposes only
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Plan contributions are almost always a poor use of capital for plan sponsors — most have
a better place to put capital
In Reality
Making contributions to fund up the plan reduces the plan’s risk and is a
good use of capital
Myth 3
Contributing to the plan
simply shifts
one risk to another
for risk management of a pension plan is often available capital
outside of the pension plan
in the pension plan
The best tool
See where the better place for use of capital is
Myth 4
Not
than using it to prepay pension benefits.
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shifts one risk to another
Contributing to the plan simply
The best tool for risk management of a pension plan is often available capital.
Myth 4
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good use of capital.
than using it to prepay
than using it to prepay pension benefits.
PBO liabilitiy
$275 M
in assets
$225 M
82%
PBO funded status
Consider a plan with...
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Thats a possible cost savings of
Terminate in 5 years
$60 M
Terminate the plan
$64 M
Terminate in 5 years
$12 M
on an annual basis, relative to other plan sponsor annual expenditures.
modest incremental financial burden,
In Reality
and needs to be solved in the near term.
large financial burden
Myth 4
today
median projected
upside projected
$56 M
The present value of 8% is $8 M, if you wait 5 years
At a present value of 8%, that's a cost of $39 M
median projected
Terminate in 5 years
$60 M
Terminate the plan
today
$64 M
Terminate the plan
today
$64 M
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Myth 5
Here's an example...
The pension plan is a
Pension benefit payments are simply deferred compensation and constitute a
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Source: SEI analysis. For illustrative purposes only.
3
median projected
Terminate in 5 years
Terminate the plan
today
Terminate the plan
today
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Thank you
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while maintaining the plan
ease the fatigue
In Reality
is the best way to end the frustration of managing a pension.
Termination
Myth 5
We can help!
There are ways to
This presentation is provided by SEI Investments Management Corporation (SIMC), a registered investment adviser and wholly owned subsidiary of SEI Investments Company. The material included herein is based on the views of SIMC. Statements that are not factual in nature, including opinions, projections and estimates, assume certain economic conditions and industry developments and constitute only current opinions that are subject to change without notice. Nothing herein is intended to be a forecast of future events, or a guarantee of future results. This presentation should not be relied upon by the reader as research or investment advice (unless SIMC has otherwise separately entered into a written agreement for the provision of investment advice).
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Questions? Tom is always available.
THarvey@seic.com
+1 (610) 676-4433
1) Pension Benefit Guaranty Corporation
2) 3.65% is the median prevailing pension discount rate, but varies by client depending on their population.
3) The cost of capital for U.S. corporations varies significantly, ranging from an estimated 4.5% to 12.5%. Source: Trainer, David. "Ranking U.S. Stocks on Weighted Average Cost of Capital." Forbes, Forbes Magazine, 12 May 2016.
An annuitization method is a type of annuity distribution structure that gives the annuitant periodic income payments for the rest of his or her life, or a specified period of time. Projected Benefit Obligation is an actuarial measurement of what a company will need at the present time to cover future pension liabilities. A nominal asset is an IOU to deliver a stream of money. For example, a bond or a share of stock. Nominal assets are not real assets. Internal rate of return (IRR) is a metric used in capital budgeting to estimate the profitability of potential investments. Transaction returns: Calculations by actuarial firms often compare the associated IRR of using current nominal asset values to decease the present value of the liabilities, calculating an associated return. This calculation ignores the actual payment stream, much of it years in the future, using an IRR (which does not account for the time to actual payment).
Footnotes and defined terms
Footnotes and defined terms
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