More employers are certain to follow in the footsteps of Verizon Communications Inc., which is purchasing a group annuity to shed billions of dollars in pension plan liabilities, experts said.
Last week, New York-based Verizon became the second major employer in recent months to announce such a pension plan risk-reduction strategy.
Under its arrangement, Verizon will transfer about $7.5 billion in benefit obligations to Prudential Insurance Co. of America by purchasing the annuity. The agreement covers some 41,000 management participants who retired and began receiving benefits before Jan. 1, 2010.
As part of the deal, Verizon will contribute about $2.5 billion to the plan that it froze in 2006.
"The transaction is expected to further Verizon's objective of derisking the pension plan while improving the company's longer-term, financial profile," Verizon said in a statement.
Verizon's action follows that of General Motors Co., which earlier this year said it would purchase a group annuity — also from Prudential — to cover the benefits of tens of thousands of salaried employees who retired before Oct. 1, 1997. GM also gave salaried employees who retired after Oct. 1, 1997, but before Dec. 1, 2011, a choice of taking a lump-sum benefit or continuing their monthly payment. Those who continue monthly payments, though, will receive them from Prudential rather than from GM's pension plan.
More employers are certain to adopt such pension risk-reduction efforts in the coming months. In the last few weeks alone, several large companies, including Archer Daniels Midland Co., Equifax Inc. and the New York Times Co., have offered certain plan participants the opportunity to convert their annuity to a lump-sum payment.
The corporate interest in such approaches "is the highest I ever have seen it," said Jason Richards, a senior consultant with Towers Watson & Co. in St. Louis, adding that the interest is coming from employers of all sizes.
Employer interest is "extremely high. The conversations have become much more serious. There will be more activity," said Margaret McDonald, a Prudential senior vice president in Hartford, Connecticut.
Several factors are driving employer interest in pension risk-reduction strategies, the biggest being that they no longer want to face unpredictable plan contributions because of swings in the equities market and changes in interest rates.
"For many plan sponsors, the volatility associated with managing a pension plan is a distraction from their core business," McDonald said.
"Corporate America is getting out of the pension business and is focusing on what they know best — running their own businesses," said Sean Brennan, a senior consultant in Mercer L.L.C.'s financial strategies group in New York.
Corporate interest is especially high for companies that, like Verizon, have frozen their pension plans, with plan participants no longer accruing benefits.
In such situations, "Employers look at the high cost of maintaining a plan and see that there is no value in keeping it going," Richards said.
There are pros and cons to the two principal pension risk-reduction approaches — purchasing an annuity from an insurer and lump-sum benefit offers.
With an annuity, an employer can be absolutely certain of the amount of risk being transferred and eliminated. On the other hand, employers have to pay a premium to the insurer to which they are transferring the benefit obligations through the annuity purchase.
While Verizon hasn't disclosed the premium it will pay Prudential, experts say the premium for annuity purchases involving plan participants already receiving benefits ranges from about 8 percent to 15 percent of the benefit obligation.
Verizon chose the annuity approach because it "was the deal that made the most financial sense," a spokesman said in an email. "Also, many of the affected retirees had already been offered the option of a lump sum when they retired."
With lump-sum offers, employers do not have to pay a premium to an outside party. On the other hand, they cannot be certain what percent of plan participants will accept the offer to convert their annuities to a lump-sum benefit.
As a result, "the amount of risk taken off the books is very unpredictable," said Ari Jacobs, a senior partner with Aon Hewitt in Norwalk, Connecticut. Aon Hewitt served as Verizon's lead strategy partner in the transaction.
"You make the offer, but you cannot" force the participant to accept the offer, said Jim McHale, a principal at PricewaterhouseCoopers L.L.P. in New York.
In addition, annuity to lump-sum benefit conversion offers require a significant corporate communications effort, Jacobs said.