Pension Settlement Trend Accelerates with Verizon Annuity Purchase - Insights Into the Evolving Pension Transfer Environment October 2012
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Consulting
Retirement
Pension Settlement Trend Accelerates
with Verizon Annuity Purchase
Insights Into the Evolving Pension Transfer Environment
October 2012
Verizon Announces $7.5 Billion Pension Settlement On October 17, 2012, Verizon Communications Inc. (Verizon) announced a $7.5 billion pension settlement for management retirees and beneficiaries. This action involves the purchase of a group annuity contract from Prudential Insurance Company of America (Prudential) to cover approximately 41,000 retirees and beneficiaries. The transaction is expected to close in December of 2012. With this announcement, Verizon adds to the growing trend of pension transfer or settlement actions among major employers. Other significant actions include those announced by Ford Motor Company (Ford) and General Motors (GM) earlier this year. However, unlike other recent actions, including those by Ford and GM, Verizon is not offering participants a lump sum payment option. Pension benefits for all affected retirees and beneficiaries will be transferred to Prudential without any changes to benefits. The $7.5 billion announced by Verizon represents the Projected Benefit Obligation (PBO) currently carried on its balance sheet for the portion of the obligation being settled. Verizon’s 8-K filing noted cash contributions totaling $2.5 billion in connection with the transaction. During Verizon's third quarter 2012 earnings call, the company did not discuss the estimated accounting impact of the transaction, including any settlement charge or ongoing earnings impact. Other Plan Sponsors are Taking Bold Steps The size of pension settlement actions announced in 2012 has redefined the market. In the U.S., the amount of pension liabilities annuitized in recent years has not exceeded $1 billion per year, and no single transaction has exceeded $1 billion since the 1980s. The transactions by Verizon ($7.5 billion) and GM (expected to be a large portion of the $26 billion in liabilities it intends to settle) are an order of magnitude larger than this. In addition to the actions described above, dozens of U.S. pension plan sponsors have implemented lump sum windows for terminated vested employees in order to shrink their pension plans. Others have taken advantage of ultra-low borrowing costs to finance large pension contributions. Some plan sponsors are considering other alternatives for funding pension deficits, such as making non-cash pension contributions. For example, on October 19, 2012, AT&T Inc. announced that it intends to contribute a $9.5 billion preferred equity interest in its AT&T Mobility unit to significantly improve the funding of its pension plans. After years of watching their pension deficits swell due to falling interest rates and lagging equity returns, plan sponsors have unleashed a wide array of bold measures to gain control of this problem. This Aon Hewitt report includes an overview of the actions announced by Verizon, Ford, and GM. We have also included discussion of important considerations for pension settlement and other financing strategies. Please note that all information summarized in this document regarding specific pension settlement programs is based on publicly available information. Aon Hewitt 1
Comparison of Major 2012 Pension Settlement Actions
As a review, the following provides a side-by-side comparison of this year’s major pension settlement actions
from public disclosures.
Ford GM Verizon
Announcement Date April 27, 2012 June 1, 2012 October 17, 2012
Participants Affected 90,000 118,000 41,000
Eligible U.S. salaried retirees Current retirees and beneficiaries Management retirees who
and U.S. salaried former (about 42,000 are lump sum began receiving payments
employees eligible) before January 1, 2010
Settlement Approach Lump sums Lump sums and annuity purchase Annuity purchase
Insurance None Prudential Prudential
Companies Involved
Approximate Amount Up to $18 billion $26 billion $7.5 billion
to be Settled
Depends on actual lump sum Some to be settled via lump sum All settled via annuity
election percentage and remainder to be settled via purchase
annuity purchase
Approximate % of
Total Pension Up to 25% 20% 25%
Liability Settled1
Cash and Financial Bob Shanks—Ford CFO, From GM’s June 1 announcement: From Verizon 8-K disclosure
Statement Impacts noted: on October 17:
“. . . cash contribution . . . to effect
“. . . minimal impact on these actions will be in the range of “Verizon currently intends to
operating income. . . noncash $3.5 to $4.5 billion… “ contribute . . . $2.5 billion to
special item charges. . . no the Plan in connection with
impact to company cash. . . .” “. . . net special charges in the the transaction. . . .”
range of $2.5 to $3.5 billion. . .”
[Aon Hewitt Note: Verizon
“ . . . ongoing annual impact to currently uses mark-to-
earnings will be approximately market pension accounting.]
$200 million unfavorable due to a
decrease in pension income.”
1
Amount to be settled as a percentage of total 2011 year-end pension benefit obligation from company 10-K filing.
Aon Hewitt 2
Important Considerations for Pension Settlements
Our experience and discussions with plan sponsors suggest that the pension settlement environment will
remain active. Analyzing plan settlements is a logical extension of implementing pension de-risking
strategies, especially those including plan freezes or redesigns, and new investment strategies including
glidepaths. Organizations with sizable legacy benefits and aging participant populations should actively
consider transition “end game” strategies for their pension plans, including various pension settlement
options. Below, we discuss issues that should be considered and reflected in such an analysis.
Prevalent Settlement Options and Strategies
The Verizon settlement approach differs from the Ford and GM strategies, in that lump sums are not being
offered to plan participants. Benefits for all affected retirees and beneficiaries will be settled via an annuity
purchase. In addition to Ford and GM, a number of other plan sponsors have also announced pension
settlement programs involving lump sum offers. These lump sum “windows” often include only terminated
vested participants, rather than retirees. Examples of companies offering such windows this year include
Sears Holdings Corporation, NCR Corporation, and The New York Times Company.
In determining whether to offer lump sums, and whether to settle retirees only or retirees and terminated
vested participants, plan sponsors should consider the relative advantages of each strategy.
Settlement Strategy Key Advantages
Group annuity Sponsor controls amount settled
purchase for retirees Participant is not required to make an election, simplifying execution and
eliminating adverse selection costs
Lifetime income protection is preserved
Lump sum offer for Purely voluntary for participants
retirees Retirees usually the largest portion of the inactive liability
Lump sum offer and Sponsor controls amount settled
group annuity purchase Participant has choice of insured or uninsured settlement
for retirees
Lump sum offer to Purely voluntary for participants
terminated vested Terminated vested participants may prefer lump sum
participants
Typically most cost-effective way to settle deferred pensioner liabilities
Little to no adverse selection cost
Regulatory approval (e.g., private letter ruling) likely not needed
Copyright Aon 2012 3
Potential Adverse Selection Costs
Any settlement strategy that offers employee choice creates potential adverse selection costs. For
instance, when a choice of annuity or lump sum is offered, healthier participants will tend to prefer the
annuity. The additional cost that the plan incurs over the life of those participants can be estimated using
actuarial methods, as in the model developed and maintained by Aon Hewitt. In some cases, this cost will
be significant. If so, the sponsor may decide to modify the choice being offered in order to control potential
adverse selection costs.
Insurance Industry Capacity—$60–80B Per Year
Total Premium for Annuity Placements
$30.0
$20.0+
$5
Total Premium (billions)
$4
$3 $2.7
$2.3
$2 $1.8
$0.8 $0.9
$1 $0.7
$0.6
$0
2005 2006 2007 2008 2009 2010 2011 Proj. 2012
Year
Source: Hewitt EnnisKnupp Global Institutional Annuity Market Update, as reported
by insurance companies surveyed. The most recent survey included 10 significant U.S. insurers.
Only a small percentage of U.S. life insurance companies are With $30 billion in expected
premiums, 2012 is a landmark
currently in the pension settlement business. As annuity purchase
year for insured pension
demand increases, new carriers are expected to enter the market
settlements in the U.S.
to satisfy this demand. Smaller carriers with lower capacity levels
may jointly underwrite business with other such carriers. But with over $2 trillion in
Reinsurance companies interested in increasing their longevity estimated pension obligations in
exposure may also play a role in expanding industry capacity. U.S. corporate defined benefit
plans, we could see even greater
Even in the wake of the Verizon and GM transactions, we believe
activity in future years.
market capacity will be available if more plan sponsors pursue
annuity purchases as part of their pension settlement strategies. Annual capacity among ten large
insurers currently active in this
market is estimated at $60-80
billion.
Copyright Aon 2012 4
Benefit Protection Available in Insured Settlement Solutions
As plan sponsors and fiduciaries contemplate the impact of an annuity settlement on participants, benefit
security is a primary concern. While the actual monthly benefit does not change when an insurer assumes
responsibility for payment, the protections do change. Important due diligence about the financial health of
the insurer(s), the structure of the annuity contract and the protections in the unlikely event of insolvency
must be performed. Some plan sponsors hire an independent fiduciary to perform this analysis and to
ensure that the participants' interests are being protected by an expert third-party.
Plan sponsors are generally familiar with the nature of the security provided to benefits paid from a PBGC-
insured pension plan. However, some may be less familiar when insured products are used. Below, we
highlight two specific protections for insured products that merit particular consideration.
Use of Insurance Company Separate Accounts
The vast majority of annuity settlements are backed by the insurance company's general account. A
separate account structure can also be used to insulate the underlying assets from an insurer’s other
policyholders and creditors. If the insurer becomes insolvent, insulated separate account assets are
typically secure from general account obligations. More importantly, in an insolvency participants in those
accounts have exclusive, first priority rights to those assets to cover their payments.
In 1995, the Department of Labor issued Interpretive Bulletin No. 95-1 as guidance for plan sponsors to
use when selecting a “Safest Available Annuity” provider. One of the criteria in the Bulletin is the structure
of the annuity contract and guaranties supporting the annuities, such as the use of separate accounts.
Each issuing state may have different rules about the development and operations of insulated separate
accounts, so careful review is necessary.
State Insurance Guaranty System
When a plan sponsor enters into an insured pension settlement, participants’ benefits are no longer
backed by Pension Benefit Guaranty Corporation (PBGC). Instead, these safeguards are replaced with the
state insurance guaranty funds. These protections vary by state and are typically based on the annuitant’s
state of residence.
Qualified annuity providers generally have A to AA credit quality ratings, and are subject to regulatory
safeguards including Risk-Based Capital levels, statutory reserve standards, cash flow testing methods,
and other rigorous requirements. In addition, they are backed by the state guaranty associations. Each
state (and Puerto Rico and the District of Columbia) has a guaranty association, operating under individual
state laws, to safeguard policyholders in the event of insurance company non-performance.
In the event of insurer insolvency, participants’ benefits will generally be covered by the applicable state
insurance guaranty first, and then any additional benefits beyond the guaranty coverage limit will be
funded from the net assets of the insurer. An analysis1 by the National Organization of Life & Health
Insurance Guaranty Associations (NOLHGA) suggests that, even if an insurer fails, minimum net asset
levels might typically produce 90% to 95% funding of insured benefits. NOLHGA found that the vast
majority of policyholders have been made whole or nearly whole in past insolvencies, regardless of state
guaranty limits. Additionally, the states have assisted distressed insurance companies prior to and during
the insolvency process in an attempt to fully protect policyholder benefits.
1
NOLGHA—Testimony for the record, Hearing Entitled “Insurance Oversight and Legislative Proposals—November 16, 2011.
Copyright Aon 2012 5
Financial and Investment Considerations
Underlying these recent settlement transactions is the sponsor’s desire to decrease their pension financial
risk by shrinking the size of their pension plan. But when viewed through the lenses of accounting, cash, or
even investments, this can become anything but straightforward. Here are just some of the issues that
sponsors will need to understand as part of this process:
Issue Considerations Observation
Accounting costs Immediate recognition of a portion of For Verizon, the 2012 action will likely
unrecognized losses (and gains) when result in a different settlement charge
plan liabilities are settled may materially than most other companies would
impact earnings and earnings-related or have due to their 2010 adoption of
stock-related compensation. mark to market pension accounting.
Impact on ongoing pension expense
and P&L will depend on a variety of
factors including any additional
funding and the mix of investments in
the trust post-settlement.
Current interest By settling now, plan sponsors may fear Sponsors may choose a phased
rates “locking in” higher liability and ultimate approach to mitigate this risk as well
costs in today’s ultra-low interest rate as the impact of any accounting
environment. settlement charges described above.
“Fully Loaded” In deciding whether annuities and lump Aon Hewitt’s modeling indicates that a
liability cost sums are too expensive, sponsors typical “fully loaded” pension
should consider the full cost of providing obligation is now 0.3% to 1.5% higher
pension benefits, including solely due to recent increases in
administrative and investment fees, PBGC premiums, making settlement
PBGC premiums, and potential actions more appealing.
measurement changes (e.g., life
expectancy improvements).
Preparing the Plans must manage large interest rate “In-kind” portfolios are often used in
investments for exposure while maintaining liquidity to larger deals to minimize transaction
settlement support the transaction. risk to both sponsor and insurer.
Lump sum acceptance rate is a critical
planning variable where applicable.
Copyright Aon 2012 6
Administration and Communications
In a typical retiree buyout program without lump sum solicitations, participants will not need to make any
decisions or sign any forms. The insurer will simply assume responsibility for all future benefit payments for
the specified retiree group. Most other large settlement programs this year have included a lump sum offer,
which requires a great deal more effort from both the plan administrator and the participant. Regardless of
the approach chosen, proper communication is critical to a successful outcome. Here are just a few of the
issues administrators can expect to encounter:
Issue Considerations Observation
Communicating Sponsors must communicate the change in Sponsors may provide additional background
to annuitized source of payment and shift from PBGC to to help retirees understand why the change is
participants state insurance guaranty fund. occurring, as well as any changes to retiree
medical coverage or ancillary pension benefits.
Communicating Participants need unbiased information to Working with retirees, as well as locating and
a lump sum understand the available options and make effectively communicating with former
offer to inactive choices based on their own financial employees can take much more time and
participants situation. Multiple forms may need to be effort than pension administration for an
completed properly, signed and notarized, ongoing “steady state” plan.
and returned in a timely fashion.
Administration All aspects of administration must be Requires considerable preparation to ensure
transferred to insurer. optional forms, QDROs, payment processes,
and deductions are preserved.
Compliance and Fiduciary Obligations
Proper management of compliance and fiduciary risks begins with the proper assignment of
responsibilities. All parties should understand the distinction between the settlor and fiduciary roles, and
decisions should be made by the appropriately assigned authority.
Issue Considerations Observation
Compliance risk Compliance issues include nondiscrimination Early involvement of legal counsel in
management testing and the potential need for a private planning discussions is crucial.
letter ruling if, for example, a lump sum is
being offered to retired participants.
Settlor role Settlor decisions are made by the sponsor, Starting with the settlor analysis allows the
and include whether to terminate the plan, company to develop a strategy that
whether to offer lump sums, and to whom. balances all parties’ needs.
Fiduciary role Fiduciary decisions are made solely on behalf Sponsor should maintain separation of
of plan participants, and include evaluating settlor and fiduciary activities, including
alternative “safest available” annuity hiring a separate advisor to advise the plan
providers. on fiduciary matters.
Copyright Aon 2012 7
Appendix—Overview of Specific Settlement Actions Copyright Aon 2012 8
Recap of Ford Settlement Actions
The charts below provide an overview of the Ford settlement action and the potential size of the settlement
relative to the remaining liability for the Ford Motor Company General Retirement Plan.
Liabilities and Participants Reported for Recent Plan Year
Funding Target Liability Participant Count
(in $billions)
2.9 21,900
0.9
65,962 33,038
65,962
13.7
Active
Terminated Vested
13.7 In Payment
Source: Data from Ford Motor Company General Retirement Plan Form 5500 for plan year ending December 31, 2011
(Department of Labor website). Updated numbers presented elsewhere in this document were disclosed by Ford on
April 27, 2012.
____________________________________________________________________________________________
Ford Settlement—Offer Lump Sums to Retirees and
Terminated Participants
What—Lump sum offer to approximately Active
90,000 salaried retirees and terminated
vested participants.
Retirees and Terminated Vested
When—Series of election periods
through 2012 and 2013.
Why—Allow additional choice and flexibility
to inactive participants, and allow company to
reduce volatility and administrative costs
related to pensions.
Potential lump sum settlement
Copyright Aon 2012 9Recap of GM Settlement Actions
The following provides a step-by-step overview of the steps GM is taking to complete its pension
settlement transaction.
Liabilities and Participants Reported for Recent Plan Year
Funding Target Liability Participant Count
(in $billions)
3.0 26,547
0.8
29,376
25.8 124,310
Active
124,310
Terminated Vested
In Payment
25.8
Source: Data from GM Salaried Retirement Plan Form 5500 for plan year ending September 30, 2011 (Department of
Labor website). Updated numbers presented elsewhere in this document were disclosed by GM on June 1, 2012.
Copyright Aon 2012 10GM’s Transaction Steps
Step 1—Offer Lump Sums
Offer lump sum payments to 36% of the retiree and
beneficiary population (about 42,000 participants).
This is generally the group which retired on or after
October 1, 1997 and before December 1, 2011. Active
Terminated Vested
When Retirees—Not Lump Sum Eligible
Lump sum elections provided to eligible retirees and Retirees—Lump Sum Eligible
beneficiaries after the announcement, with a required
return date of July 20, 2012.
Lump Sum Distributions
Step 2—Split the Pension Plan
Create a new plan for active and, presumably,
terminated vested participants.
Active
When
Terminated Vested
Late 2012
Retirees to be Annuitized
Step 3—Terminate and Purchase Annuities
Lump Sum Distributions
Terminate retiree/beneficiary plan for those
participants not receiving a lump sum payment
and buy annuities from Prudential.
When
By the end of 2012
Active
Terminated Vested
Annuity Purchases
Copyright Aon 2012 11Recap of Verizon Settlement Actions
Liabilities and Participants Reported for Recent Plan Year
Funding Target Liability Participant Count
(in $billions)
22,310
3.0
57,901
7.3 1.4 57,901 26,109
7.3
Active
Terminated Vested
In Payment
Source: Data from Verizon Management Pension Plan Form 5500 for plan year ending December 31, 2011
(Department of Labor website). The figures shown above reflect the merger of several union plans into the Verizon
Management Pension Plan during 2010. Updated numbers presented elsewhere in this document were disclosed by
Verizon on October 17, 2012.
___________________________________________________
Verizon Settlement—Purchase Annuities for Retirees
What—$7.5 billion liability settlement
from Prudential for employees
Active
retiring before January 1, 2010.
Terminated Vested
When—By the end of 2012. Retirees to be Annuitized
Retirees Not Being Annuitized
Why—Reduce volatility associated with
pension plan, reduce administrative costs,
and allow greater focus on core business.
$7.5B liability settlement
Copyright Aon 2012 12Contact Information For more information, please contact: Rick Jones Senior Partner and Leader of Retirement Consulting National Practices rick.jones@aonhewitt.com 847.295.5000 Eric Keener Partner and Chief Actuary eric.keener@aonhewitt.com 203.852.1100 Alan Parikh Associate Partner and Pension Risk Specialist alan.parikh@aonhewitt.com 847.295.5000 About Aon Hewitt Aon Hewitt is the global leader in human capital consulting and outsourcing solutions. The company partners with organizations to solve their most complex benefits, talent and related financial challenges, and improve business performance. Aon Hewitt designs, implements, communicates and administers a wide range of human capital, retirement, investment management, health care, compensation and talent management strategies. With more than 29,000 professionals in 90 countries, Aon Hewitt makes the world a better place to work for clients and their employees. For more information on Aon Hewitt, please visit www.aonhewitt.com. Copyright Aon 2012 13
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