The Risks of De-Risking to Eliminate Company Pension Liability

Ever since the passage of the Pension Protection Act of 2006, plan sponsors have struggled to keep their defined benefit plans adequately funded in the midst of increasingly volatile capital markets, shorter asset and “interest smoothing” periods, and higher targeted funding levels. Efforts to manage this pension risk have ranged from simply taking a more active approach to managing plan investments through liability-driven investment (LDI) techniques, to pension buy-ins and lump-sum offers to plan participants. One de-risking technique, however, has attracted significant attention as of late: plan buyouts through the purchase of group annuity contracts.

The benefit of such an arrangement, however, can be significantly undermined by the company’s failure to carefully consider the legal and governance issues involved. As is the case with many actions in the Employee Retirement Income Security Act-covered plan universe, pension buyouts are an invitation to litigation. The sizes of these deals, both in terms of the dollar amounts and the number of plan participants, make for increased demands on all parties involved—plan sponsors, administrators, consultants, and insurers. All must remain mindful of their obligations under ERISA in order to reduce the possibility that lawsuits by aggrieved annuitants will render the buyout medicine worse than the pension-disease. By engaging in the necessary procedural prudence up front, companies should be able to ward off—or at least successfully defend—resulting litigation or enforcement actions.

Plan buyouts have been around for some time, but the sizes of two recent deals have brought this particular type of de-risking transaction to the fore. In June 2012, General Motors Company announced a deal that it had struck with The Prudential Insurance Company of America for the purchase of over $26 billion worth of annuity contracts to satisfy its pension obligations to approximately 42,000 salaried retirees. And in October, Verizon Communications Inc. announced its own buyout deal with Prudential, this one involving the purchase of $7.5 billion in obligations. With no previous pension buyout since the 1980s surpassing the $1 billion mark, many pension experts have cited these two recent deals—with their sheer size and the prominence of the parties—as signaling the beginning of a significant trend toward de-risking through dramatic plan-wide buyouts.

The Threshold Question: Fiduciary or Not?

The vast majority of significant ERISA litigation arises when a plan participant or class of participants feels that some decision made by the plan sponsor or the parties administering the plan violated the fiduciary duties owed under ERISA. However, it is important to note that these fiduciary duties are only implicated when the decision or action at issue involves an exercise of discretion over the management or disposition of the plan’s assets, or the administration of the plan. Decisions with regard to the plan that can be characterized as “strictly business”—plan creation, amendment, or termination—are not the type of decisions that the company must make as a fiduciary, and therefore are not decisions that pose litigation risk.

This distinction, while seemingly technical, is incredibly important in the context of pension buyouts: while the buyout decision itself is unlikely to expose the sponsor to fiduciary breach claims, the actual transaction and the winding-up of the plan is one that requires a host of discretionary decisions concerning the disposition of plan assets and the administration of the plan, and therefore ERISA’s fiduciary duties are likely to apply to these discretionary decisions. In the context of a pension buyout, the duty of loyalty, the duty of prudence, and the duty to administer the plan in accordance with plan documents may all need to be navigated at various points in the process.

The Duty of Loyalty to Participants