SEI has released a white paper evaluating the potential impacts of offering lump sum payments to terminated-vested participants of pension plans.
Average pension funding levels increased significantly last year, and many plan sponsors are considering the benefits of offloading a portion of plan liabilities through lump sum pay-outs. However, according to SEI’s analysis, this strategy works best when used in conjunction with a de-risking portfolio strategy.
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For plans with a return-seeking strategy in place, which is the majority of U.S. corporate pension plans, lump sum pay-outs could prove counterproductive.
"A plan engaged in an asset optimization strategy is to some degree undermining its own strategy by reducing assets under management, and giving up the potential for positive investment returns. This is particularly the case for plan sponsors delaying de-risking strategies based on an anticipated increase in interest rates," said Thomas Harvey, Director of Advisory Team, SEI’s Institutional Group.
"Under the current low interest rate environment, costs of settling benefits through term-vested lump sum pay-outs now may turn out to be relatively high."
SEI’s research analyzed a sample plan with $255 million in plan assets and $300 million in Pension Benefit Obligation (PBO) liability.
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By GlobalDataAssuming the plan had a diversified portfolio of 60 percent equities, 30 percent medium duration fixed income, and 10 percent alternatives, the sponsor would see about a $4.5 million funding gap benefit to retain the assets over the next five years, rather than offer a lump sum pay-out.
The analysis goes a step further to incorporate impending new mortality tables and a subsequent rise in liabilities, with similar results.
In addition, PBGC premiums are scheduled to rise from $46 per person to $57 per person over the next three years.
While lump sum pay-outs do result in cost savings by reducing the number of people covered by the pension plan, SEI’s analysis found that this strategy would not significantly offset the median investment returns on the assets if retained.
"While lumping out term-vested plan participants is perhaps one of the lowest cost strategies for reducing pension plan risk, it should be treated as one component of an overall de-risking strategy," Harvey said. "Plan sponsors and committees should approach pension management in a holistic fashion, aligning their asset allocations with other pension-related decisions."
