Record pension deficits for U.S. corporate pension plans of more than $700 billion are sure to keep the CFOs of plan sponsors small and large, public and private, busier than ever. 

Market volatility, low interest rates, and an explosion of Employee Retirement Income Security Act (ERISA) lawsuits are a few of the factors in the continued interest in a variety of approaches known as “pension de-risking.” The group of solutions made headlines in the United States and the United Kingdom, and General Motors, NCR, and Verizon are a few of the firms that have de-risked this year.

While there is no universal definition of “de-risking,” many experts use the term to refer to any type of transaction that: allows a company to transfer part or all of its pension obligations to a third party like an insurance company; settle up with plan participants by offering a lump sum payout; or embark on an investment strategy like liability-driven investing. The choices vary, as do the advantages and disadvantages. CFOs everywhere will need to do their homework about what makes the most sense for their pension plan participants.

If experts are right, more pension de-risking deals are on the way. While there are plenty of reasons that a company may want to consider restructuring one or more of its ERISA plans, a final decision must be based on a comprehensive assessment of costs versus benefits, as well as taking legal and governance considerations into account.

Fiduciary fatigue is likewise motivating companies to explore ways to partially or fully transfer the risk of pension plans to big financial institutions. To paraphrase the lament of one executive, “We don’t want to be in the pension business anymore.”

A company’s failure to show that its ERISA fiduciaries thoroughly considered the merits of all relevant choices — something jurists describe as “procedural prudence” — is an invitation to a lawsuit or enforcement action or both. Adding to the complexity of pension de-risking due diligence is the potential problem that arises when a CFO or other company insider serves as an ERISA fiduciary — yet makes a decision mostly based on enterprise value enhancement for shareholders.

Beyond the obvious number-crunching needed to vet what’s often a large dollar transaction, the decision to de-risk should minimally include:

  • A thorough evaluation of the financial, operational, and legal strength of the annuity provider as required by the U.S. Department of Labor Interpretative Bulletin 95-1.
  • Independent pricing of any hard-to-value assets that will be contributed as part of a de-risking deal.
  • Economic assessment of opportunity costs in a low interest rate environment and whether it is better to delay a transaction or close immediately.
  • Review of vendor and counterparty contracts that may need to be unwound in the event of a full transfer of pension assets and liabilities to a third party.
  • Review of direct and indirect fee amounts to be paid by a plan sponsor as the result of a de-risking transaction.
  • Assessment of litigation risk associated with plan participants asserting that they’ve been unfairly treated as the result of a pension de-risking arrangement.
  • Creation of a strategic communications action plan to ensure that plan participants, shareholders, and other relevant constituencies are provided with adequate information.

The increased trend by plan sponsors to transfer responsibility for pension risk to external parties raises myriad legal considerations. To ensure compliance with the spirit and letter of ERISA, fiduciaries must show that any pension de-risking considered — and possibly accepted — would be mainly in the best interest of participants, not shareholders. In the event of a lawsuit, the threshold analysis will be whether the company was acting as a fiduciary under ERISA in offloading its pension risk.

ERISA defines a “fiduciary” as one who exercises discretionary authority or control over the management of plan assets. Often, the courts find that the answer requires a factual analysis of the specific acts performed. This can unfortunately preclude early dismissal of litigation maintaining a fiduciary breach. Certain acts concerning benefit plans, such as establishing, amending, or terminating a plan, do not invoke ERISA’s fiduciary obligations, however.

Because the transfer of pension liabilities constitutes a termination, or partial termination, of a benefit plan, ERISA’s fiduciary responsibilities may not be implicated. But the law is unsettled, and to the extent the transfer of pension liabilities is deemed to involve the management of plan assets, ERISA’s dual standard of prudence and loyalty to plan participants will be triggered.

For those pension de-risking transactions that require the hiring of an annuity vendor, affected parties may be tempted to file a claim if there is any concern that a “safest available” provider has not been selected. To defend such claims, companies, to the extent they are deemed fiduciaries, must be able to show that they acted as a reasonable person in like circumstances would have done.

Some prudence challenges may focus on the amount paid to the annuity provider. Participants may assert that the future liabilities were undervalued or calculated at too high an interest rate, causing the company to provide inadequate funds to the annuity provider at the time of transfer.

Challenges asserting a breach of fiduciary loyalty will likely contend that the company offloaded its pension liability to benefit the company and its shareholders, at the expense of the participants. The low interest rate environment fuels such claims, as participants may view the company as de-risking to avoid increased funding requirements, as well as the higher insurance premiums that must be paid to the Pension Benefit Guaranty Corporation.

The Pension Rights Center (PRC) has already called for a moratorium on de-risking transactions until policymakers can evaluate their effect on retirement security. Among other concerns, the PRC claims that such transactions leave retirees without the usual protection of insurance by the Pension Benefit Guaranty Corporation against pension underfunding or delinquency. Instead, the PRC contends that the pension annuities fall under the lesser protection provided by State Guarantee Associations.

While participants may find the transfer of responsibility for their pension entitlement unsettling, the risk of litigation should not be a deterrent to plan fiduciaries. Lawsuits by the participants involve significant cost and resources, and will likely not succeed without proof of harm. Litigation to stop the transaction may well be deemed premature and speculative as to damages.

Only in the clearest of situations that a transfer will result in harm is a court likely to direct it to be stopped. Notwithstanding the risk of challenge, pension transfers, if done carefully, can beneficially provide retirement security to retirees and financial strength and growth to the company.

 Susan Mangiero is managing director of Forensic & Litigation Consulting at FTI Consulting. Nancy G. Ross is an attorney and partner in the Chicago office of McDermott Will & Emery and heads the firm’s ERISA litigation practice group.

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