Risk Management

How to Handle an Employee Benefit Windfall

Prudential IPO may mean big bucks to employer/policyholders.
David KatzMay 10, 2001

When the arcane word “demutualization” pops up in the news, CFOs should pinch themselves to stay awake—and read on.

The reason? If an employee benefits provider demutualizes, or transforms itself from a mutual to a stock company, its policyholders could get million-dollar windfalls in cash or stock in the resulting IPO. That, in turn, could trigger the need to make thorny risk management choices promptly.

CFOs for the thousands of companies whose benefit plans are underwritten by Prudential Insurance Co. of America, the latest player in a surge of insurance demutualizations that has also included John Hancock and MetLife, would do well to mobilize for such choices.

In six months or so, if all goes well, the Newark, N.J.- based insurer will demutualize. In exchange for ownership rights, the insurer will hand out the total value of the company to eligible policyholders.

This week, the Pru launched a “get out the vote” mailing for its plan. In order for the conversion to move forward, by July 31 one million policyholders must vote and two- thirds of the voters must approve the plan. Then the New Jersey banking and insurance commissioner must okay it.

About 40,000 of Pru’s 11 million policyholders are institutional clients, including corporate buyers of group insurance benefits and retirement services, a press representative of the insurer says.

If they paid part or all of the premium, employers providing Pru group life, disability, or health insurance benefits under policies in force on December 15, 2000 (the date Pru’s board approved the demutualization) may eventually find themselves with whopping distributions.

Most distributions would be in the form of the stock of Prudential Financial Inc., the holding company slated for funding by the IPO. Thus, a big decision would be whether to hold the stock, which wouldn’t be subject to federal income tax, or to sell it and be taxed.

But a more important choice would concern who owns the distribution— the employer, the employees, or both. For pension or 401(k) plans, however, there would be no choice.

Under the Employee Retirement Income Security Act (ERISA), the distribution would be considered an asset of the benefit plan, not the corporation. Thus, it would all have to be used for the benefit of the employee rather than the employer. (Typically, the benefit plan, rather than individual employees, get the distributions.)

For non-retirement welfare benefits, like life or health coverage, the situation is different. If employers paid the premiums in full, the total distributions could go to them.

But if the premiums for welfare benefits have been paid completely by employees–as they tend to be in supplemental life insurance plans, for example–the distribution would go to the benefit plan, not the employer.

Here Come the Actuaries

The complexities—and the actuaries—come into the picture when the payments for welfare benefits have been shared by employers and employees.

In such cases, “the employer has to make a good-faith effort to go far back and reconstruct the relative contributions” to itself and to the benefit plan, Bill Brossman, a consulting attorney with William M. Mercer Inc., in Princeton, N.J., tells CFO.com.

Once an employer has done that, it may face other tough choices involving distributions to plans covering different employee groups.

Disputes may erupt, for instance, if the employer divides the loot in ways that seem to unduly favor union over non-union workers or current employees over retirees, suggests Brossman, who says Mercer has thousands of clients that might be affected by the Pru demutualization.

The U.S. Department of Labor (DOL), which enforces ERISA, will expect employers to be even-handed, the consultant thinks. He offers the example of his client, who received a distribution from a demutualized insurer after the employer had gone through a big downsizing.

If the employer immediately had placed the distribution into the plan, that would have created “a disparate result” in favor of current employees, he says. The DOL would look to the employer to come up with a way to provide benefits to the plan beneficiaries who were no longer with the company, Brossman adds.

In fact, to avoid DOL penalties, employers getting distributions “need to be thinking out at the front end,” he advises.

Once Pru stock applicable to plan assets is distributed, an employer has only a year to put it into a custodial account, according to a Feb. 15 letter ruling by the Pension and Welfare Benefits Administration of the DOL.

“This is an area where DOL has been out auditing,” warns Brossman, noting that he’s had clients receiving distributions connected with the MetLife demutualization that were audited by the DOL for not moving promptly on the issue.

Another reason employers need to get up to speed on a prospective distribution is to avoid lawsuits. Employers should be careful about the steps they take to retain or terminate employees in connection with a distribution, the consultant says.

The unfairness of certain strategies could spawn litigation, according to Brossman.

Choices about holding or folding distributed stock and the timing of the transactions could also land employers in court if beneficiaries think they performed their fiduciary roles improperly.

Come to think of it, some employers might do well to use part of their distribution money to buy fiduciary liability insurance. Welcome as windfalls are, they often produce unexpected consequences.