Pension De-Risking for Employee Benefit Sponsors Minimizing Risks and Ensuring ERISA Compliance When Transferring Pension Obligations to Other Parties Today’s faculty features: 1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific The audio portion of the conference may be accessed via the telephone or by using your computer's speakers. Please refer to the instructions emailed to registrants for additional information. If you have any questions, please contact Customer Service at 1-800-926-7926 ext. 10. WEDNESDAY, JANUARY 16, 2013 Presenting a live 90-minute webinar with interactive Q&A Susan Mangiero, Managing Director, Fiduciary Leadership, Trumbull, Conn. Anthony A. Dreyspool, Senior Managing Director, Brock Fiduciary Services, New York David Hartman, General Counsel and Vice President, General Motors Asset Management, New York Sam Myler, McDermott Will & Emery, Chicago
Transcript
Pension De-Risking for
Employee Benefit Sponsors Minimizing Risks and Ensuring ERISA Compliance
When Transferring Pension Obligations to Other Parties
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FOR LIVE EVENT ONLY
Pension De-Risking for Employee Benefit Sponsors
Minimizing Risks and Ensuring ERISA Compliance When Transferring Pension Obligations to Other Parties
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Susan Mangiero Fiduciary Leadership
Anthony A. Dreyspool Brock Fiduciary Services
David Hartman General Motors
Asset Management
Outline I. De-risking overview
A. Current trends B. Different approaches
1. Transfers to third parties 2. Lump sum payouts for participants 3. Investment strategies
II. Procedural prudence & meeting ERISA fiduciary requirements
1. Prudence 2. Care 3. Loyalty
III. Potential challenges from plan participants A. Grounds for challenges B. Likelihood of success
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Current Trends For Defined Benefit Plans and Sponsors • Low equity returns (and high volatility)
• Low bond yields
• Higher inflation
• Higher life expectancy
• Cash contributions
• Increased regulation
• Higher PBGC premiums
• Accounting impact
• Dilution of management’s focus on strategic shareholder wealth creation
• Litigation risks
• M&A deals gone awry due to pension issues
• Debt capacity
• Liquidity constraints
• Cost of capital
• Potential impact of large pension obligations on stock price
Many plan sponsors want
OUT of the pension business
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What is Pension De-Risking?
Two
Approaches
In-Plan
De-Risking
Change the asset-liability profile of a plan’s investments
Corporate Balance Sheet Pension De-
Risking
Pension liabilities show up on the
corporate balance sheet
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In-Plan De-Risking
Overview
Modify targeted mix among asset classes
Reduce volatility and better match plan’s investment mix to
liability profile
Triggered by plan fiduciary decisions
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Corporate Balance Sheet De-Risking
Overview
Impact and scale can be mitigated in variety of
ways
Lump sum offering, purchase of annuities,
etc
Triggered by “settlor” decision but fiduciary
needs to make determinations in
carrying out decision
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Where to Start • Understand what initiatives are being pursued • Review governing documents to check for
possible conflicts • Map out which decisions are settlor versus
fiduciary actions • Identify who will make fiduciary decisions and on
what basis • Determine what regulatory approvals are needed • Understand when information must be filed and
who will prepare and then review requisite reports
• Make sure that all participant data is available and “clean”
• Create communications strategy to fully inform plan participants, shareholders and other relevant constituencies
• Assess economic opportunity costs in terms of acting now versus waiting until later when (a) interest rates may go up, (b) insurer capacity may be constrained, and (c) preferred fixed income securities may be in short supply
Important to map out key roles and
responsibilities
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Asset Consideration Issues
Partial List
Lump Sums
Estimate Amount of Liquidity Needed
Determine Sources of Liquidity
Purchase of Annuities
Negotiate With Insurer Regarding
What Assets They Will or Won’t Accept
How and Whom Values “Hard to
Value” Assets
Purchase of Assets Requested by Annuity
Provider
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Company Size and De-Risking
• There is a point where the company can spend too much to get rid of too small of a liability
• Plan sponsor needs to candidly assess whether its limited staff size and/or lack of ERISA expertise means that plan participants would be better served with experienced professionals in charge of managing assets and liabilities
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Pension Risk Taxonomy
• No universal consensus on terms such as “pension risk management” or “pension de-risking”
• Is pension de-risking a sub-set of pension risk management or a separate category of strategies and considerations?
• No risk-free solution
• EVERY transaction introduces some new incremental risk(s) while facilitating the anticipated reduction of other risk(s)
• U.S. Department of Labor guidance regarding derivatives: “Plan fiduciaries have a duty to determine the appropriate methodology used to evaluate market risk and the information which must be collected to do so. Among other things, this would include, where appropriate, stress simulation models showing the projected performance of the derivatives and of the plan's portfolio under various market conditions. Stress simulations are particularly important because assumptions which may be valid for normal markets may not be valid in abnormal markets, resulting in significant losses. To the extent that there may be little pricing information available with respect to some derivatives, reliable price comparisons may be necessary. After entering into an investment, a plan fiduciary should be able to obtain timely information from the derivatives dealer regarding the plan's credit exposure and the current market value of its derivatives positions, and, where appropriate, should obtain such information from third parties to determine the current market value of the plan's derivatives positions, with a frequency that is appropriate to the nature and extent of these positions.”
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Procedural Prudence
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• Terminating or amending a plan is an employer’s decision, not a fiduciary one, however, selecting an annuity provider is a fiduciary decision under ERISA (see Memorandum Opinion in the Verizon case)
• Procedural prudence is an ERISA concept The standards under ERISA section 404(a) for a fiduciary (i.e. the duty of acting as a “prudent expert”) acting exclusively for the purpose of paying benefits and defraying reasonable plan administrative costs, acting solely in the interests of plan participants and beneficiaries, and acting in accordance with the plan’s documents
• If a fiduciary is procedurally prudent, there will not be 20-20 hindsight by the DOL or a court
• How to prove prudence? Careful analysis of the right action to be taken: cash out; purchase of annuity for all or some of plan participants; termination of plan
U.S. Department of Labor Guidance About De-Risking • Interpretive Bulletin 95-1 This is still leading guidance for defined benefit plan
fiduciaries selecting annuity provider for benefit distribution. It says:
• Fiduciary must choose the “safest available annuity provider”, unless under the circumstances it would be in the interest of participants to do otherwise
• Fiduciary must conduct objective, thorough and analytical search
• Fiduciary can’t rely solely on insurance rating agencies to rate insurer
• Fiduciary should consider: (i) quality and diversification of insurer’s investment portfolio; (ii) size of insurer relative to proposed contract; (iii) level of insurer’s capital and surplus; (iv) lines of business of the insurer and other indications of its exposure to risk; (v) structure of the annuity contract and guarantees supporting the annuities, like separate accounts; (vi) the availability of protection through state guarantee associations and the extent of the guarantee
• The plan sponsor should hire an independent expert to give it advice if it doesn’t have the necessary expertise
• If there would be a reversion of excess assets from the plan to the sponsor, the sponsor may need to hire an IF. The plan sponsor may want to hire an IF in any case to transfer fiduciary risk and avoid conflict claims
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Advisory Opinion 2002-14A 12/18/02 (to MetLife) • Relates to IB 95-1 as it pertains to defined
contribution plans
• Gives a modest amount of guidance on the relevance of state guarantee funds
• Fiduciary can take into consideration the cost of the annuity if the amount of payment would be greater to the participant, but can’t base its decision only on the cost
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ERISA Section 404(a)
• Establishes safe harbor for selecting annuity provider for individual account plans
• This regulation essentially incorporates the guidance of IB 95-1, but says, among other things, that the plan sponsor should consult with an independent fiduciary if it deems it necessary to do so
• De-risking for a defined contribution plan is viewed differently because the plan sponsor does not have to fund the plan, however, the safe harbor is useful in connection with the annuitization of benefits under the plan.
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Selecting an Independent Fiduciary • Ask for help from plan actuary or attorney to identify possible IFs;
send out RFPs; carefully analyze responses; interview the candidates
• Hire an IF based on its knowledge of the insurance industry and the possible providers, its expertise in analyzing bids from the insurance companies, its ability to effectively negotiate contract with the provider, and its experience with the type of assignment at hand
• Once selected, the sponsor should be in frequent contact with the IF regarding its activities and analyze the IF’s decision to look for conflicts of interest or other obvious flaws in the IF’s analysis and decision
• The sponsor must also not agree on a more than reasonable fee to the IF if the plan is paying the bill
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“Safest Available” Testing: Some Key Elements
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• Quality and diversification of annuity provider’s investment portfolio
• Size of insurer relative to proposed contract and capacity
• Level of insurer’s capital and surplus and insurer’s risk management policies and procedures
• Annuity provider’s liability exposure from other lines of business
• Structure of the annuity contract (and related items) and guarantees supporting the contract
• Safety net structure from state and/or federal guarantees
* Source: DOL Interpretative Bulletin 95-1
Susan Mangiero, PhD, AIFA®, CFA, FRM • Dr. Susan Mangiero is a managing director with Fiduciary Leadership, LLC. Dr. Mangiero is a CFA charterholder, certified Financial Risk
Manager and Accredited Investment Fiduciary AnalystTM. She has provided testimony before the ERISA Advisory Council, the OECD and the International Organization of Pension Supervisors as well as offering expert testimony and behind-the-scenes forensic analysis, calculation of damages and rebuttal report commentary for various investment governance, investment performance, fiduciary breach, prudence, risk and valuation matters. She has over twenty years of experience in capital markets, global treasury, asset-liability management, portfolio management, economic and investment analysis, derivatives, financial risk control and valuation. This includes work on trading desks for several global banks, in the areas of fixed income, foreign exchange, interest rate and currency swaps, futures and options.
• Some of her recent engagements include: (a) analysis of DB plan funding status for a private equity buyer of a closely-held company (b) analysis of an investment manager’s actions by a group of union plans (c) review of annuity terms for DB and DC plans (d) review of investment policy statement language in the aftermath of bank downgrades (e) assessment of damages by an asset manager that did not properly hedge positions (f) review of benefit distributions by a plan sponsor that is being investigated and (g) analysis of fees paid by a large trust. Dr. Mangiero has provided insights about asset allocation, fiduciary duties, risk management, modeling, hedge effectiveness, hedge funds, private equity funds, ERISA, valuation and industry best practices for consulting clients and employers that include the General Electric Company, Prudential Retirement, PricewaterhouseCoopers, Mesirow Financial, Bankers Trust, Bank of America, Chilean pension regulator, World Bank, Pension Benefit Guaranty Corporation, RiskMetrics, U.S. Department of Labor, Northern Trust Company and the U.S. Securities and Exchange Commission. Dr. Mangiero is the author of Risk Management for Pensions, Endowments and Foundations (John Wiley & Sons, 2005), a primer on risk and valuation issues, with an emphasis on fiduciary responsibility and best practices. Dr. Mangiero has written chapters for several books, including the Litigation Services Handbook and The Handbook of Interest Rate Risk Management.
• She is a frequently invited speaker and has keynoted or led workshops for organizations such as the Stable Value Investment Association, Harvard Law School, Florida Public Pension Trustees Association, New York State Department of Insurance, Association of Public Pension Auditors, AICPA - Employee Benefits Section, National Association of Corporate Directors and Financial Executives International. She is a member of the 401(k) vendor RFP best practices committee for the Association of Financial Professionals. Susan can be reached at [email protected] or 203-261-5519.
Anthony A. Dreyspool is a Senior Managing Director of Brock Fiduciary Services LLC. Mr. Dreyspool is in the private practice of law specializing in the investment of assets of ERISA-covered employee benefit plans and all aspects of ERISA fiduciary law compliance. Mr. Dreyspool has more than 30 years of experience with respect to ERISA matters and has substantial knowledge in the structuring and forming of private real estate and equity funds for the institutional investment market. He has counseled many of the world’s largest fund managers and retirement plans on ERISA fiduciary law compliance matters. Before starting his private practice, Mr. Dreyspool was a partner at DLA Piper (US) LLP and, prior to that, Of Counsel at Paul, Hastings, Janofsky & Walker LLP. Previously, he was the chief ERISA attorney for The Equitable Life Assurance Society of the United States, where he advised Equitable and its investment management subsidiaries on all legal requirements involved in the investment of ERISA plan assets. Mr. Dreyspool began his legal career at Dewey, Ballantine, Bushby, Palmer & Wood LLP and was also an employee benefits and executive compensation lawyer at J.C. Penney Company, Inc. Mr. Dreyspool is the founder and President of Park Avenue Presentations, Inc., a producer of webinar conferences on ERISA and other legal and business-related matters. Mr. Dreyspool received his J.D. from the University of Pennsylvania Law School and his B.A., with high honors, also from the University of Pennsylvania. He is admitted to the New York State Bar. He is a frequent speaker on ERISA fiduciary matters and is the author of ERISA Fiduciary Law for Non-Lawyers.
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David Hartman
David Hartman is General Counsel and Vice President at General Motors Asset Management (GMAM), a wholly-owned subsidiary of General Motors Company located in New York City. GMAM manages in excess of $85 billion of client assets, including GM’s U.S. defined benefit and defined contribution employee benefit plans.
Mr. Hartman’s practice focuses on institutional investment management, investment transactions including those in alternative asset classes, fiduciary and ERISA matters, regulatory matters and general corporate and transactional work. Mr. Hartman joined GMAM in 2001. Prior to that, he worked as an in-house attorney, specializing in asset management and financial services matters, at each of Zurich Scudder Investments and AIG. He began his legal career as an associate at Simpson Thacher and Bartlett, LLP.
Mr. Hartman received his J.D. degree from the UCLA School of Law and his B.A., with high honors, from Colgate University.
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“A civil action may be brought in the event that the
purchase of an insurance annuity in connection with
termination of an individual’s status as a participant . . .
violates [ERISA’s fiduciary provisions] or the terms of the
plan . . . to obtain appropriate relief . . . to assure [receipt of
benefits].”
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Civil Liabilities Annuitant Claims – § 502(a)(9)
Part of the Pension Annuitants Protection Act of 1994
Enacted in Response to Executive Life Collapse and Litigation
– Kuntz v. Reese, 785 F.2d 1410 (9th Cir. 1986) (suggesting that annuitants are no longer plan participants, and as such, lack standing to sue the plan or its fiduciaries for breach in connection with the purchase of the annuity)
Appears to Authorize a Wide Variety of “Appropriate Relief”
– Posting of bond to secure annuity
– Purchase of “back-up” annuity
– Any relief appropriate to assure receipt of payments under the annuity
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Civil Liabilities De-Risking Efforts
Liability-Driven Investment
– Investing plan assets with an eye toward current and future liabilities as opposed to total benchmark return
Lump Sum Distributions
– Distributions to former employees that have yet to reach retirement age
– Distributions to retirees that have yet to receive annuity payments
– Distributions to retirees currently receiving annuities
Annuity Purchases
– Transfers of legacy obligations to an insurer through purchase of annuity
– The Decision to Adopt LDI – Is the decision to adopt LDI motivated by the company’s financial statement or the interests of plan participants?
• § 404(a)(1) – Duty of Loyalty
– The Investment Portfolio – Does the complexity associated with LDI make such a strategy imprudent for a particular plan?
• § 404(a)(1)(B) – Duty of Prudence
• § 404(a)(1)(C) – Duty of Diversification
– The Expenses Associated with LDI – Do the expenses associated with an LDI strategy (management fees, transaction fees, etc.) violate the duty to defray reasonable expenses?
• § 404(a)(1)(ii) – Duty to Defray Reasonable Expenses
– Fiduciary could potentially be required to restore plan to pre-breach funding levels - § 502(a)
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Civil Liabilities De-Risking Efforts
Liability-Driven Investment
Lump Sum Distributions
Annuity Purchases
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Civil Liabilities Lump-Sum Distribution Risks
Potential Benefits Claims
– Lump sum payment must be the actuarial equivalent of the annuity
• Mortality Tables – Malloy v. Ameritech, No. CIV 98-488-GPM (S.D. Ill.
2000)
• Cost of Living Adjustments – Laurenzano v. Blue Cross/Blue Shield of
Mass. Ret. Income Trust, 134 F. Supp. 2d 189 (D.Mass. 2001)
– Participant must exhaust administrative remedies and administrative
decision entitled to deference
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Civil Liabilities De-Risking Efforts
Liability-Driven Investment
Lump Sum Distributions
Annuity Purchases
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Civil Liabilities Annuity Purchase Risks
Potential Claims
– Fiduciary Claims
– Annuitant Claims
Purchase of annuity “possibly the most important decision in
the life of the plan.” Waller v. Blue Cross of California, 32 F.3d
1337 (9th Cir. 1994)
Fiduciary Act?
– Decision to Purchase Annuities – Settlor Function
– Selection Process and Choice of Provider – Fiduciary Act
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Civil Liabilities Annuity Purchase Risks
DOL Interpretive Bulletin – 95-1
– Fiduciaries must take steps calculated to obtain “the safest annuity available”
– Fiduciary must consider:
• Diversification of provider’s portfolio
• Size of provider relative to the proposed contract
• The insurer’s capital levels
• The insurer’s exposure to liability
• The structure of the contract
• The availability of additional protections through state guarantee associations
– Safest annuity may be unnecessary if, for example, the provider is unable to properly administer the annuity
– Special care must be taken in reversion situations to avoid conflict of interest
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Civil Liabilities Annuity Purchase Risks
Bussian v. RJR Nabisco, 223 F.3d 286 (5th Cir. 2000).
• Former employees of RJR Nabisco subsidiary brought suit against plan
fiduciaries that purchased annuities from failed Executive Life Insurance
Company.
• Fifth Circuit overturned district court grant of summary judgment in favor of
plan sponsor; court found that a number of factual questions existed as to
whether plan fiduciaries violated their duties of loyalty and prudence in
selecting an annuity provider.
– Discussed a number of problems with sponsor’s investigation and selection of
annuity provider
– Found that even assuming a proper investigation was conducted, jury could
determine that selection of Executive Life would have been imprudent as judged
by the prudent person standard
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Civil Liabilities Annuity Purchase Risks
Bussian v. RJR Nabisco, 223 F.3d 286 (5th Cir. 2000).
– Duty of Loyalty
• Decision to terminate plan by purchasing annuities is not itself a fiduciary act and not a violation of duty of loyalty
• Duty of loyalty may be violated if provider selected based on cost or size of asset reversion rather than safety of annuity
• Duty of loyalty does not demand that plan purchase “safest annuity available”; must make decision with “an eye single” to the interests of participants
– DOL Bulletin only “entitled to respect,” not binding on the Court
– Duty of Care (Prudence)
• Must structure and conduct a “thorough and impartial investigation” of providers
• DOL IB – 95-1 is instructive as to factors to be considered by fiduciary in deciding upon provider
• Engaging independent outside advisor serves “dual purpose” of mitigating potential conflicts and ensuring appropriate investigation of providers
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Civil Liabilities Annuity Purchase Risks
Lee v. Verizon Communications Inc., 12-cv-4834-D (N.D. Tex. 2012)
– Suit stemming from Verizon de-risking
– § 502(a)(3) Claims
• Violated 102(b) by not disclosing in the SPD that it retained the right to transfer pensions to an insurance company
• Failed to comply with plan document and its rules because the plan did not authorize purchase of annuities
• Breached duty of loyalty by removing participants from the Plan and the attendant protections of ERISA and the PBGC
• Violated duty to diversify the plan investments by purchasing annuities from one provider
– § 510 Claim
• Discrimination against participants forced to accept annuity
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Civil Liabilities Annuity Purchase Risks
Lee v. Verizon Communications Inc., 12-cv-4834-D (N.D.
Tex. 2012)
– Court recently denied plaintiffs’ request for temporary restraining order
– § 502(a)(3) Claims
• 102(b) does not apply to change in plan terms
• Verizon entitled to amend plan and complied with the terms as amended
• Duty of loyalty claims fail because it is not a fiduciary act to amend or terminate a
plan
• Duty to diversify claims fail because purchase of annuity is not an investment
– § 510 Claim
• Plaintiffs fail to establish that Verizon had “specific intent” to interfere with their rights
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Civil Liabilities Annuity Purchase Risks
Potential Relief – Prior to Provider Default
– 502(a)(3)
• Injunction prohibiting the transaction
• Restitution of participant’s vested benefit used to purchase the annuity
– Would need to be brought against the annuity provider
• Constructive trust imposed on sponsor’s “ill-gotten profits” in reversion situation
– 502(a)(9)
• Section explicitly mentions “posting of a security”
• Any other “appropriate relief” to assure receipt of benefit to be provided by annuity
– e.g. bonding, back-up annuities, injunctions
– 502(g)
• Court has discretion to award reasonable attorneys fees and costs
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Civil Liabilities Annuity Purchase Risks
Potential Relief – Following a Provider Default
– 502(a)(3)
• Surcharge
– Monetary compensation for a loss resulting from a trustee’s breach of duty
– 502(a)(9)
• Any other “appropriate relief” to assure receipt of benefit to be provided by annuity
– Traditional monetary relief
– Requiring fiduciary to purchase new annuities from solvent provider
• Reasonable prejudgment interest
– 502(g)
• Court has discretion to award reasonable attorneys fees and costs
