Pension Settlements Through Terminated Vested Lump Sum Windows

Pension Settlements Through

Terminated Vested Lump Sum

Windows

Insights into Plan Sponsor Experience

February 2013

port Document Title

Sub-Title of Report Document

Date

Retirement

Summary

Several headline-grabbing pension settlements took place in 2012, most notably the actions by GM, Ford, and Verizon to settle tens of billions of dollars in pension obligations. While these generated a great deal of media coverage and interest, many other plan sponsors offered terminated vested participants a lump sum. The total number of participants eligible for such offers easily exceeded the number of offers made in the GM, Ford, and Verizon transactions.

Given the continued pressure to better manage volatility and risk in pension plans, we expect plan sponsors to continue to settle the liabilities associated with terminated vested participants. With approximately 15% of pension plan liability in the United States attributable to terminated vested

participants (as measured by Target Liability on Form 5500 filings), this can be a cost-effective approach that can materially reduce pension risk for plan sponsors.

Plan Sponsor Interest

Since the Pension Protection Act of 2006 (PPA) was signed into law, we expected 2012 to be a turning point for companies looking to transfer pension liability off their balance sheets through lump sum distributions—the primary reason being that PPA allows companies to calculate lump sum payments using yields on corporate bonds, rather than treasury rates. The corporate bond rates are completely phased in beginning with 2012 calculations. This means pension liabilities can now be settled at effectively the same rates used to measure them. Additionally, these programs allow participants more flexibility regarding how they manage their financial security.

We expect that lump sum windows will continue to be popular in 2013 as more pension plan sponsors pursue pension settlement and de-risking strategies. According to the 2013 Aon Hewitt Hot Topics in

Retirement survey, 39% of companies reported that they are “very likely” or “somewhat likely” to add or

liberalize a lump sum option through a window approach in 2013.

Our Experience

In this paper we examine data collected from terminated vested lump sum windows completed during 2012. The purpose of this analysis is to determine factors and trends, and identify actions plan sponsors can pursue to make lump sum windows successful. Some of the highlights of our analysis include:  The average lump sum election rate among the plan sponsors was 55%

 Results varied significantly between plan sponsors

 The lump sum election rate decreased as the size of the lump sum increased  A comprehensive communication plan increased the lump sum election rate  Short window periods decreased the lump sum election rate

Data Analysis

The data used in our study covers over 30 plan sponsors and approximately 150,000 participants who were offered a lump sum under window programs. For nearly all the participants included in our study, this was their first opportunity to receive a lump sum payout.

The study reflects a broad cross-section of participants, plan sponsors and third-party advisors. Aon Hewitt’s involvement in these windows ranged from minimal to extensive, and the programs were administered by both Aon Hewitt and other organizations.

The potential and actual liabilities settled in these offerings were approximately $4.3 billion and $1.9 billion, respectively.

Lump Sum Election Rates

Analysis of lump sum election rates was performed looking at the averages among the plan sponsors, as well as on a dollar-weighted basis (i.e., where results are weighted by the size of the available lump sum). High-level results are shown in the graphics below.

Lump Sum 45% Deferred 53% Annuity 2%

Dollar-Weighted Participant Elections

Lump Sum 55% Deferred 44% Annuity 1%

Participant Elections

The data is grouped into the following categories:

 Lump sum—These participants received a lump sum during the window. Some participants elected to receive this form of distribution, while others automatically received a lump sum because the present value of their benefit was less than the cash-out threshold defined by the plan.

 Deferred—These participants did not commence a benefit during the election period. In some instances they started but did not complete the necessary paperwork. Other participants replied with the stated desire to defer commencement. Most of this group simply did not respond to the offer, as this was the default option for participants with a benefit greater than the cash-out threshold defined by the plan.

 Annuity—These participants voluntarily elected to commence an annuity benefit during the window period. This option is required by law when a lump sum offer is made. The majority of participants who elected to receive an annuity benefit were already retirement-eligible.

Variability of Results

Plan sponsors experienced an average lump sum election rate of 55%. Results ranged between 25% and 85%, with a majority of results between 45% and 65%. The election rates for each plan sponsor included in this study are plotted below.

0% 25% 50% 75% 100%

Variability in Lump Sum Election Percentage

Plan Sponsor Experience Average

Lump Sum Election Rates Decrease as Lump Sum Amounts

Increase

As shown in the pie charts on the prior page, the lump sum election rate was higher on a straight average basis than on a dollar-weighted basis. This is because the lump sum election rates were highest for participants with smaller lump sums. The election rate decreased in a somewhat predictable fashion as the size of the lump sum increased. This is illustrated in the graphic below.

0% 10% 20% 30% 40% 50% 60% $0 $50,000 $100,000 $150,000 Lum p Sum E le ct ion P e rc e nt ag e

Size of Lump Sum

Each circle in the graphic represents the lump sum election percentage for participants with similar lump sum amounts from $5,000 to $150,000. The calculations were based on $1,000 benefit groupings. Over 98% of the participants in our study had a lump sum benefit of less than $150,000.

Lump Sum Election Percentage by Age

The percentage of benefits paid as a lump sum decreased as participants neared retirement age. Younger participants are more likely to have smaller lump sums and are therefore more likely to be paid through an automatic cash-out.

0% 20% 40% 60% 80% 100% 30 - 34 35 - 39 40 - 44 45 - 49 50 - 54 55 - 59 60 - 64 El e ct ion P e rc e nt ag e Age

Election Percentage by Age

Voluntary Lump Sum Automatic Cash Out Did not Take Lump Sum

As noted in the chart above, total lump sum cash-out rates tend to decrease as participants age. When excluding automatic cash-outs, however, the rates across the range of ages tend to be much more stable—around 50%. This is illustrated by comparing the relative sizes of the “voluntary lump sum” and “did not take lump sum” sections of the graphs above. This suggests that for those making an active election, age was not a driving factor in decision making.

Other Notable Variables Considered

Several other variables in our study did not have a noteworthy impact on the lump sum election rate, such as:

 Salaried vs. hourly: The election rates for salaried and hourly participants were approximately the same. The election rate for salaried participants was 1% higher than the election rate for hourly participants.

 Union vs. non-union: The election rates for union and non-union participants were approximately the same. The election rate for non-union participants was 1% higher than the election rate for union participants.

 Male vs. female: The election rate for female participants was 2% higher than the election rate for male participants. In general, this is the result of larger lump sums for male participants. The lump sum election rate for male and female participants with similar lump sum amounts were

approximately the same.

Leakage

For the purpose of this study, we define “leakage” as distributions of benefit value outside the tax-qualified retirement plan system. To measure this factor, we analyzed roll over data for approximately one-third of the participants in our database.

Fifty-one percent of the participants who elected to receive a direct lump sum rolled over their distribution to a 401(k) or IRA, preserving funds in the tax-qualified retirement system. The remaining 49% elected to receive their benefit as a cash distribution. While they have the ability to roll the cash distribution over, our experience suggests that many will not—resulting in leakage of funds out of the retirement system. The graph below shows the roll over experience for the participants in our study, along with data on defined contribution plan behavior from the 2012 Aon Hewitt Universe Benchmarks study.

0% 20% 40% 60% 80% 100% $5-$9k $10-$29k $30-$49k $50-$99k $100k+ R ol lov e r P e rc e nt ag e

Size of Lump Sum

Rollover Experience

As shown in the chart above, participants with a larger benefit are more likely to roll over their benefit. Additionally, participants with a pension lump sum benefit are more likely to roll over their benefit than participants with a defined contribution balance of the same size.

Project Management and Communication

When implementing a lump sum window, there are a number of project management and communication approaches that can help make a lump sum window successful. These include:

 Frequent planning and status meetings

 Daily or weekly reporting on election percentages  Address searches

 Data validation  Announcement letters  Personalized benefit packets

 Reminder postcards and phone calls  Access to the Personal Finance Center  Personalized modelers

It is critical that participants understand their choices and that the process to execute their election is simple.

In general, we found that more communication leads to a higher election rate, especially “high touch” communication. For example:

Reminder Phone Calls Increased Election Percentages

Did Not Make Reminder Calls

Elected Lump Sum 62% Did Not Elect Lump Sum 38%

Made Reminder Calls

As noted above, plan sponsors that made reminder phone calls experienced a higher lump sum election rate. Most plan sponsors in our study sent reminder postcards. However, eight plan sponsors went a step further and used targeted outbound phone calls or messages to reach as many participants as possible. Lump sum election rates were 62% for these plan sponsors, compared with 45% for the plan sponsors that did not make such calls.

Plan sponsors that completed outgoing phone calls reported that they helped ensure participants had received the paperwork and understood their options. These calls also helped confirm the authenticity of the mailings and other communications to participants.

Window Design

Similar to communication and project management, there are a number of design decisions plan sponsors need to make when implementing a lump sum window.

Several of these decisions are administrative in nature, but others will have an impact on the lump sum election percentage.

Shorter Window Periods Seem to Decrease Election Percentages

Our results show a higher lump sum election rate is more likely if the election period is at least 45 days long. Beyond 60 days, however, it is harder to discern a difference due to the varying results and decreasing sample size. In the graph below, the election rates for companies included in our study are plotted based on the length of the election period.

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% 20 30 40 50 60 70 80 90 100 110 120 130 Lum p Sum E le ct ion P e rc e nt ag e

Length of Window (Days)

Lump Sum Election Rate by Length of Window

Missing Participants

Most plan sponsors completed an address search to help find participants who were eligible for lump sum payouts. However, plan sponsors found that finding all the participants is one of the challenges for these programs. In some instances, difficulty in finding participants led to a lower lump sum election

percentage.

Preparation

Experience shows that pension plan sponsors should not rush through preparation or execution of a lump sum window. There are several steps necessary to ensure success, and plan sponsors need to have the time and capacity to work through a detailed project plan before and during the window period, regardless of the length.

Preparation can take place far in advance of actually running a lump sum window. For example, plan sponsors can clean up data and find missing participants in advance of a decision to execute a lump sum window. Taking these steps ahead of time will allow plan sponsors to focus on the critical areas of project management and communication during the window.

Adding Lump Sums as an Ongoing Feature Decreases Lump

Sum Election Rate

Some pension plan sponsors have added a permanent lump sum feature to the plan for terminated vested participants for many of the same reasons others are offering lump sum windows. In certain instances, plan sponsors have communicated the new feature as part of a lump sum window. In these cases, the lump sum election rate was around 20%. While additional lump sums will emerge over time, plan sponsors that use this approach should anticipate a lower lump sum election rate in the near term.

About Our Study

Our study included over 30 plan sponsors and covered approximately 150,000 terminated vested participants who were offered lump sums in 2012.

The plan sponsors included in our study represent a broad cross-section:  The number of participants ranges from 100 to 35,000

 The individual plan sponsor lump sum election rates range from 25% to 80%

 The plan sponsors in our study offered lump sums to a variety of populations, including: – All terminated vested participants in the plan

– All terminated vested participants in the plan who were not currently retirement-eligible – All terminated vested participants with a lump sum less than a set threshold (e.g., $20,000;

$50,000; etc.)

 The plan sponsors cover a diverse set of industries and geographies

 Aon Hewitt involvement in these windows ranged from minimal to comprehensive

 The lump sum windows in our study were administered by both Aon Hewitt and other organizations

To Learn More

We will continue adding plan sponsors and variables to our study as we continue our work on terminated vested lump sum windows. Our study of prior lump sum windows helps us understand what makes a successful window and informs plan sponsors of strategies for projects in 2013 and beyond.

While understanding lump sum election rates is a useful exercise, it certainly does not guarantee results. Each lump sum window is different and there are a number of quantitative and qualitative components that lead to success. There is no substitute for detailed project planning, thoughtful design, and a robust communication strategy when implementing windows.

For more information, including the financial impact for your organization, please contact the individuals noted on the following page, or your Aon Hewitt consultant.

Contact Information

Rick Jones

Senior Partner and Leader of Retirement Consulting National Practices Retirement Consulting +1.847.295.5000 rick.jones@aonhewitt.com Chris Birch Associate Partner Retirement Consulting +1.312.381.7208 chris.birch@aonhewitt.com

About Aon Hewitt

Aon Hewitt is the global leader in human resource solutions. The company partners with organizations to solve their most complex benefits, talent and related financial challenges, and improve business

performance. Aon Hewitt designs, implements, communicates and administers a wide range of human capital, retirement, investment management, health care, compensation and talent management strategies. With more than 29,000 professionals in 90 countries, Aon Hewitt makes the world a better place to work for clients and their employees. For more information on Aon Hewitt, please visit

www.aonhewitt.com.

© 2013 Aon plc

This document is intended for general information purposes only and should not be construed as advice or opinions on any specific facts or circumstances. The comments in this summary are based upon Aon Hewitt's preliminary analysis of publicly available information. The content of this document is made available on an “as is” basis, without warranty of any kind. Aon Hewitt disclaims any legal liability to any person or organization for loss or damage caused by or resulting from any reliance placed on that content. Aon Hewitt reserves all rights to the content of this document.