Learning Center
Plans & pricing Sign in
Sign Out

Contract Attorney + Document Review+ San Francisco


Contract Attorney + Document Review+ San Francisco document sample

More Info
									                           Pension Plan Terminations

                                    David W. Greene

                               2002 SOA Spring Meeting
                              Session 007 June 24, 2002

Terminating a defined benefit plan is a complicated process with potentially over 2 dozen
separate tasks. Many of these tasks are completed by actuaries. Some by the Plan
Sponsor. Some by attorneys. Some by specialty consultants like ourselves.

What can you expect of this session?

   − A sense of the process that includes tasks you might not have thought about.
   − The level of detail and precision that is needed in this process vs. ongoing
     actuarial work.

Handout #1 is a timetable of the major tasks. Tom covered many of the forms. I’m
going to concentrate on a few of the tasks that we are almost always involved in. These

   −   The up front preparation work,
   −   Searching for missing participants and deaths,
   −   Drafting the request for proposal to obtain a group annuity quote,
   −   Conducting the due diligence meeting,
   −   Holding the bid auction,
   −   Reconciling the data after purchase, and
   −   A possible PBGC audit

Preparation – the Importance of Starting Early

   − Plan amendments may need to be adopted in advance.
   − Example: Plan Sponsor that calculated voluntary contributions in terms of current
     trustee’s investment vehicles; needed to change to fixed or indexed rate so
     insurance company could administer effectively.
   − Example: Plan Sponsor that had disability provision in pension plan; changed to
     provide this benefit through long-term disability plan.

                               D. Greene & Company                                        1
                              970 Dewing Avenue, Suite 300
                                  Lafayette, CA 94549
                                     (925) 284-8630
   − Determine whether the lump sum option should be offered to those not currently
     eligible. Especially relevant if interest rate was high at beginning of plan year but
     rates are dropping. If Plan Sponsor wants to make a change, a plan amendment
     will be needed.
   − Hedge strategy.
   − Develop data requirements.
   − Receive and edit initial census data.

Deceased and Missing Participants

   − Death register search.
   − When beneficiaries of retired participants die, the sponsor is not usually notified.
   − If vested terminated participant is deceased, how is surviving spouse located?
     Usually there are a significant number of vested terminated participants who have
     not left forwarding addresses.
   − Missing participant search.

Request for Proposal

   − Start with plan document to develop detailed plan specs.
   − Cull out provisions that are irrelevant to the insurance company.
   − Example: Benefit service is irrelevant but vesting service for future is not. This
     also may require a plan amendment.
   − Add detail not in document but relevant to calculations.
   − Example: Specifics of how lump sum option is calculated. Specifics on how
     future vesting service is calculated.
   − Provide examples in the RFP for particularly complicated plan provisions.
   − Compare plan document with SPD and plan provisions section of actuarial report.
   − Example: Plan document says to reduce benefit for REA death benefit but Plan
     Sponsor was not administering this way.
   − When we find discrepancies, we question and reach consensus on how to write
     the specs.
   − We simplify based on actual data and plan amendments.
   − Example: Plan Sponsor had complicated death benefit provision, but it only
     turned out to affect 3 participants. See Handout #2 for a description of this
     provision. We decided to leave it out of the RFP and handled it separately with
     the winning insurance company.
   − Example: Plan Sponsor had special death benefit that had been grandfathered.
     No participants were in this category. We left out of RFP.
   − Example: Plan Sponsor had very complicated early retirement provision that
     involved service with two predecessor employers. We simplified the wording of
     the RFP and compensated by providing more data that could just be applied by

D. Greene & Company                                                                      2
   − We want Plan Sponsor, actuary and attorney to review the RFP.
   − See Handout #3 for sample early retirement provision. Involves grandfathered
     provision with predecessor plan.
   − Importance of clear RFP.

Due Diligence

   − Basic ERISA requirements.
   − DOL 95-1 expanded and clarified these rules, primarily because of Executive Life
   − See Handout #4 for sample section of Due Diligence report dealing with DOL
   − Conflicts of interest.
   − Timing of Due Diligence meeting should be before Plan Sponsor sees prices so
     that Plan Sponsor is not influenced by price.
   − Details of topics covered during the meeting.
         o State guaranty funds. Covers only those living in the US and some
              territories. Does not cover participants who to Spain.
         o Ratings of each company separately and side-by-side comparison.
         o Key financial indicators for each company separately and side-by-side
   − We monitor rating agency changes and news articles.


   − Pricing model
   − General description


   − For large, complicated plans there are always changes to the data.
   − Example: Retired participants who are found to have deceased prior to the
     contract date.
   − Example: New vested terminated participants who suddenly show up.
   − Example: Participants whose benefits were calculated incorrectly.
   − In most cases, final reconciliation takes a few months.
   − In some cases, final reconciliation can take close to a year.
   − Need to track all debits and credits and reach agreement with insurance company
     on refunds and extra premiums required.

PBGC – Another Audit?

   − PBGC reserves the right to audit the plan termination.
   − Keep all documents for 6 years after filing Form 501.

D. Greene & Company
June 24, 2002
                                                                2002 SOA Spring Meeting
                                                                Session 007 June 24, 2002
                                                                              Handout #1

                            STANDARD TERMINATION

Description                                    Timing Requirement

Determine whether the plan is sufficient. If
yes, how will excess assets be distributed?
If no, will the plan sponsor make an
additional contribution?
Select the proposed termination date,
keeping in mind the timeline required for
all the steps described below. Determine if
lump sums should be offered to more
participants than usual. Determine if the
disability provision should be modified.
Amend Plan document: freeze benefit
accruals; terminate the plan; fix any
disability provisions that will cause
problems for insurance company; provide
for expanded lump sums if desired; general
housekeeping provisions since last update.
Develop an investment strategy for plan
assets. In particular, consider a hedge
strategy. Determine if any assets (e.g.,
bonds) may be of value to the insurance
Prepare basic census data of plan
participants, including last known address.
Prepare the initial selection of insurance
companies who will be asked to participate
in the bid.
Send the Notice of Intent to Terminate         Between 60 and 90 days prior to the
(NOIT) to plan participants. If there is a     termination date. The NOIT cannot be sent
replacement plan, include communication        outside this range. The Notice of Annuity
of this. Consider sending the Notice of        Information must be sent to participants no
Annuity Information with this packet.          later than 45 days before the distribution
Note: need to verify that the plan qualifies   date.
for the exemption of the special rule for
foreign language.
Conduct missing participant searches.
Includes death certificate search.
File IRS Form 5310 - Application for           Before filing PBGC Form 500
Determination upon Termination.
D. Greene & Company
June 24, 2002
Calculate individual plan benefits as of the
termination date. Include all optional
forms available to participants.
Develop communication packet that will
supplement the Notice of Plan Benefits
(e.g., election forms, explanation of
Send the Notice of Plan Benefits to            Before filing PBGC Form 500.
participants. Include election information
at the same time.
File PBGC Form 500, including Schedule         On or before the 180th day after the
EA-S.                                          proposed termination date.
Note PBGC 60-day period for notice of
noncompliance runs from date Form 500 is
filed. Plan assets must be distributed
within 180 of the end of the 60-day period.
Prepare insurance company RFP. Reviews
by plan sponsor, actuary, attorney.
Prepare census data for insurance company
RFP. Determine which elements are
provided by client and which by actuary.
Send RFP to selected insurance companies.
Conduct due diligence meeting to               Prior to the time of the auction that will
determine safest available annuity             determine the price of annuities.
Conduct insurance bid auction.
Client to wire transfer funds. This is the     Typically 1 week after annuity auction.
distribution date of plan assets.
                                               Plan assets must be distributed by the later
                                               of: (1) 180 days after the expiration of
                                               PBGC’s review period; or (2) 120 days
                                               after receipt of a favorable IRS
                                               determination letter.
File PBGC Form 501 and related                 Within 30 days after completion of final
Schedules and Attachments. (PBGC is            distribution of plan assets. Note, however,
informed of the annuity provider in this       that PBGC will not assess a penalty as long
filing).                                       as this form is filed within 90 days.
Participants are notified of the insurance     No later than 30 days after all plan benefits
company selected (Notice of Annuity            are distributed.
Acceptance agreement signed by client,
after review by consultants and attorney.
Final data reconciliation to insurance

D. Greene & Company                            2
June 24, 2002
Contract signed by client, after review and
modification by consultants and attorney.
File IRS Form 5310 if there is an excise tax
on any reversion of plan assets.
File a certificate of asset distribution with
the IRS.
Insurance company sends individual
certificates to participants, after review and
modification by consultants.
Make sure all files are retained in good         Files must be kept for 6 years after filing
order for post termination audit by the          Form 501.

D. Greene & Company                              2
June 24, 2002
                                                                2002 SOA Spring Meeting
                                                                Session 007 June 24, 2002
                                                                              Handout #2

Special Minimum Death Benefit

This provision applies to retired, active and terminated vested participants who
participated in the plan prior to 1976. These participants are identified by a nonzero entry
in the “1/1/76 Minimum Death Benefit” field on the census data. The participant does
not need to be married to be eligible for this benefit. Calculate the benefit as follows:

   1. Take the 1/1/1976 Minimum Death Benefit (from the census data) and add
      interest at 5% from 1/1/1976 to the date of death.
   2. If pre-retirement, subtract the Actuarial Equivalent of the normal ERISA survivor
      annuity described above. If the participant is unmarried, this amount will be zero.
   3. If post-retirement, subtract the Actuarial Equivalent of benefits previously paid
      plus the Actuarial Equivalent of future benefits to be paid to a Joint Annuitant or
   4. If the resulting amount is positive, it should be paid in a Lump-Sum to the
      participant’s Beneficiary.

D. Greene & Company                           2
June 24, 2002
                                                                   2002 SOA Spring Meeting
                                                                   Session 007 June 24, 2002
                                                                                 Handout #3

                               REQUEST FOR PROPOSAL

                             SAMPLE PLAN PROVISIONS

                The Sample Company Salaried Employees Pension Plan

Early Retirement Date and Benefit
The earliest retirement age is the first of the month coinciding with or next following the
attainment of age 55. A participant must have at least 10 years of service to commence
benefits early. Participants who are vested with at least 5 years of service but less than 10
years of service will commence benefits at age 65. Please note that all disabled
participants have 10 or more years of service; therefore service is not shown in the census

A participant who draws their benefit early is subject to an early retirement adjustment.
This adjustment consists of one set of reductions for the Schmidt-related benefits and
another set of reductions for the Sample-related benefit.

Calculation of a participant’s early retirement benefit is as follows.

Let e1 = Schmidt early retirement factor, equal to .003333 per month benefits commence
prior to age 65. If a participant had 20 years of service (the “Schmidt Unreduced at 62”
flag is “Yes”) and retires on or after age 62, there is no reduction (Note that this is a cliff
reduction; retirement before age 62 is subject to reduction from age 65 in all cases).
Let e2 = Simpson early retirement factor, as described in the Group (1) Sample RFP.
[Note: Schmidt is a company that Sample Company purchased in 1994.]

From the data:
s1 = Schmidt benefit from hire through 12/31/82
s2 = Sample benefit from 1/1/83 through term
s3 = Sample benefit from 1/1/83 – 10/31/83
s4 = Sample benefit from hire through term
s5 = Sample benefit from hire through 10/31/83
s6 = minimum target benefit

The benefit payable under this annuity contract is calculated as x6 below.
x1 = (s1)(e1) + (s2)(e2)
x2 = (s1)(e1) + (s3)(e2)
x3 = max [x1; (s4)(e2)]
x4 = max [x2; (s5)(e2)]
x5 = x3 – x4
x6 = max[x5; (s6)(e2)]
D. Greene & Company                             2
June 24, 2002
Early Retirement Supplemental Benefit
If the participant retires before age 62 after having worked until age 55 and completed 10 years of service,
an early retirement supplemental benefit is payable from retirement age through the 1st of the month
preceding the month the participant turns age 62 (e.g., the last payment would be 8/1 for a participant
turning age 62 on 9/15).

   − A terminated vested participant who has an amount in the ERSB field is eligible for this
     supplemental benefit if they start their pension before age 62. If no amount is shown, the
     participant did not qualify for the supplement.

   − A disabled participant who has an amount in the ERSB field is potentially eligible to receive the
     supplement. The supplement for these participants should be paid only if they terminate on or
     after age 55 and commence their benefit early.

                                                                                   2002 SOA Spring Meeting
                                                                                   Session 007 June 24, 2002
                                                                                                 Handout #4

                                      DUE DILIGENCE REPORT

                                           SAMPLE EXHIBIT I

                              What it Means to Pension Plan Sponsors


In March 1995 the U.S. Department of Labor (DOL) issued Interpretive Bulletin 95-1 (IB 95-1) spelling
out a new standard for purchasing annuities from assets of a pension plan:

               Plan fiduciaries choosing to purchase annuities have a duty to select the safest
               available annuity provider, unless under the circumstances it would be in the interests
               of participants and beneficiaries to do otherwise.

DOL’s standard applies to any annuity purchases that transfer to an insurer the obligation to pay benefits
of a pension plan that is subject to ERISA Title I. Annuities that may be used for other purposes such as
investments are not subject to this standard. The plan can be terminating or ongoing, defined benefit or
defined contribution. The DOL standard is effective January 1, 1975, the date ERISA fiduciary standards
under Title I went into effect.

It should be noted that IB 95-1 represents the DOL interpretation of the law with respect to the purchase
of annuities in this limited circumstance. IB 95-1 is not a regulation and a court looking at the
appropriateness of a plan’s purchase of an annuity contract would not give the same deference to an
interpretive bulletin as it would give to a regulation. Under ERISA, a purchase of a group annuity
contract by a plan fiduciary is subject to the same requirements as any other fiduciary decision. The
purchase must be undertaken in compliance with the rule of prudence, solely in the interest of the plan
and its participants and their beneficiaries, and for the exclusive purpose of providing benefits to
participants and their beneficiaries and defraying reasonable expenses of administering the plan.

Under IB 95-1, the DOL concludes that, in most of the situations covered by the interpretive bulletin, it is
the duty of the ERISA fiduciary to select the “safest available annuity” provider to provide the annuity
benefits for its participants and beneficiaries. Despite the use of this term, however, the DOL recognizes
that in many instances a fiduciary may conclude that more than one annuity provider is able to offer the
“safest available annuity”. The DOL provides a list of factors to be considered by the fiduciary in making
its determination regarding which providers offer one of the safest available annuities. The DOL also
recognizes that in certain situations it may not be in the best interest of the plan’s participants and
beneficiaries for the plan to purchase an annuity that qualifies as the “safest available annuity”.

What Employers Must Do

Searching for an Insurer

To select annuity providers, plan sponsors must, at a minimum, conduct an objective, thorough and
analytical search.     They must consider factors relating to insurers’ claims-paying ability and
creditworthiness, including the following:

       −   Quality and diversification of an insurer’s investment portfolio
       −   Insurer’s size, relative to the proposed contract, and ability to administer the contract
       −   Level of an insurer’s capital and surplus
       −   Insurer’s lines of business and exposure to liabilities
EXHIBIT I (cont.)

       − Structure and guarantees underlying the annuity contract, such as the use of separate
       − Extent of additional protection from state guaranty funds

Plan fiduciaries must use a qualified, independent expert in this search unless they have the necessary
expertise in-house. The DOL notes that many plans will be well served by engaging independent
experts to assist them in the process. Based on the search, a fiduciary may conclude that m than
one annuity provider offers the safest annuity available.

What Employers Must Not Do

Costs and Ratings

Plan fiduciaries often are company officials and thus may have a conflict in fulfilling their fiduciary
duty to act solely in the interests of participants. DOL makes clear that plan fiduciaries generally may
not try to save money for the employer (or increase the amount of a reversion) by choosing an “almost
safest” insurer. However, in situations where cost savings will directly benefit participants, it may be
acceptable to purchase annuities that are slightly less safe—for example, from an insurer with excellent
ratings but slightly less capitalization—if the cost is substantially lower. DOL warns, however, that it
is never acceptable for fiduciaries to purchase an “unsafe” annuity. Although ratings from financial
rating services may be a useful tool, a plan sponsor may not rely solely on ratings to choose an insurer.

Background and Purpose

The “safest available annuity” standard reflects a paradigm shift that began in the early 1990s when the
pension world suddenly woke up to the danger of insolvency at major life insurers.

Before 1990 there was not a great deal of concern about the safety of annuities. Conventional wisdom
was that life insurers had an excellent track record, and state guaranty funds or the Pension Benefit
Guaranty Corporation (PBGC) would back them up if necessary. In purchasing annuities, a few plan
sponsors performed and documented thorough due diligence reviews, other employers screened out
insurers with poor financial ratings, and still others simply took the lowest bid. It does not seem that
anyone recommended buying the “safest available annuity”. The ERISA agencies treated all licensed
insurers the same; for example, in December 1989, the PBGC issued procedures telling plans to report
the name of any annuity provider within 30 days after distribution of plan assets.

Early in 1990 Standard & Poor’s and Moody’s sharply downgraded the high financial ratings of a
major life insurer. Senate hearings into annuity purchases highlighted junk bond investments by that
insurer, gaps in state guarantees of insured by guaranteeing their annuities (although some
congressmen and others said this PBGC position would not stand up in court). In March 1990 PBGC
announced that terminating plans must report the name of any annuity provider 45 days before annuity
purchases became final, and indicated DOL would question the use of weak insurers. (Under that rule,
still in effect, DOL does not reveal its standards for questioning the use of annuity providers who
appear unacceptable.)

In 1991 several large life insurers failed because of investment losses in junk bonds, mortgages, or real
estate. Soon afterward, PBGC and DOL said they would publish standards for selecting annuity
providers. The only existing standard was that a pension plan could satisfy its obligation to pay
benefits by purchasing annuities fully guaranteed by a licensed insurer, or by distributing cash or other
property. [See DOL Reg § 2510.3-3(d)(2)(ii)] DOL considered amending this rule, for example by
requiring minimum financial tests for insurers, but later decided instead to specify a process for
selecting a safe insurer.

D. Greene & Company                             2
June 24, 2002
EXHIBIT I (cont.)

The new DOL standard for annuities seems designed to:

       − Reorganize only the interests of participants and beneficiaries, disregarding the employer’s
         interests, in keeping with basic ERISA fiduciary rules,
       − Put the burden of proof on plan fiduciaries in the event of an annuity provider’s failure, past
         or future, even if financial ratings at the time of selection were favorable, and
       − Support DOL’s existing annuities from failed life insurers.

Implications for the Private Pension System

Short-term Impacts

The market for annuities has been shrinking, and DOL’s “safest available annuity” standard may
accelerate this trend. In recent years, employers who buy annuities have insisted that annuity providers
meet higher minimum standards in terms of financial ratings from Standard & Poor’s, Moody’s and
Duff &Phelps. For example, insurers whose ratings had slipped to A+ were forced to withdraw from
the market as employers raised the bar to AA. Today, even an insurer with an AA rating might fall
below the new DOL standard.

Insurers must establish heavy initial reserves for annuities they sell, often creating losses for several
years before favorable experience begins to produce profits. Increasing competition in all lines of
business and scarce capital have made insurers less willing and able to allocate surplus to put more
annuity business on their books. Today, the “safest” annuity providers can charge higher prices that
produce profits more quickly, but it is not clear whether these few blue-chip insurers will meet the
demand fo r reasonably priced annuities. Also, top-rated insurers may justifiably decline to quote on
cases that are small or that have an unattractive mix of immediate versus deferred annuities.

It is interesting to note that in the early 1990s pension plans also were hit by losses from guaranteed
investment contracts (GICs) issued by failed life insurers. Typically these were defined contribution
plans, which the plan sponsor could make whole by buying the GIC from the fund and absorbing the
loss. Defined contribution plans soon found ways to fix the problem (lack of diversification) and
deliver essentially the same investment results as a GIC (intermediate-term Treasury rate of return with
guaranteed principal), using alternative investment media available even to smaller plans. Although
investment markets thus could fill the gap created by concerns about GICs, the same is not true for
annuities because conventional investment products lack the ability to pay life annuities.

National Policy Issues

Ever since the events of 1990-91, something close to the new DOL standard has seemed almost
inevitable, requiring maximum safety when annuities are purchased. To understand why, consider
how our private pension system guarantees annuities after plan termination: a single insurer stands
behind benefit guarantees that may extend 25 years, 50 years, or even longer. The annuitant has put all
his benefit eggs in one insurer’s basket and must hope not to outlive the basket. If the insurer were to
fail, some annuitants stand to lose benefits because of gaps or shortfalls in the state guaranty funds.
Given this uncertain system of guarantees, DOL’s strict new standard protects participants about as
well as possible, but there are problems:

       − Insurers and state regulators ha ve strengthened the industry’s ability to ride out financial
         cycles, but have not created a bulletproof system of guarantees. Thus, relying on one
         insurer to pay a participant’s entire benefit is simply a failure to diversify as taught in
         Investments 101. Even the best credit risk can go bad over time.
       − Annuities will be scarce and costly if few insurers can sell them under the new DOL
         standard. Meanwhile, most life insurers have been shut out of this traditional market.

D. Greene & Company                             3
June 24, 2002
EXHIBIT I (cont.)

       − Lump-sum distributions will become even more prevalent as an alternative to
         annuities. Because most lump-sum benefits get spent for non-retirement
         purposes, this trend moves the nation away from the goal of adequate
         retirement income.
       − There is something wrong with a system that has PBGC guarantee benefits
         when a terminating plan is under funded, if only by $ 1 (a “distress”
         termination), but shifts the guarantor from PBGC to private insurers if a plan
         is fully funded (“sufficient” in PBGC terminology). It would seem the
         participants are better off with the PBGC guarantee.

Are these problems big enough for employers, employees, insurers and their
representatives to consider changing the laws governing today’s system of pension
guarantees after a plan terminates? If so, here are two incremental ways to fill the gaps in
benefit guarantees and perhaps address other problems too:

       − Strengthen the present guaranty program so that the combined state funds
         back up all annuity payments from pension plans that PBGC was guaranteeing
         before a plan terminated or settled; and
       − Make PBGC the insurer if the state guaranty funds cannot pay all benefits that
         PBGC was insuring before a plan terminated.

Alternatively, here are three other approaches that would involve major reforms:

       − Establish a single pooled annuity program for terminated plans in which many
         insurers join together to provide annuities. This kind of pooled method has
         been used very successfully since the 1960s to cover millions of government
         workers by Federal Employees’ Group Life Insurance (FEGLI). A FEGLI-
         type annuity program administered through one insurer would have low costs
         and diversification;
       − Let PBGC itself provide annuities for terminated plans. PBGC would invest
         the assets in immunized bonds with the same durations as benefit payments,
         leaving little or no investment risk—this is the same investment policy that
         annuity providers now use. Such an approach might seem revolutionary, yet it
         would be quite workable and consistent with the language of ERISA as
         enacted in 1974; and
       − Have PBGC provide annuities for terminated plans and transfer the risk to
         insurers. For example, PBGC could periodically take bids on blocks of
         annuities from syndicates of insurers who compete somewhat as investment
         bankers do. This approach would use free- market economic forces to set
         annuity prices and diversify each risk among many insurers.

In summary, DOL’s new standard is an admission that the traditional way of terminating
a well- funded pension plan by buying annuities is unsatisfactory over the long run, and so
plans must minimize risks by using “gilt-edged” annuities. As we gain experience with
this standard, perhaps one of the alternatives listed above will start to look better.


To top