Defined benefit (DB) plan considerations for M&As

This blog is the fourth in a series of six that will highlight considerations for and the impact of employee benefit plans on mergers and acquisitions (M&A) transactions. Click here for additional blogs in this series. To learn how Milliman consultants can help your organization with the employee benefits aspects of M&As, click here.

Transactions occur regularly and come in a multitude of structures and players. Sometimes they’re simple two-dimensional deals—one buyer, one seller—sometimes they’re multidimensional—multiple buyers and sellers, plus unions, government entities, federal agencies, etc.

Urgency usually is the call of the day. Properly and quickly assessing the deal landscape under a current lens, as well as a forward-looking post-deal lens, can be crucial for the deal to be successful for all involved.

The incidence of defined benefit (DB) pension plans requires separate expertise to be included on the due diligence and post-merger teams. The amount of work involved in this area can usually be quickly assessed by an experienced actuary. It may have little impact on the structure of the deal or it may drive large elements of the deal, significantly impacting the purchase price or killing the deal entirely.

CONSIDERATIONS
Below are a few elements to consider from the buyer’s perspective and some examples of the impact they can have on the deal:

Element Consideration Impact
Discount Rates Can vary significantly depending on different viewpoints and market fluctuations. Can impact annual costs, balance sheet entries, and funded status significantly.
Plan Demographics and Demographic Assumptions Can vary significantly from expectation.

For example, a business might have a pension plan with 10 times the number of plan participants as employees.

Review demographics assumptions used in the valuation compared with experience and critical plan provisions.

This can impact go-forward policies and plan operating requirements.

Key benefit provisions could be undervalued or not valued at all with significant liability underreporting.

Auditors Have varying practices.

For example, some audit teams allow companies to net supplemental employee retirement plan (SERP) liabilities against rabbi trust assets.

Accounting allowances vary significantly between auditors: acceptable to theirs may not be acceptable to yours.
Balance Sheets Only show net amounts. Can mask underlying plan size and corporate impact. Even the slightest movement in plan assets or liabilities can dramatically change balance sheet entries.
Liabilities Withdrawal liability. Can be surprisingly high.
  Management employment contracts. Usually trigger additional liabilities with change-in-control.
Termination liabilities. Buyer should be aware that ERISA or GAAP funded status may not be a good measure of the cost to terminate the plan.
Unpredictable contingent event benefits (UCEBs) that are due to plant shutdown or layoff. Buyer should be aware of these provisions and potential impact to cash funding and expense.
At-risk status. Plans with a low enough funded status will require additional cash contributions, special Pension Benefit Guaranty Corporation (PBGC) valuations and reporting, a potential freeze on benefit accruals, and restrictions on some optional forms of payment.
Funding Onboarding underfunded plan. Can affect entire controlled group executive nonqualified deferred compensation (NQDC) plans and loan covenants.
  Merging an underfunded plan. Can trip funding thresholds in combined plan with amplified effects.
  Synergy-driven plant closings. Can trigger unsought involvement of federal pension oversight agencies and massive accelerations in cash contribution requirements.
  Uncertified plan benefits.

 

Require additional work and perhaps additional liabilities.
  Seller may be obligated for continued, post-close contributions. Who is responsible, especially if agency agreements are in place?
Carryover and prefunding balances (credit balances). Large credit balances may mask upcoming cash contribution requirements.
  Contribution due dates.

 

Can cause surprises. Who pays, who deducts?
  Plans may have existing agreements with the PBGC. May require additional contributions.
  Project plan costs. Significant changes in cost might emerge in near-future years, impacting economics of deal.
Legal Noncompliant plans.

 

Bring significant resource diversions and legal liability.
  Current audits or investigations by the Internal Revenue Service (IRS), PBGC, or U.S. Department of Labor (DOL). May impact legal and financial obligations as well as reputational risks.
  Material claims pending or threatened related to the plans. Same.
Valuations Negotiated benefit increases or cost-of-living adjustments (COLAs) in collective bargaining agreements (CBAs) might not be fully reflected in valuations. Liabilities that are due to current contractual agreements may not be reflected in liability disclosures.

Additional retirement plan considerations include:

• Inventory discovery may lead to undisclosed plans and liabilities
• Carve-outs can spin plans many different ways, affecting future plan/corporate economics
• State of target’s plan administration could bring burdens
• Proper administration support for the pension plans
• In-house pension expertise evaporating on both sides
• Poison pills need valuation and assessment
• Foreign plan issues such as termination indemnities (if any)
• With the elimination of the Internal Revenue Service (IRS) approval process for individually designed qualified retirement plans, it will be important that plan changes going forward do not jeopardize the qualified tax status of the plans, upon random audits from the IRS.

Pension plans can add complexity to a merger or acquisition. It is important to involve an actuary in the process to identity and help mitigate risks.

Declining discount rates drive corporate funded status down by $10 billion in April

Milliman has released the results of its latest Pension Funding Index (PFI), which analyzes the 100 largest U.S. corporate pension plans. Despite strong investment returns of 0.84%, in April the deficit for these pension plans increased from $247 billion to $257 billion, the result of a decrease in the benchmark corporate bond rates used to value pension liabilities. The funded ratio for these pensions fell from 85.3% to 84.9% over the same time period.

Tracking these pensions lately has been like watching a game of ping pong. Robust investment returns are in a rally with interest rates, and in this metaphor we’re all waiting on interest rates to advance the game.

Looking forward, under an optimistic forecast with rising interest rates (reaching 4.28% by the end of 2017 and 4.88% by the end of 2018) and asset gains (11.0% annual returns), the funded ratio would climb to 93% by the end of 2017 and 107% by the end of 2018. Under a pessimistic forecast (3.48% discount rate at the end of 2017 and 2.88% by the end of 2018 and 3.0% annual returns), the funded ratio would decline to 80% by the end of 2017 and 73% by the end of 2018.

To view the complete Pension Funding Index, click here. To receive regular updates of Milliman’s pension funding analysis, contact us here.

Public pensions regain ground lost in Q4, experience $78 billion improvement in funded status

Milliman has released the first quarter results of its Public Pension Funding Index (PPFI), which consists of the nation’s 100 largest public defined benefit pension plans. In Q1 2017, the funded ratio of these plans regained ground lost at the end of last year, climbing from 70.1% at the end of December to 72.0% as of March 31, 2017. These plans saw their funded status improve by $78 billion for the quarter, the result of strong investment returns (measuring 4.29% in aggregate) that led public plan asset growth to outpace the rise in pension liabilities.

Thanks to robust market performance in Q1, the funded ratios for our Milliman 100 plans improved across the board, with five additional pensions crossing the 90% funded mark. And while quarterly investment returns dwarfed those of Q4, the wide range in performance–from a low of 2.12% to a high of 5.06%–highlights the challenge that lies ahead for many poorly funded plans.

Of the Milliman 100 plans, 15 have funded ratios above 90%, 64 have funded ratios between 60% and 90%, and 21 have funded ratios lower than 60%. The Milliman 100 PPFI total pension liability (TPL) increased from $4.659 trillion at the end of Q4 to an estimated $4.698 trillion at the end of Q1. The TPL is expected to grow modestly over time as interest on the TPL and the accrual of new benefits outpaces the benefits paid to retirees.

To view the Milliman 100 Public Pension Funding Index, click here. To receive regular updates of Milliman’s pension funding analysis, contact us here.

Multiemployer pension funding levels experience slight uptick overall, but poor plans grow poorer

Milliman has released the results of its Spring 2017 Multiemployer Pension Funding Study, which analyzes the funded status of all multiemployer pension plans. As of December 31, 2016, these plans have an aggregate funding percentage of 77%, a 1% increase since June 2016. During that six-month period, the market value of assets increased by $17 billion while pension liabilities increased by $13 billion, resulting in a $4 billion-decrease in the aggregate funding status shortfall.

But results vary by plan; while non-critical plans experienced an aggregate funding percentage of nearly 85%, the funding level for critical plans is under 60%. The gap continues to widen between critical and non-critical plans. While the funding percentage of healthier plans has increased slightly, critical plans have seen no appreciable increase. Persistent strong returns would be needed to see any appreciable improvement in funded status.

A closer look into how contributions are distributed shows that plans facing severe funding challenges only spend 38 cents of each contribution dollar on new benefit accruals, while 50 cents of every dollar goes to pay down funding shortfalls. Healthier plans spend 56 cents per contribution dollar on benefit accruals and 32 cents on funding shortfalls. The remaining 12 cents in both scenarios is spent on expenses.

This is the first of three pension funding studies Milliman will be releasing this week. To view the complete study, click here. To receive regular updates of Milliman’s pension funding analysis, contact us here.

Administrative tips for lump-sum window offerings

Lump-sum windows can present a “win-win” scenario for both defined benefit (DB) pension plan sponsors and participants. Sponsors can decrease their PBGC premiums by reducing the amount of participants within a plan. On the other side, participants in need of cash can benefit from a lump-sum payout.

Before implementing a lump-sum window sponsors must first consider the various administrative aspects related to such an offering. The DB digest article “Lump-sum windows: Administrative tips to consider” by Nicholas Pieper highlights these nine administrative tips that can help plan sponsors with the process.

• Identify the eligible population
• Clean up the data
• Seek legal counsel assistance
• Determine the duration of your window
• Set a manageable deadline
• Deliver an announcement mailing
• Anticipate participant inquiries
• Create the ultimate lump-sum window packet
• Prepare for special circumstances

To learn more about lump-sum windows, click here.

TIPS vs. dividends: Inflation deliberation

Treasury inflation-protected securities, or TIPS, are often considered the ideal risk-free investment in retirement. Their government backing virtually eliminates credit risk, and the CPI adjustment on the principal ensures that its value will rise with inflation. Milliman consultant Joe Becker offers more perspective at MRIC.com.