Proposed Plan Buyouts Would Offer Sponsors an Alternative to Standard Plan Terminations, with Significant Differences

Under proposed models for DB plan buyouts, a plan sponsor would  transfer plan assets, along with funds to cover any plan underfunding, plus  additional money to compensate for risk and administrative costs, to a  financial company. The financial company would become the new plan  sponsor, taking over all obligations of the original sponsor. A plan buyout, like a  standard plan termination via an insurance company, is intended to allow  the sponsor to transfer all plan responsibilities to another company, but  possibly at lower cost than a termination. Proposed Plan Buyouts Seek to Offer Alternative to Termination, with Possible Flexibility and Cost Advantages to Plan Sponsors

While there are different models for DB plan buyouts, the basic  transaction would involve the transfer of the assets and liabilities of a  pension plan from a plan sponsor to a financial entity. The  objective of the original sponsor, the employer, would be to shed all of its  sponsorship responsibilities and liabilities. For example, a  sponsor could segregate the benefits for retirees or former employees and  sell this “legacy” portion of a plan to a new sponsor, with assets moving to  the new sponsor to cover only the benefit liability for these participants; a  buyout of this kind would resemble that of a hard-frozen plan in that  benefits for retirees and separated employees have ceased accruing. The sponsor would pay PBGC premiums, and PBGC  guarantees would continue to apply to plan benefits. Oversight of the  plan would remain within the jurisdiction of federal pension regulatory  agencies: PBGC, Labor, and Treasury. In contrast, a standard plan termination ends the plan itself. State  regulation of insurance companies is grounded in statutory valuations of  an insurer’s assets and liabilities and risk-based capital requirements, as  laid out by the National Association of Insurance Commissioners (NAIC),  the organization of state insurance regulators. Some Plan Buyouts Could Benefit Participants and PBGC, but in General Pose New Risks

DB plan buyouts by financial companies could, in some cases, improve the  security of benefits. For example, the new sponsor assuming  responsibility for paying plan benefits would not have an employment  relationship with participants, raising concerns about its incentives to  manage the plan for the exclusive benefit of participants. Buyouts by financial  sponsors may also create regulatory ambiguities and conflicts between the  goals of agencies regulating financial sponsors and those regulating  pensions. For PBGC, the potential risk associated with any particular DB plan  buyout depends in part on the structure of the new sponsorship. This ruling decided  whether DB plans bought out by third-party sponsors complied with or  violated the “exclusive benefit” rule of the Internal Revenue Code (IRC). These include the  following: (1) companies should give advance notice of plan buyouts to  participants and regulators; (2) only financially strong entities in well- regulated sectors would be permitted to acquire a pension plan in a plan  buyout transaction; (3) the parties to the transaction would be required to  demonstrate that participants’ benefits and the pension insurance system  would be exposed to less risk as a result of the buyout, and that the  buyout would be in the best interests of the participants and beneficiaries;  (4) limitations on buyouts would be imposed to limit undue concentration  of risk; (5) transferees and members of their controlled groups would  assume full responsibility for the liabilities of transferred plans and would  comply with post-transaction reporting and fiduciary requirements; and  (6) subsequent buyout transactions for a plan would be subject to the  same rules as the original buyout.
Why GAO Did This Study

Some U.S. financial and pension consulting firms have recently proposed alternatives to terminating a defined benefit (DB) pension plan and contracting with insurance companies to pay promised benefits. In their proposals, a plan sponsor would typically transfer the assets and liabilities of a hard-frozen DB plan--one in which all participant benefit accruals have ceased--along with additional money, to a financial entity, which would become the new sponsor. Such buyouts would have implications for participants, plan sponsors, and the Pension Benefit Guaranty Corporation (PBGC), the federal agency that insures private DB plans. This report addresses the following questions: (1) What is the basic model of proposed sales of frozen DB plans to third-party financial firms and how does it compare with a standard plan termination? (2) What are the potential risks and benefits of plan buyouts for participants, PBGC, plan sponsors, and other stakeholders? To address these questions, GAO reviewed proposed models for plan buyouts and analyzed regulatory and statutory issues associated with terminations and buyouts. GAO also interviewed labor and pension advocacy groups, pension regulatory agencies, and pension experts.

What GAO Found

In proposed DB plan buyouts, a third-party financial company would take over sponsorship of a hard-frozen plan from the original sponsor, in exchange for money to compensate for plan underfunding, expenses, and risk. As with a standard plan termination, the objective of a buyout would be to allow the original sponsor to shed its obligations to the plan, but potentially at lower cost and possibly with greater flexibility. In buyout proposals, the new sponsor would assume all plan responsibilities and PBGC guarantees would continue to apply to plan benefits. In comparison, a standard termination ends the plan, and an insurance company contracts to pay accrued benefits to participants (to the extent participants' benefits are not paid out by the plan as part of the termination); PBGC guarantees no longer apply, but state guarantees do. Insurance companies generally must comply with state-based risk-based capital requirements, which may provide safeguards against insurer insolvency and protections for pension benefits paid this way. In some cases, plan buyouts could increase the security of DB pensions by allowing weak sponsors to transfer plan sponsorship to firms with stronger financial backing and improved plan management. However, buyouts would sever the employment relationship between sponsors and participants, possibly eroding incentives to manage the plan in the interests of participants. Buyouts could increase the risk of a large claim against PBGC by increasing the concentration of assets and liabilities held by a single sponsor or sector. They could also lead to conflicts between agencies regulating financial companies and those regulating pensions. In August 2008, the Internal Revenue Service issued a ruling declaring that a DB plan that was bought out by a nonemploying entity would not qualify for tax preferences under current law.