Leon LaBrecque, JD, CPA, CFP®, CFA, Managing Partner, LJPR, LLC
As probably everyone is aware, Ford Motor Company is preparing to offer a series of one-time voluntary lump-sum pension payments to its salaried retirees. The purpose of the lump sum is to reduce Ford’s pension liabilities, under the concept that some retirees will opt for the payment, thereby removing their pension liability from Ford’s books (and the balance sheet). Of course, the retiree decision is highly individualized, so we’ve been working on a comprehensive White Paper for our Ford clients, but as I worked on the section of the paper ‘shifting of mortality risk’, it occurred to me that this action (the lump sum payment) could actually increase liabilities to Ford, at least on a relative basis. Here’s why:
When
a pension plan wants to offer lump-sum benefits, it is required to make the
calculations based only on interest rate and unisex mortality. In other
words, to the Ford GRP, all 63 year old retirees are exactly the same in the
amount of time they will live. If a plan is paying monthly benefits, and
someone dies early, the pension plan gains (because the liability went away and
the money stayed in the plan). This is called an actuarial gain. If a
retiree takes the lump sum payment, Ford has removed the liability, but it has
also eliminated the possibility of any actuarial gain (the actuarial gain has
been shifted to the retiree’s family).
So,
let’s take a simple example: There are four 63-year-olds in the pension
plan, all of whom are receiving either a single life benefit or a reduced joint
and survivor benefit of the same monthly amount:
- Tom, a 63 year old male, single with an adult child, high blood pressure and a history of heart disease.
- Candace, a 63 year old female, single with no children, marathon runner, yoga practitioner, and in perfect health with a living nonagenarian mother and aunts.
- Mike, 63 in poor health, married to Sue, 63, in great health.
- Kathy, 63 in good health, married to John, 63 in poor health.
Under
the current pension & actuarial rules, Ford’s liability is exactly the same
for each of the retirees due to the unisex mortality table, even though
according to the chief actuary of Social Security, 63 year-old women will
outlive 63 year-old men on average by 2.83 years. It’s likely that
Tom will predecease Candace, and that Sue and Kathy will probably outlive their
spouses, So, with the four above participants, if the healthy people lived 5
years longer than the table and the people in poor health lived 5 years
shorter, there would have been actuarial (mortality) gain on Tom and Mike, and
actuarial losses on Candace and Kathy.
From
the pensions’ liability standpoint, it would be a wash. Now, let’s look
at the situation with the lump sum payments. Ford is required to offer the same
amount to all four participants, let’s say its $483,000. Tom and Mike would
possibly take the lump sum and Candace and Sue would not (life expectation
considerations). Same scenario as before, healthy people live 5 years longer
than assumed, unhealthy people live 5 years less. Although Ford reduced its
liability on Tom and Mike, it also gave up the actuarial gain; it retains the
liability on Sue and Candace AND suffers the actuarial loss. This could
potentially increase the overall liability.
In
other words, by offering a lump sum, it’s logical that the retiree who may
benefit from it (I am going to estimate about 20%) will take it, leaving a
cohort of healthy retirees who cost the plan more in the long run. The
plan reduces liability by 20%, but increases the remaining liability with
mortality experience. Balance sheet gets a boost because of the pension
math; it's brilliant.
Maybe
in the future, plans will send bacon and butter gift packs and hang-gliding
coupons to retirees.
Leon
Leon
