Guest Article

(From the May 11, 2009 issue of Deloitte's Washington Bulletin, a periodic update of legal and regulatory developments relating to Employee Benefits.)

GAO Reports on Proposal to Allow Buyouts of Pension Plans

Asked to identify a basic model for the proposed sale of frozen pension plans to third-party financial firms and to identify the risks and benefits associated with such a proposal, the GAO concluded that buyouts would provide plan sponsors who seek to shed pension liability with greater flexibility and potential costs savings when compared to the sole current alternative of plan termination. However, the GAO also said buyouts would offer participants few advantages for benefit protection beyond that already provided under ERISA, and would raise risks that are difficult to quantify.

In March 2009, the Government Accountability Office (GAO) issued its Report to Congressional Requesters, Defined Benefit Plans -- Proposed Plan Buyouts by Financial Firms Pose Potential Risks and Benefits (GAO-09-207). In it, the GAO examined the proposal to allow a third-party financial company to take over the sponsorship of frozen underfunded defined benefit plans from the original sponsor. The new sponsor would also receive cash outside the plan to compensate it for the plan's underfunding, expenses and risk. The transfer would enable the original sponsor to shed all of its obligations to the plan with greater flexibility and at a potentially lower cost than plan termination. Congress asked the GAO to identify the basic model for the proposal and to identify the potential risks and benefits for participants, PBGC, plan sponsors, and other stakeholders.

Background: A Framework Suggested in 2008

Although buyouts under a similar framework have been used in the United Kingdom for several years, the proposal was not brought squarely to the forefront in the United States until August 2008 when the Internal Revenue Service issued a ruling flatly prohibiting plan sponsors from making such transfers because of the exclusive benefit rule of IRC § 401(a). At that time, the Treasury Department -- together with the Departments of Labor and Commerce and the Pension Benefit Guaranty Corporation -- issued a news release identifying the features they considered necessary in the event Congress decided to establish a mechanism to allow such pension plan transfers. Those features included advance notice to the participants and ERISA regulators, limiting the acquiring entities to those in well-regulated sectors, requiring a demonstration that the transfer would reduce risk to participants and the PBGC, limiting the concentrations of risk, and imposing liability on the transferee's controlled group.

GAO Report: Risks and Benefits

A plan buyout differs from a termination because the buyout treats the plan as an ongoing concern. Under the proposal that was examined by the GAO, oversight of the plan would remain within the jurisdiction of the federal pension regulatory agencies (i.e., PBGC, and the Departments of Labor and Treasury). The new sponsor would continue to pay PBGC premiums and the PBGC guarantees would continue to apply. The requirements under ERISA and the IRC would also continue to apply (e.g., the new sponsor would have to satisfy the funding requirements, make all the required disclosures, etc.). Based on market research, the GAO assumed that new financial sponsors would primarily target slightly underfunded, hard-frozen plans.

The GAO Report identified both the risks and benefits with the proposal. The key advantages are to the plan sponsor. The buyout would serve the same function as a plan termination, but would provide:

GAO's Conclusions

The GAO concluded that, to the extent a buyout results in a stronger sponsor for the pension plan, it could make participant benefits more secure and could reduce somewhat the PBGC's financial exposure. Also, plan sponsors would benefit from the increased, presumably lower-cost, option that buyouts would provide for those who want to shed pension liabilities. However, the report identified as troubling the fact that buyouts involve risks that may be difficult to foresee or quantify.

The report noted that buyouts would offer few advantages for benefit protection beyond that already recognized by ERISA. The advantage appears to be limited to the circumstance where a buyout by a strong sponsor rescues the plan from a distress termination and saves the participants from benefits that would have otherwise been lost because they were uninsured. The GAO observed that, even if successful, buyouts could erode worker benefits by encouraging sponsors to freeze plans in order to avail themselves of the option.

Amidst the competing risks and benefits, the GAO finally concluded that opening the door to buyouts would fundamentally change the nature of pension plans, from an employer-provided benefit to one based on the monetary value of the benefit -- and that a person's assessment of buyouts is likely affected by their personal view in that regard. In the GAO's words:

The report is available on the GAO website at: www.gao.gov/new.items/d09207.pdf.

The information in this Washington Bulletin is general in nature only and not intended to provide advice or guidance for specific situations. If you have any questions or need additional information about articles appearing in this or previous versions of Washington Bulletin, please contact: Robert Davis 202.879.3094, Elizabeth Drigotas 202.879.4985, Mary Jones 202.378.5067, Stephen LaGarde 202.879-5608, Erinn Madden 202.572.7677, Bart Massey 202.220.2104, Mark Neilio 202.378.5046, Tom Pevarnik 202.879.5314, Sandra Rolitsky 202.220.2025, Deborah Walker 202.879.4955. Copyright 2009, Deloitte.