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How Pension Outsourcing Could Hurt Your Retirement

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Around the country, employers have increasingly moved away from pension plans that require them to take responsibility for their workers' retirement benefits. As a result, it's getting extremely rare for younger workers to have access to a traditional pension plan, with the more likely offering being a 401(k) plan that requires workers to take on investment responsibilities.

But the move away from pensions goes beyond changes for new hires. Companies have also taken some dramatic steps to try to make their pensions easier to handle, or when they can, to get rid of having to deal with them entirely.

Verizon's pension outsourcing 
Earlier this week, Verizon (NYSE: VZ  ) finalized a deal originally announced in October that allowed it to move some of its pension obligations out of its hands. The company's strategy was simple, as it did something that financial planners might well advise a retired client to do: It went and bought an annuity.

Specifically, Verizon transferred $7.5 billion in pension commitments to Prudential (NYSE: PRU  ) , basically buying annuities for the 41,000 former management employees that had been covered under the pension plan. Prudential will take on the responsibility of paying retirees the same benefits they had been receiving directly from Verizon, while Verizon will no longer have to worry about investing pension-fund assets to deliver promised payouts to those workers. All in all, the $7.5 billion represents about a quarter of the assets that Verizon manages for all of its pension obligations.

But the retired workers involved aren't happy about the move. In a lawsuit, they argued that if something happens to Prudential, they'll no longer be covered under the Pension Benefit Guaranty Corporation and could therefore lose their benefits. They also said that Verizon was breaching its fiduciary duty to diversify by concentrating benefits into an annuity option. The court, however, didn't accept those arguments and ruled in Verizon's favor.

Following in GM's footsteps
Verizon isn't the first company to make this move. Earlier this year, General Motors (NYSE: GM  ) did the same thing with about 110,000 of its salaried retirees, with Prudential again winning the business.

Many GM retirees had a big advantage over Verizon's former workers, though. GM gave 44,000 of its white-collar retirees the choice to take a lump-sum payment in lieu of the monthly pension benefit. In other words, GM gave its workers an opt-out provision that would have let them decide how to invest the value of their pension benefits, rather than farming out the responsibility to Prudential. About 30% of the workers that were eligible took that buyout, and Verizon's workers argued in their lawsuit that they should have had the same option GM's workers did.

It's not immediately clear why Verizon would have had a problem giving workers a choice. After all, it presumably transferred a fixed sum to Prudential based on the amounts it was paying to workers and their life expectancies. Diverting that fixed sum away from Prudential and directly to the worker would be a trivial exercise, requiring only the internal corporate infrastructure to handle such requests for thousands of workers.

Moreover, buyout offers have also become quite popular as ways for companies to reduce the uncertainties of pension liabilities. Ford (NYSE: F  ) tackled what it saw as a $50 billion risk to its business by making lump-sum offers to nearly 100,000 of its retirees and other former employees earlier this year, as it attempted to reduce its exposure by as much as a third.

Protect your pension
As employers work harder to get rid of pension liabilities, workers who are entitled to pension benefits may find themselves facing tough decisions like this. In general, taking a lump sum gives you the most flexibility, as you can always buy yourself an annuity and get monthly payments with some or all of your money. Yet if Verizon's method becomes more popular, workers and retirees may not get that choice, and insurance companies may end up being the big winners.

Meanwhile, as investments, companies that handle pension risk are actually helping shareholders. For Ford, its pension moves are just the latest in a series of strong business moves it's made lately. But is that enough to make Ford a buy? To answer that question, one of our top equity analysts has compiled a premium research report with in-depth analysis on Ford's prospects and risks. Simply click here to get instant access to this premium report.


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  • Report this Comment On January 07, 2013, at 2:02 PM, BKlounge22 wrote:

    Dan,

    I think your premise that pension outsourcing to insurance companies will hurt participants is a little bit off. Most companies focus their energies on businesses other than running a pension plan (as they should). Letting an insurance company that presumably has a lot of expertise in managing long-term liabilities take over has a lot of positive aspects.

    In terms of the Verizon participants (and most other pension plan participants this could apply to), they were not losing a choice. They are in basically the same position as before -- they receive their monthly checks every month according to the election they made at retirement. If they had a lump sum option in their plan, it would be a protected benefit that would only disappear if the PBGC took the plan over.

    The retirees at Ford and GM got an EXTRA choice -- they had previously elected their annuity benefit in their preferred form, and the company allowed them a one-time do-over if they wanted.

    The Verizon participants who sued as a result of the annuity purchase were making the argument that their pension is at greater risk now because they lose PBGC protection. However, Prudential is financially strong and highly regulated, and the likelihood of a government bailout if they went belly-up would protect participant in the same way that the PBGC does. I think their pensions are safer with Prudential than with Verizon.

    BKLounge22

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Dan Caplinger
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Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.

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