In this discussion, four Towers Watson experts explain why lump sum offerings are an increasingly attractive strategy for de-risking pension plans and discuss the factors required for successful execution.

In 2012, Towers Watson advised more than 110 organizations on lump sum pension payment offerings and implemented 93 bulk lump sum programs covering approximately 400,000 participants formerly employed by these organizations. We advised a majority of U.S. pension plan sponsors that took action and implemented approximately one-half of the total lump sum activity.


Matt Herrmann

Senior Retirement Consultant

Pierre Jraiche

Senior Pension Administration Consultant

Karolyn Karl

Rewards, Talent and Communication Consultant

Michael Marion

Senior Technology and Administration Solutions Consultant

In the past year, there’s been a dramatic uptick in the number of organizations using lump sum offerings to de-risk their pension plans. Why have these offerings grown in popularity?

Herrmann: Lump sums give plan sponsors a way to reduce their plan’s size, which can lower the operational cost and financial risk associated with managing a pension program.

For years, many plan sponsors have considered lump sum offerings. But it wasn’t until the Pension Protection Act (PPA) of 2006 changed the basis for calculating lump sums that the offerings became viable solutions for many organizations. Prior to the PPA’s enactment, plan sponsors often had difficulty offering lump sums, because they had to calculate them using a 30-year Treasury-rate basis, which made lump sums more expensive than funding or accounting liabilities. Under the PPA rules, lump sums now are calculated on a corporate-bond basis that’s more closely aligned with the funding and accounting measures of pension obligations. This new lump sum basis was phased in over a five-year period starting in 2008, meaning that 2012 was the first year the new basis was fully in effect.

How does a plan sponsor know whether a lump sum offering is an appropriate de-risking strategy?

Herrmann: Lump sums can be a useful tool to reduce the size of pension obligations, but they must fit within the context of an organization’s overall financial and HR strategies. If the plan sponsor’s objective is to reduce its pension risk, the first question is: “Are we better off settling our liabilities, either through lump sum payments or other risk transfer mechanisms such as an annuity purchase, or are we better off trying to manage these risks ourselves?” The answer depends on a number of factors, including the financial environment, discount rates, the plan’s funded status and the size of the plan’s obligations.

These factors change continuously, so plan sponsors should periodically evaluate whether it’s the right time for a lump sum offering or other de-risking action. A strategy that isn’t right today might be perfect tomorrow. In early 2012, for example, lump sum offerings weren’t top of mind for many organizations. But when the financial environment changed, these offerings became a much more attractive risk management approach. Plan sponsors evaluating de-risking strategies should always ask themselves: “If not now, when?” They shouldn’t dismiss the option prematurely based on a temporary market environment.

It’s important to keep in mind that the factors that drive the decision to execute de-risking actions vary among plan sponsors.

Once a plan sponsor decides to offer lump sum payouts, what steps should it take to ensure a positive outcome for both the organization and plan participants?

Jraiche: The plan sponsor needs to be ready to execute the strategy when conditions are right for the organization.

Crucial early steps include assessing and improving data quality. For example, if a sponsor can’t reach the plan participants, it can’t make them an offer. The organization must locate eligible participants and be able to accurately calculate their final benefits. This process can be very difficult — many participants may have left the organization years ago or, if there’s been an acquisition, might never have worked for the organization at all.

The sponsor also needs to make design decisions. To whom will it extend the offer? Does the design need to align with accounting implications or other considerations that are important to the organization? Does the sponsor want to offer the minimum lump sum amount required by law or a larger amount?

Each plan sponsor will answer these questions differently, and there’s no right or wrong choice. What’s important is that the sponsor fully understands the financial impact of its choices on the organization, as well as the likelihood of the offer being accepted.

When and how should sponsors inform eligible plan participants of the offer?

Karl: Once a sponsor decides to offer a lump sum payment, it needs to design a comprehensive communication campaign with two primary goals: legitimizing the offer and engaging plan participants throughout the offer period.

Legitimizing the offer is important, because the eligible participant’s connection to the sponsoring organization may be tenuous. This is likely for those whose only association with the organization came via an acquisition that happened late in the participant’s career or after retirement.

To capture and hold participants’ interest in the offering, sponsors need to send engaging, action-oriented mailings to eligible participants before and during the offer period. In 2012, we mailed more than one million communication pieces on lump sum offers, and one point was clear: The easier it is for participants to make a lump sum election, the more likely they are to do so. Distributing user-friendly materials can also help the plan sponsor limit the number of election packages submitted with errors that must be resolved before lump sums can be paid out.

Are hard-copy mailings still the best way to communicate with plan participants about these offers?

Karl: Yes, mailing printed information to eligible participants’ homes is still the best method, because it’s the channel most likely to reach them. In addition, mailing addresses may be the only means a plan sponsor has of contacting plan participants who left the organization years ago.

Typically, organizations announce the offer via formal letters or postcards to eligible participants. Then they deliver decision-making materials prior to or as part of an election kit mailing. This kit details the eligible participant’s payment options and amounts, and also includes the forms the participant can use to elect a lump sum payment. Once the kits have mailed and the offer period has begun, the sponsor usually sends reminder postcards periodically to keep participants engaged and remind them of decision deadlines.

What common pitfalls in the offer process have you seen, and how can plan sponsors avoid them?

Marion: A big pitfall is underestimating the need for speed. Of the lump sum offers we executed last year, 85 were available for a period of between 30 and 60 days. Participants must accept the offer within a relatively short time period, and many wait until the last minute to make their decisions. Organizations need to be prepared for a rush of last-minute elections and be ready to answer the participant questions that often go along with them. We often find that making the offer available for a longer period doesn’t lead to a higher acceptance rate, so the ability to execute within a very tight time frame is important.

Jraiche: Another common pitfall is overestimating data readiness. Often, the quality of participants’ address data isn’t as good as the organization may feel it is, and the result is a returned-mail rate of anywhere between 5% and 15%.

Inadequate data can cause other problems, too. The kits contain individual calculations for each participant, and the recipients look at those calculations very closely. If the data are incomplete or inaccurate, they will trigger many more questions, making the project even more intense for all involved. In addition, there’s a real risk of under- or overpaying plan participants.

From a design perspective, it’s important for plan sponsors to keep the target audience for the offering in mind. Approaches that are appropriate for vested former employees who left the organization years ago may vary greatly from those that are appropriate for active and retired participants with whom the organization has stronger connections.

What factors should sponsors consider when deciding whether to offer only the minimum lump sum or something more?

Jraiche: They should look at more than just the difference between the lump sum amounts. The sponsor’s choice could affect acceptance rates, which in turn could have significant financial implications for the organization over the long term. Sponsors should have a clear understanding of the short- and long-term implications — and how those interact — before making decisions.

Any overall pieces of advice for organizations considering de-risking options?

Herrmann: Often, the biggest challenge plan sponsors face is getting internal consensus around their objectives. If an organization can clearly articulate what it’s trying to accomplish, there are solutions to meet those objectives. This time last year, most organizations didn’t think retiree lump sum offerings were possible, and believed the annuity market volume would continue to track between $1 billion and $3 billion of obligations per year.

Today, only one year later, we’ve gone through a significant transformation relative to the retiree and terminated vested lump sum marketplace, and there has been an unprecedented $35 billion in annuity purchases.

If you’re able to get alignment with your objectives within your organization, you can find a solution that meets your organization’s needs and be positioned to act quickly when opportunities arise.

Observations on Marketplace Activity

Towers Watson rigorously analyzed data based on the lump sum offerings we administered in 2012. The trends and lessons learned can guide plan sponsors as they seek to implement successful offerings. Below are a few highlights from this research. Please contact your local Towers Watson consultant for a copy of the research findings.

  • In 2012, lump sum offers presented a de-risking option across all plan types (frozen, closed or open), regardless of the size of the plan. Among plan sponsors taking action, there was a wide distribution of plan types and sizes.
  • Many sponsors elected to offer lump sum payouts in the second half of 2012 due to a decline in market interest rates, and new legislation that reduced the funded-status barrier and increased ongoing operational costs.
  • Acceptance rates varied according to a number of factors, including participants’ age and geographic location, as well as the benefit size and relative value.