Ford announces program to “buy-out” retirees and former employees in its U.S. salaried retirement program – A good risk management move? Depends on your perspective…

by Andy Peterson, SOA Staff Fellow, Retirement Systems

On April 27, Ford Motor Company announced a voluntary program to provide lump-sum payouts to salaried retirees and former employees in the U.S. in exchange for receiving no further payments from the company’s pension plan in the future. This announcement was framed in the context of a previously announced long-term strategy that Ford is pursuing to de-risk its funded pension plans globally, which includes a shift in asset allocation to 80% fixed income over the next several years (see Ford’s 12/31/2011 year-end filings).  So is this a good risk-management move or not? Maybe – it depends on your stake in Ford and its pension plans.  And if Ford is de-risking, where is the risk going?

Actuarial science is about managing risks. For a retirement plan sponsor, good plan management involves comprehensive risk management. As pension plans have matured, particularly, in manufacturing industries like the auto industry, the size of these plans has become significant relative to other company assets. In the case of Ford, its 2011 year-end financial statement reported global pension assets of $58.6 billion and pension liabilities of $74.0 billion compared with total balance sheet assets of $178.3 billion and a current market cap of about $44 billion. Ford’s pension liabilities exceed their market cap; clearly pensions matter at Ford. Market volatility in pension assets (particularly if highly invested in equities) could have a highly leveraged impact on Ford’s overall financial results.

As an actuary, I applaud Ford’s move to de-risk its pension plans as an example of better corporate risk management. The shift in asset allocation to fixed-income securities (presumably of longer duration) that more closely matches the interest-sensitive-behavior of the pension liabilities makes a lot of sense.  However, even a fully asset-liability matched portfolio does not deal with Ford’s likely concern about the size of pension assets relative to its overall balance sheet.  Thus, Ford has taken the additional step to offer the voluntary program to cash-out retirees and other former employees.  It’s an unusual move, but not necessarily surprising.  It remains to be seen how many of its former employees will take Ford up on this offer and thus how successful it will be, but it certainly makes sense from a balance sheet perspective and shareholders should applaud this move.

However, there is another perspective: that of the participants who must decide whether to take this offer.  Whether this offer is helpful to them is not so clear. One of the positive features of traditional defined benefit plans is their ability to provide lifetime income to plan participants. This protection is extremely valuable – particularly as participants age.

To the extent that participants elect the lump sum, they have effectively given up the security of the lifetime income, unless they turn around and buy an annuity from an insurance company. However, this is not a “cost-free” transaction.  While each situation varies, it is highly unlikely that individuals will be able to take their lump sum from Ford and turn around to buy the equivalent annuity from an insurance company. Ford will be required to calculate the lump sum cash-outs according to fairly conservativeIRS-prescribed rules.  But insurance companies have administrative fees, general conservatism and profit motives built into their calculations that likely make the pricing of an equivalent annuity more than what Ford will pay to the participants in a lump sum.  Plus, insurers often assume any individual interested in purchasing an annuity knows something about their own expected longevity (e.g.great-aunt Mabel lived to be 92) and prices the annuity accordingly (versus better rates generally available in a group-purchasing context).

On the other hand, retirees, who may have watched friends at other automakers or other companies have their benefits cut through bankruptcy may jump at the chance to have the money “in hand” rather than “take their chances.” The Pension Benefit Guaranty Corporation does provide relatively robust guarantees, particularly for those who have been retired for some time, but this information may be hard to ascertain and, even with facts in hand, may not dissuade some retirees.   And finally, the flexibility of a large lump sum – to pay medical bills, help put the grandkids through college, etc. – can be more immediate than the seemingly remote chance of living to be 92 or more.

In reality Ford is transferring risk to plan participants who accept this offer. Ford has every right to manage their costs and balance sheet for the long-term view. But this leads to a number of questions which need to be debated at the policy level:

  • What are the implications of transferring risk to individuals who may have less understanding and ability to manage and mitigate that risk – particularly the risk of outliving the assets?
  • Does this leave some participants open to bad decisions or unscrupulous advice?
  • Does this have implications for society and taxpayers if participants fail to implement strategies to effectively manage the lump sum and need further financial support later in life?

While this may be a good move for some individuals, I can only hope that Ford will provide a comprehensive education campaign so that its retirees and former employees will fully understand the choice. I would point them to publications the SOA has produced for consumers, like our recent Managing Retirement Decisions series including briefs on “Finding Trustworthy Financial Advice for Retirement and Avoiding Pitfalls” and “Designing a Monthly Paycheck for Retirement”.

Ford is taking bold steps to de-risk its pension plans and for that it should be applauded. One can only hope that individuals affected will also be able to make good risk management decisions as they decide whether to accept the offer.

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Discussion

4 responses to "Ford announces program to “buy-out” retirees and former employees in its U.S. salaried retirement program – A good risk management move? Depends on your perspective…"

  • Bob Boeckner says:

    Good article, Andy. I agree that lessening the risk for Ford transfers the risk to the participant who likely will not be a pension expert and to any insurance company that issues an annuity in return for the lump sum. The risk does not magically vanish.

  • Yvonne Socha says:

    Thank you for your comments. As a “surviving spouse” of a Ford Motor Company employee, and a current pension recipient, there are many factors to consider. On the plus side, as a surviving spouse, I cannot pass my monthly check on to anyone when I die. If I take the lump sum (hopefully) there may be some amount left to pass on to my heirs. There are so many questions – several of which you addressed in your article. Also, are we going to be allowed to roll this money over into an IRA; or, are taxes due upon Ford’s distribution to us? The bottom line is, and always has been, about the money. It all depends on the dollar amount that Ford offers. If the employee/spouse feels it is fair they will take it – if they feel the monies are insuffient-they will decline. It will be very interesting to see what ultimately happens. I am keeping your article to review when I receive my “buyout” package. Thank you.

  • Andy Peterson says:

    For more perspectives on issues that individuals should consider in whether to accept this offer, Steve Vernon (also an actuary) has written a nice article responding to Ford’s announcement for his CBS MoneyWatch column. See: http://www.cbsnews.com/8301-505146_162-57425528/fords-retiree-cashout-a-trap-for-the-unwary/?tag=mncol;lst;4

  • It does seem like a good idea, exercising “good risk management”. One thing about large companies such as Ford is that they look at the bigger picture ahead of them. How does the situation in Detroit affect this move reported in 2012? Does this only affect retirees and former employees really?

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