Interest rates rose rapidly in 2022 and have remained elevated, resulting in a dramatic increase in the number of lump-sum window de-risking strategies being implemented by defined benefit plan sponsors. Higher interest rates have also affected plan participant behavior. This article reviews lump-sum window participant election experience observed since 2022 and items for plan sponsors to consider before implementing a lump-sum window de-risking strategy.

Background on pension plan lump-sum windows

A pension plan must allow participants to elect their benefit in the form of a monthly annuity that is payable over their lifetime. A lump-sum window provides participants a one-time voluntary opportunity to receive the full value of their pension as one payment in lieu of a monthly lifetime annuity.

Implementing a lump-sum window strategy can be an attractive option to incorporate into a plan termination, given that it may reduce the relatively higher costs associated with transferring non-retiree obligations to an insurer; insurers will generally include larger loads when taking on non-retiree liabilities because it is more difficult for them to hedge the underlying risk. Insurer loads for retiree obligations are generally modest as it is easier for insurers to manage their underlying risks.

Many plan sponsors also offer lump-sum windows as a stand-alone strategy (i.e., not in conjunction with a plan termination), given that they reduce the plan’s risk profile, reduce the plan’s ongoing operational costs, and can be structured to take advantage of interest rate volatility, thereby reducing the de-risking strategy’s implementation cost.

Regardless of its application, the success of a lump-sum window campaign is only as effective as the number of participants utilizing it. As a result, we analyzed how participant behavior has changed since 2022 and, in turn, how changes in participant behavior may impact the de-risking strategy.

Lump-sum window experience: Historical norms

Lump-sum election rates

Lump-sum window election rates (i.e., the percentage of eligible participants electing a lump sum) vary depending on whether the window is offered in conjunction with a plan termination. Based on our experience, election rates are generally 10% to 25% higher when offered in conjunction with a plan termination. For example, assume an election rate for a window offered outside of plan termination is 50%. An organization offering a window to the same participants in conjunction with a plan termination may see an election rate of 60% among its former employees and 75% among its current employees.

Monthly lifetime annuity election rates

As described previously, pensions must provide participants with the option of commencing their benefit as a monthly lifetime annuity. Although most participants making an election during a window will elect a lump sum, some will instead choose a monthly lifetime annuity. Based on our experience, the percentage of participants electing a monthly lifetime annuity is modest, generally less than 2%.

Lump-sum window experience: Observations since 2022

Lump-sum election rates

Election rates for lump-sum windows have remained strong when offered in conjunction with a plan termination. However, we have observed a marked decrease in the election rates for lump-sum windows when offered outside of plan termination; almost 10% lower. This is likely because the higher interest rates reflected since 2022 result in relatively smaller lump sums, all else being equal. Additionally, there were many articles discussing the reduction in lump-sum amounts from 2022 to 2023, which likely had an influence on election rates.

This reduction in election rates can have a significant impact on the cost of the de-risking strategy. For example, consider a plan sponsor with a $100 million non-retiree obligation. A 10% decrease in election rates will result in $10 million of obligation (and risk exposure) that will continue to be carried by the organization. Further, operational costs associated with maintaining these obligations will remain, e.g., annual Pension Benefit Guaranty Corporation (PBGC) premiums and participant notices.

Monthly lifetime annuity election rates

Regardless of whether the lump sum is being offered in conjunction with a plan termination or a stand-alone strategy, since 2022 we have observed a marked increase in the percentage of window participants electing a monthly lifetime annuity.

Whereas we previously saw an average election rate of 2% or less, we are now seeing an average election rate between 3% and 5%. Further, we have observed election rates between 5% and 10% among nearly half of our clients who have terminated their plans. It is uncertain why the rate has increased. It could be because the lump sums look less attractive, or it could be due to a general increase in retirement activity since the onset of COVID-19

Takeaways in light of recent observations about pension lump-sum windows

• A lump-sum window offered in 2024 while interest rates remain high may have higher lump-sum election rates as the negative publicity around the change in lump-sum amounts from 2023 to 2024 will be less dramatic.
• Regardless, plan sponsors offering a stand-alone lump-sum window should consider the following:
  • Allowing employees who are at least age 59 ½ to participate in the window.
    IRS regulations allow plans to offer in-service distributions to employees older than 59½. Expanding the window population to include these participants may help the plan sponsor better meet its risk and cost management objectives.
  • Carefully structure the timing of the window.
    Window preparations can be extensive. Further, it may take time for an organization to make a go/no-go decision. In addition, it is not uncommon for plan sponsors to schedule their windows to end just before a critical deadline that can’t be shifted (e.g., before the end of a plan year, fiscal year, or some other key date of importance).
    Given the effort involved in offering a window, plan sponsors should consider structuring the window with enough time to accommodate a reaction strategy in the event lump-sum election rates are lower than desired. For example, structuring the window such that it can be extended or can accommodate a call campaign to confirm participants received their election packages could be helpful.
• Higher monthly lifetime annuity election rates may or may not be helpful depending on the circumstances.
  
  Higher monthly lifetime annuity election rates may be helpful if the elections take place in conjunction with a plan termination. As described earlier, insurer pricing for retirees is generally much more favorable than the pricing for non-retirees. Therefore, a participant whose status has been updated from a non-retiree to a retiree may reduce the cost of the plan termination.
  
  If the plan is not being terminated, these liabilities will remain on the organization’s balance sheet, and the plan will still be subject to ongoing costs associated with maintaining its obligations (e.g., PBGC premiums). As a result, plan sponsors offering a stand-alone window to a large non-retiree population may want to consider, as a follow-up strategy and if the size warrants, purchasing annuities for those who elected a monthly lifetime annuity (i.e., consider transferring their obligations to an insurer), perhaps including other retirees in the plan as well.

In conclusion: Advice for pension plan sponsors considering lump-sum window strategies

Plan sponsors considering a lump-sum window should carefully review how they structure their campaigns in light of changes in participant experience.

As with any pension strategy, many factors need to be considered. Furthermore, fiduciary regulations require the plan to be operated solely for the benefit of plan participants. We encourage plan sponsors to contact their consulting actuaries and ERISA legal counsel to discuss the best course of action.