Look to Annuities to Salve Pension Fears.

• Author: Cahill, Charles
• Position: Pension plan management

It isn't a strategy for every company, but purchasing annuities for the retired portion of a defined-benefit plan's liabilities can help minimize risk and generate additional income.

In this busy world, a well-funded retirement plan may seem to be the least of a company's worries, but the world is not stagnant. Markets turn -- as they have in recent months -- and one day a company may find itself with a retirement plan with large liabilities, a bad balance sheet and substantial funding requirements at the exact time when it least wants to have to turn its attention to the retirement plan.

Consider recent events. Partly due to the run-up in the equity markets in the past few years, the stampede toward terminating defined-benefit plans has significantly lessened. Because of improved funding levels, these plans often no longer require contributions. In the meantime, CFOs are busy managing their companies to respond to the New Economy. However, liabilities in the defined-benefit plans continue to grow, and this growth is creating potentially hidden risks for the company's financial stability.

With proper planning and follow-through, however, a company's defined-benefit plan may provide a substantial opportunity to improve its bottom line. This opportunity arises by taking advantage of an old game -- purchasing annuities for the retired portion of the plan's liability. The settlement of liabilities under FASB Statement No. 88 can generate income by accelerating the recognition of accumulated gains that have built up on the balance sheet. At the same time, the plan's liabilities and assets decrease, lowering the risk to the plan from decreasing settlement rates and weaker investment returns. As an added benefit, when annuities are purchased, the insurer assumes responsibility for keeping tabs on the company's retirees, eliminating a substantial administrative headache for a benefits department.

The bull market of the 1990s was unprecedented. Year after year, well-invested pension plans earned double-digit returns, outstripping even the most aggressive actuarial assumptions. Through the '90s, the average annual return on a typical asset allocation (60 percent equity and 40 percent fixed-income) was about 15 percent. Offsetting these excess asset returns was the fact that through the middle or latter part of the '90s, liabilities continued to increase as interest rates dropped. Until very recently, however, interest rates had moved back up, helping many plans reach unprecedented funding levels

Still, many companies have seen accrued pension liabilities grow on their financial statements. Because of the differences between the recognition of liabilities under FASB statement No. 87 and the limitations on contributions under the Employee Retirement Income Security Act (ERISA), companies have been booking annual expenses for their pension plan, but have not been required to make cash contributions. So even though plans' funded positions have been improving, the bottom-line liability on the corporate balance sheet has been growing. Some companies have been booking pension income in recent years, but even for these companies the...