Verizon/Prudential Pension-Risk Transfer Survives Court Challenge

(December 7, 2012) – A district court in Dallas ruled today that Verizon’s $7.5 billion pension-risk transfer to Prudential can proceed, despite two retirees’ last-minute lawsuit to block the transfer.

The deal is set to be one of the largest in history—though trailing in value to Prudential’s recent $26 billion transaction with GM.

The court struck down the retirees’ claim that Verizon breached its fiduciary duties, and violated the Employee Retirement Income Security Act (ERISA). The plaintiffs had argued that the transfer was not authorized by the pension plan documents, and in pursuing it Verizon acted against members’ best interests.

However, the court ruled that the “Plaintiffs’ fiduciary duty claim necessarily fails because it is not a fiduciary act to amend or terminate a pension plan.” Furthermore, the “purchase of the annuity contract is expressly authorized by Verizon’s amendment to…the plan, adopted October 17, 2012, and effective December 7, 2012.”

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Verizon in fact entered into a Definitive Purchase Agreement with Prudential and an independent fiduciary for the annuity purchase on the same day it changed the plan to allow such a transaction, according to various court documents. Altering the pension’s policy was within Verizon’s legal rights, the court ruled: “Although there is a fiduciary duty in selecting an appropriate annuity provider, the decision to amend a plan to purchase an annuity does not implicate a plan fiduciary’s duties.”

The complaint, filed by William Lee and Joanne McPartlin on November 27, alleges that the “Verizon/Prudential transaction places the affected members in an inferior safety-net.” Both sides acknowledge that the handover would strip all 41,000 retirees involved of the pension protections legislated in ERISA and by the Pension Benefit Guaranty Corporation (PBGC). As annuity holders, the retirees will instead fall under insurance guaranty regulations, which vary from state to state.

Prudential argued in its court filings that retirees would in fact be “better off after the transaction than they were before, and more secure in their expected retirement payments.”

The court ruled that the “the annuity contract will provide the same rights to future payments, such as survivor benefits, as each retiree currently has…Plaintiffs have failed to establish a substantial likelihood that Verizon has a specific intent to interfere with their rights under the [pension] Plan and ERISA.”

Verizon’s response to the lawsuit included sworn statements from its heads of employee benefits, Chief Investment Officer Ronald Lataille, and risk-transfer guru Ari Jacobs.

Jacobs, a senior partner at consultancy AonHewitt, said Verizon hired him and Hewitt EnnisKnupp (an Aon subsidiary) in 2011. The company asked the consultants to compare the expected security of an ERISA-backed pension plan and group annuity contract, according to Jacobs. In the affidavit, his conclusion is substantially more conservative than Prudential’s stance. Jacobs set out six conditions for robust annuity security: a Prudential-level provider; fully-funded status through a separate account; backed by the insurer’s general account; governed by strict regulations; overseen by government regulators; and subject to state insurance guaranties. If all of these are met, then retirement “income is properly regarded as well protected by meaningful safeguards.”

Jacobs did not offer any holistic comparisons between the security of ERISA/PBGC-backed pension plans and life annuities.

A number of industry players, including corporate CIOs and insurance experts, have expressed concern that corporate appetite for risk transfers is outpacing aging regulation. (When Gerald Ford signed ERISA into law in 1974, the first major pension-to-annuity transaction was still nearly forty years off.)

“It’s not that I’m against pension-risk transfers,” Edward Stone, a legal counsel to the retirees, recently told aiCIO. But they are “extremely new and there’s no legal precedent set yet…You get cowboys at the forefront in these situations. But at the end of the day, this is such a serious issue, there has to be transparency and uniformity in the annuity guaranty.”

The Verizon-Prudential transaction must close by December 17 or be renegotiated, according to the annuity purchase agreement, which was published in court filings.

(December 7, 2012) — Investors could be in line for further pain should the European Central Bank (ECB) cut already low interest rates in the Eurozone after the institution’s president warned discussions had been held on the matter.

Mario Draghi, who leads the ECB, said in a statement yesterday that senior staff had discussed whether the region needed a reduction in interest rates to help stimulate growth and recovery.

Although the committee decided against lowering the rate, analysts said if the ECB was not confident the Eurozone would make a marked improvement in the second half of next year, another cut could happen.

Low interest rates in the region have hit institutional investors in several ways. Firstly, defined benefit pension fund liabilities, which are discounted using this measure, have soared in some countries. For example the Netherlands, which had always had a well-regarded pension system, has seen several of its pension funds reduce member benefits and increase contributions from employers and staff.

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Earlier this year, John Van Scheijndel, CIO at A&O Pension Services, told aiCIO: “Declining interest rates have increased the value of the liabilities substantially for our client, the industry-wide pension fund of the painters, BPF Painters. It should not hurt in the long term, but the solvency ratio is a very important ratio for the Dutch National Bank and the pension fund board. We do not want to be dependent on interest rates and market movements.”

The second issue is the impact on bond yields. As national interest rates fall, corporate bonds usually follow. Figures from data monitor Thomson Reuters this month showed high-yield bond issuers were enjoying record low borrowing rates. For investors, this means potentially lower returns on even the riskiest of credit assets when very little is performing in their portfolios. Additional data from Thomson affiliate Lipper showed European investors were holding record amounts of debt.

A note from Insight Investment last month said: “In Europe there has already been a marked compression of yields in a range of assets, including swap spreads, corporate bonds and outer core Eurozone government bonds such as France or Belgium. However, although Italian and Spanish bonds have tightened somewhat since ECB president Mario Draghi started to signal outright bond purchases in July, they remain relatively wide.”

Thirdly, falling interest rates have forced custodian banks to begin charging clients to hold their deposits. Credit Suisse became the latest to charge a fee for holding client assets in Swiss francs, due to the country’s negative rates. BNY Mellon and State Street have already begun imposing this charge on clients holding assets in Swiss Francs and Danish Kroner.

A note from Credit Suisse that was confirmed to Bloomberg, said: “Due to the current market situation and after closely monitoring the situation over the course of this year, we have decided to start applying negative credit rates on cash clearing accounts above a certain threshold…We invite our customers to keep cash balances as low as possible to avoid negative credit charges.”

With the ECB exploring the possibility of dropping rates, it’s an open question whether other central banks presiding over low rates and weak growth are considering the same tactic.