The novel coronavirus has caused almost every economic industry major strife over the last 6 months. However, corporations were struggling with their pension liabilities long before the pandemic hit. According to Mercer’s 2020 Defined Benefit Outlook, at the end of 2019 the average pension fund only had 85% of their pension liabilities covered, while 63% of companies with defined benefit pensions were considering termination within 5 years. If these companies were struggling to cover their pension liabilities during a decade-long economic expansion you can bet the recession of 2020 has severely hindered their ability to pay these debts.
This raises the question, will Northrop Grumman freeze pension lump-sum payments? What would it look like if they did?
As the economy dipped into recession earlier this year, the Federal Reserve has lowered interest rates. The Federal Funds Rate has been lowered to a target range between 0.00% and 0.25%, down from 2.00% this time last year. Generally, when interest rates decrease, pension lump sums increase, so this is good news for employees retiring in the near future. However, when lump-sums increase so do corporations’ pension liabilities. If interest rates continue to stay low and lump-sums continue to stay high what will Northrop Grumman do? Where will they get the money to pay for these future liabilities? Will they freeze the lump-sum payment?
In an environment with declining interest rates and the recession hurting profit margins, it will be difficult for Northrop Grumman to keep making pension payments in full. Something has to give. Numerous companies have already taken steps to mitigate their risk, with some companies choosing to freeze their defined benefit plans. General Electric, who have the biggest pension liability in the country, decided to freeze their pension plan for 20,000 employees. Other companies are adjusting their interest rate benchmark to the higher corporate bond rate.
The Paycheck Protection Act of 2006 ended a requirement to use the 30-Year Treasury rate in a corporation’s lump sum calculations. This allows them to use a higher corporate bond rate to mitigate the projected increases in payouts as a result of lengthening mortality tables. The PPA also instituted restrictions on lump sum distributions depending on the funding percentage of the pension plan. In the event that a defined benefit plan is funded at less than 60%, participants would be prohibited from electing a lump sum. Also, in the event of a bankruptcy, lump sum payouts are prohibited unless the plan is 100% funded already. While these may seem like extraordinary circumstances, tracking done by Milliman, notes that average defined benefit plan funding for the largest 100 plans in the US fell to just 81.1% in July of this year.
Northrop Grumman instituting a freeze of the lump-sum offer is a possibility and, if implemented, could drastically change your retirement plans. It’s important to speak with a financial advisor in order to be prepared in the event that the lump sum is unavailable when you leave Northrop Grumman.
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