The ERISA Advisory Council held a hearing last week on “Model Notices and Disclosures for Pension Risk Transfers.”  The Council, which advises the Secretary of Labor on the Labor Department’s administration of ERISA, is working to develop model disclosures to participants who receive lump sum offers in connection with de-risking transactions.  While the Council is focused on lump sums offered in connection with limited election windows, the model disclosures might apply any time an individual is offered a lump sum distribution in lieu of an annuity benefit.

The Council heard testimony from several witnesses, many of whom proposed text or offered suggestions to be included in model disclosures—including testimony by our own Robert Newman of Covington & Burling LLP.  While the Council deliberates, employers conducting lump sum windows might wish to consider some of the disclosures suggested at the hearing.

Recent Attention on Lump Sum Disclosures

The Council’s hearing on lump sum offer disclosures comes on the heels of recent increased attention by policymakers.  The Council heard testimony in 2013 on pension de-risking more generally and issued a call for increased disclosure.  Last October, two Senators sent a letter to regulatory agencies requesting, among other things, increased disclosure requirements in connection with lump sum windows and other pension settlements.  Earlier this year, the General Accounting Office issued a report reviewing lump sum offer disclosures.  The 2015 GAO report, in particular, was a focus of the recent Council hearing.

For its report, the GAO had reviewed sample disclosures from a small number of plan sponsors and interviewed 33 participants who received lump sum offers.  The GAO concluded that key information was missing from the disclosures.  The GAO recommended that disclosure materials contain additional information and identified eight key factors that should be addressed.  See GAO Report (at pgs. 37-38).

May 2015 Council Hearing 

A contingent of witnesses testified at the hearing that model disclosures should be designed to “nudge” participants toward a decision to reject lump sum offers.  For example, Erzo F.P. Luttmer, a Dartmouth Professor of Economics, testified regarding studies showing that many participants may systematically devalue annuities and that the choice between a lump sum and an annuity “is a cognitively challenging task that leads people to make choices that are typically inconsistent with standard economic theory.”  In light of these studies, it was argued that providing participants with better information may not be enough to ensure that participants make good decisions and that “choice architecture” should be used to encourage participants to make annuitization decisions that are in their best interest.

Other witnesses argued for a more balanced approach, whereby necessary information is presented concisely, simply, and without a thumb on the scale toward a particular decision.  Of note, Robert Newman testified that the myriad of existing disclosure requirements regarding lump sum offers often results in voluminous disclosures to plan participants, and that many employers are already providing thoughtful and comprehensive information to plan participants.  Mr. Newman testified that while it is not entirely clear that additional information could be helpful to plan participants, in light of the Council’s desire to create model disclosures, the following principles should be used as a guide:

  1. Model disclosures should be voluntary and customizable to meet the needs of a diverse workforce.
  2. Model disclosures should minimize burdens on employers and plan administrators. 
  3. Guidance should be coordinated with existing rules. 
  4. Model disclosures should be concise.

Employer Takeaways

Employers should expect that at the conclusion of their deliberations, the Council will recommend that the Department of Labor adopt specific model disclosures.  Employers might wish to consider whether to incorporate any model disclosures the Council recommends into participant communications, even if Department of Labor does not immediately respond to the recommendations of the Council.

In the meantime, companies that are currently drafting lump sum offering communications may wish to consider incorporating model language suggested by witnesses before the Council hearing—including the topics for possible model disclosures and text suggested by Robert Newman, a sample of which is copied below:

Lump Sum vs. Annuity 

Participants presented with an offer to receive their retirement benefits in the form of a lump sum distribution might consider the following:

Management and Risk Tolerance. Receiving a lump sum distribution will require the participant to manage the proceeds of this distribution. A model disclosure could explain that by accepting a lump sum distribution, a participant will take on the obligation of managing his or her retirement funds and that returns may vary. E.g., “You will be responsible for the investment of your lump sum distribution. Your benefit’s value will depend on the performance of the investments you choose. You should give careful consideration to how you will manage the lump sum payment, and you might wish to consult with a financial advisor.” 

Investment Return Risk. A model disclosure could address the fact that participants who elect lump sum distributions take on the risk that any expected return on investments may not be achieved. E.g., “You should consider the risk that you may not achieve the return you expect on investments of your lump-sum payment. If, instead, you elect to receive your benefit as an annuity, the payment of your benefit does not depend on investment return because annuity payments are guaranteed for life.”

Longevity Risk. Whereas annuities provide for a fixed income for life, participants that elect to accept lump sum distributions take on the risk of outliving their retirement funds. A model disclosure could address this uncertainty. E.g., “Choosing a lump sum provides less certainty. If you live longer than expected, you could exhaust the lump sum benefit before you die.” 

Inflation Risk. Participants who elect to receive annuities that provide fixed monthly payments might consider the fact that the payments made earlier have greater value than payments made later, due to inflation. A model disclosure could address this point. E.g., “If you decide to take an annuity, the amount of your monthly annuity will be fixed for the rest of your life (and, depending on the form you elect, the life of your spouse). Your monthly amount is not adjusted by interest or to account for increases in the cost of living. Accordingly, payments made later may be worth less than payments made today.”

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Photo of Jason Levy Jason Levy

Jason Levy helps clients navigate complex issues related to employee benefits and executive compensation, including compliance with the Internal Revenue Code and ERISA. Jason utilizes his deep knowledge in the ERISA space and his background as a former litigator to craft advice that…

Jason Levy helps clients navigate complex issues related to employee benefits and executive compensation, including compliance with the Internal Revenue Code and ERISA. Jason utilizes his deep knowledge in the ERISA space and his background as a former litigator to craft advice that is both practical and strategic. His practice includes:

  • counseling on design, establishment, administration, and maintenance of qualified defined contribution and defined benefit retirement plans;
  • designing, drafting, and amending a wide range of executive compensation arrangements, including nonqualified deferred compensation plans, equity incentive plans, and change in control bonus plans;
  • representing employment, human resources, and benefit interests in mergers and acquisitions;
  • advising clients on multiemployer plan operations and risk management, including withdrawal liability and plan funding issues; and
  • providing benefits expertise in legislative initiatives.