The coronavirus has caused the oil & gas industry major strife over the last year and a half. However, corporations were struggling with their pension liabilities long before the pandemic hit. The number of Fortune 500 companies who offer a traditional defined benefit pension plan has dropped by 43% in the last 20 years. In an environment with declining interest rates, low oil prices, and a high dividend, Chevron simply cannot afford to keep making pension payments in full. Something has to give. We've already seen ExxonMobil freeze their 401(k) matching program last year in an effort to cut costs. This raises the question, will Chevron freeze pension lump-sum payments?
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.
As the economy dipped into recession last 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 in 2019. 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 Chevron do? Where will they get the money to pay for these future liabilities? Will they freeze the lump-sum payment?
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 more than 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 last year.
Chevron instituting a freeze on the lump-sum offer is a very real possibility and could drastically change your retirement plans. It’s important to speak with a retirement advisor in order to be prepared in the event that the lump sum is unavailable when you leave Chevron.
Sources:
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“Pension Funding Index September 2020.” Milliman | US, https://us.milliman.com/en/insight/pension-funding-index-september-2020 Accessed 16 Oct. 2020.
Bomey, Nathan. “‘It’s Really over’: Corporate Pensions Head for Extinction as Nature of Retirement Plans Changes.” USA Today, 10 Dec. 2019, https://www.usatoday.com/story/money/2019/12/10/corporate-pensions-defined-benefit-mercer-report/2618501001/
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