Perhaps you’re a member of a mergers and acquisitions (M&A) team and your company is considering an acquisition. What if you’re not a pension expert? What if, during due diligence, you discover that the company you are considering acquiring has one or more DB pension plans or other long-term obligations such as retiree health benefits? How do you adjust your bid? What factors require consideration? And, do you have a strategy to manage the ongoing pension risk after the deal closes?
These are leading questions, of course. To begin answering them, the buyer needs to develop a clear vision of which obligations it will take on in the acquisition, the expected financial costs of these obligations and managing those costs after the deal closes.
Integration planning
Developing an integration plan during due diligence is critical. It forms the basis for determining an estimate of the initial financial position and the ongoing cash and accounting costs of the assumed obligations, as well as the associated risks.
Many private sector organizations have adopted a DC philosophy for providing retirement benefits to their employees. As such, if the context of the acquisition permits, the preferred approach is to move the acquired employees into a DC plan and leave the DB pension plan and other obligations with the seller. To mitigate the constructive dismissal risk, the buyer may need to provide a temporary enhancement to the DC benefits—or some other form of compensation—if there is a gap in the benefit value between the DC plan that the acquired employees will join and the seller’s pension plan.
If the business context of the deal requires the DB plan to be included in the transaction, the implications can be challenging—especially for buyers not familiar with managing these plans. The buyer needs to understand a number of factors to develop a successful integration plan, including the following:
- What will the pension benefit strategy be after closing? Is the benefit subject to collective bargaining and, if so, how is it likely to change as a result of future negotiations?
- Will the workforce integration plan have an impact on the DB pension costs? How is the current and future financial position of the plan affected if some employees are terminated?
- How will the future risks of the pension plan be managed, and what is the buyer’s level of risk tolerance? If the DB plan is frozen or can be frozen (i.e., no future pension accruals), then a near-term strategy may be to remove the burden of managing the plan by terminating it.
Determining the financial position of any DB plans included in a transaction is important as buyers should seek a price adjustment for assuming any deficits at closing. However, it is becoming increasingly common for discussions during due diligence to also focus on assessing the ongoing plan risks and determining how they will be managed.
Managing risk requires a strategy
Buyers who do not feel comfortable with the pension risk they’re assuming should have a plan in place to manage the risk after the deal closes. One approach would be to terminate the plan—although this is not always possible. Another approach that is gaining momentum is dynamic de-risking.
A dynamic de-risking strategy provides plan sponsors with a framework to define their target risk end state, along with a road map to get there. For example, as the financial position of the plan improves over time, the allocation to hedging assets can be increased to better match assets and liabilities. One key aspect of a de-risking strategy is that it requires the ability to react to market conditions as opportunities present themselves.
The buyer must understand the risks being taken on in a transaction and be ready with a plan for how to manage these risks after the deal closes. Depending on the strategy adopted by the buyer, the financials provided by the seller may or may not be relevant to the costs that the buyer may experience post-closing. Developing the integration plan and evaluating the risks and costs as expected under this plan will best support the ultimate success of a transaction.
De-risking of the DB pension to mitigate ongoing financial exposure requires a sophisticated knowledge of the plan’s assets and liabilities, as well as an integrated approach to risk reduction and plan management.
There are many factors that determine why some M&A transactions succeed and why others fail. All too often the post-closing, or implementation, phase of the transaction is overlooked or given only cursory consideration. Human capital issues, cultural differences between the two organizations and the integration of people, policies and programs can cause delays in achieving the financial benefits of the deal. Adopting an inclusive strategy to address the management of ongoing operational and liability issues and pricing this into the implementation cost of the transaction are strongly recommended.
Just as not all companies are the same, not all M&A deals (or pension issues) are the same. The need to assess and address risks, as well as deficits, can be paramount in determining whether a proposed merger or acquisition will achieve the business objectives and the financial targets established for success.
Doug Johnson, partner, and Bart Hermans, M&A leader, Mercer