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A significant issue facing many business owners is the impact of underfunded multiemployer pension plans. This is most common, but not exclusive to, unionized businesses. In this episode, Todd Solomon joins Domenic Rinaldi to talk about multiemployer pension plans and addressing the needs of participants. Todd is a partner at McDermott Will & Emery, specializing in matters such as pensions and employee benefits. Don’t miss this episode as Todd and Domenic discuss the proactive steps owners can take to get ahead of future issues regarding pension participants.

Listen to the podcast here:

Multiemployer Pension Plans: Addressing The Issue Of Underfunding With Todd Solomon

A significant issue facing many business owners is the impact of underfunded multiemployer pension plans. This is most common, but not exclusive to unionized businesses. As we all know, many of these multiemployer pension plans might be struggling to maintain sufficient liquidity to address the future needs of the pension participants. This issue can quickly dominate and/or foil a proposed merger or acquisition if there is an outstanding pension liability. Our firm has been involved in a good number of M&A transactions where an unfunded pension liability becomes a significant barrier to an owner being able to walk away from their business.

In this episode, we are being joined by Todd Solomon, who is a Partner at McDermott Will & Emery, and serves as Global Head of the firm’s Employee Benefits and Executive Compensation Practice Group. For many years, Todd has helped organizations maximize the value of and return on their investments in human capital while avoiding exposure to liability. Todd is a fellow of the American College of Employee Benefits Counsel, which recognizes attorneys who have made significant contributions to the advancement of the employee benefits field for years. Todd, welcome to the show. I look forward to discussing the proactive steps owners can take to get ahead of this potential issue, which is not insignificant if they’re in a multiemployer pension plan that’s underfunded.

Thank you, Domenic, for having me on.

Todd, I gave some highlights on you, but can you give us a little bit more about your firm and yourself? We’ll then dive into this issue a bit.

I’ve been with McDermott Will & Emery my entire legal career, straight out of law school. In fact, I was an intern at the firm while I was still in law school. It’s becoming increasingly a dinosaur thing to do, but I’m proud to have a setup shop there in one place and have moved through the ranks. You’re exactly right, there’s a lot of mobility amongst lawyers, although McDermott does a nice job of retaining a lot of people for a long time. It’s been a great place to work. It’s a global law firm with over 1,000 lawyers worldwide with about twenty offices throughout the globe, Europe and spread throughout the US. I’m in the Chicago office, which was our founding office. We’ve got a couple of hundred lawyers in Chicago. I’m in the Employee Benefits and Executive Compensation Practice Group, which is about a 30-person practice group spread throughout the US through Chicago, Washington, DC, New York, Boston and Dallas.

You guys have had a tremendous experience in this area and I’m interested in diving into this because it’s coming up more as Boomers are getting ready to retire. They’re part of these multiemployer pension plans. As it relates to M&A, this issue becomes potentially a significant time bomb. Why don’t we start with at the highest-level explanation about this whole multiemployer pension universe and then the specific issues that you start to see when these pensions are underfunded or maybe trending in that direction.

I’ll start it at somewhat of a basic level and grow into it because we want to make sure, the readers, even if this isn’t something they’ve been exposed to, get what we’re talking about. There are two types of retirement plans in the world. There are defined-contribution plans like savings plans that people know as 401(k) plans and defined-benefit pension plans. The savings plans are not what we’re talking about because these are fully funded. They go up and down with the market. They might grow or decrease if the market is bad, but they’re fully funded. Every dollar in that account belongs to a participant.

The defined-benefit pension plan is different because they provide a defined-benefit at retirement. There’s a mathematical formula that essentially promises a benefit to an employee at retirement, which might be age 65 or earlier, depending on the terms of the plan. It sets a promised benefit and isn’t fully funded on day one so there’s an opportunity for that benefit to be well-funded by the employer along the way. The employer puts in enough money and in some cases, perhaps too much money to fund the benefits. More commonly, the employer tries to fund it along the way, but because of actuarial assumptions and variability of investment market performance, particularly in a down market, it may be that the company is not putting enough into the plan to fund the future benefits. That creates the exact situation you’re talking about, where you have what’s called an underfunded pension plan, which means on an actuarial basis, the liabilities exceed the assets.

Most pension plans in the country are underfunded in some sense. Click To Tweet

Unlike another retirement plan where you might purchase it in M&A and either some administrative costs and some integration to think about, a pension plan can throw a wrinkle in the M&A because it’s significantly more complicated for a buyer to deal with and significantly might weigh down a seller depending on how underfunded it is. A complication that arises that compounds the underfunded pension plan problem is the multiemployer pension problem. A multiemployer plan is a special kind of pension maintained by the union for unionized employees that an important employer contributes to, not just for its own employees, but also for the employees of other employers. You get a pool of companies contributing on behalf of people that are in the same collective bargaining union. The complication is there in addition to the normal underfunded pension problem that you might have under any pension plan.

A multiemployer plan contains a compounded significant extra problem, which is if you ever want to leave one of those plans, either bargain out of it, terminate it or somehow be done with it, you have to pay what’s called withdrawal liability. It is essentially an undivided portion of the underfunding of the entire plan. The way to think about it is a private pension plan. You’re stuck with your own stuff and that could be significant if you’re underfunded on your own stuff. On a multiemployer plan, you’re stuck with not only your own stuff but an undivided portion of everybody else’s stuff. If everybody else is not contributing enough and the fund isn’t doing a good job of investing or getting assets, you could on the way out of one of these things before it contributes on behalf of the other employers in your fund.

There’s so much there to unpack, Todd. As you point out, it’s bad enough if you’ve got your own plan and you’re not doing the job, but you’re tied to every other employer in that plan and it’s out of your control.

Even the investments under such plans are in-large part out of your control because you are a contributing employer. You and the company are contributing employer to the multiemployer plan, but the plan is sponsored by the union, invested by the fiduciary to the plan that isn’t necessarily appointed by you. When you’re in one of these plans and you bargain, in some sense, the positive part about it is you don’t have to maintain it. You don’t have to administer it. You only have to contribute to it. The negative is it is outside of your control. There are bad investments that are underfunding over time that gets compounded year over year. You, the company, are significantly disadvantaged because if you ever want to get out of one of these things, it’s not just about paying your own fair share, you might have to contribute on behalf of the remaining underfunding. The underfunded pension problem, I’ve seen it disrupt M&A many times over the years, but in the multiemployer plan context, it gets even more complicated.

To put some context, is there any accounting of how many multiemployer plans there are in the US and how many of those might be underfunded?

I don’t have the statistics with me on hand, but these are public funds so there are certain public disclosures. You can readily learn information on the funded status of the plan if you know the fund that you’re in or that you or your employees might consider. For example, the Central States Pension Fund, you can google it. You can pull up a page for that plan and find financial information about how many assets the plan has, what are the present value of the liabilities, what the funded status is, and the government, which in the pension world is PBGC the Pension Benefit Guaranty Corporation. It has rules that require pension plans to essentially calculate their annual funding percentage and provide disclosures about that.

In the union context, solely in the multiemployer plan context, there is a fairly rudimentary color scheme that makes sense. When I say it out loud, red, yellow, green. The union plans are rated as being green because they’re well-funded. Yellow is more at risk and then red is more critical. For the published information, I don’t have the numbers off the top on how many funds there are across the country, but are there many local union numbers in each region. There are a number of funds and they’re still rather popular because it’s such a valuable benefit for the union workforce to bargain for.

Could you venture a guess on what percentage might be underfunded? Do you think it could be 50%, 70%, 20%?

 

I think it would be a high number. Keep in mind, most pension plans in the country are underfunded in some sense. Even plans that are “green” might be 85% funded. That pension withdrawal liabilities are hard to manage, particularly in a down economy, like we were in nowadays. Even the well-funded pension plans might be in the low to mid-80% or 90%. Oftentimes, you’ll see a well-funded plan in a small professional services context, like a doctor’s group or a law firm pension plan might be a 100% funded, but the vast majority of plans are underfunded, both private and multiemployer. Where the rubber meets the road is in terms of withdrawal liability and what the exposure is out there. Are we talking about yellow or are red on some of the tougher ones on how chronically underfunded? Some of them are 55% to 60%. They are poorly funded and frankly, in financial distress, that government agency, that PBGC would come in because it guarantees up to certain limits of guarantees pension liabilities in the event and can’t meet those.

To make sure I understand this, the Pension Benefit Guaranty Corporation, they provide uniform standards. Every multiemployer pension group is reporting the same way with the same metrics. You can’t have one group reporting one way and another group reporting another way. They have uniform standards so you can compare apples to apples. Did I get that right?

There are certain actuarial assumptions that have some variability, but in general, that’s right. The PBGC has rules on minimum funding, how much you have to contribute to the plan, how you value, what interest rate assumptions you use, and what amortization period do you use to measure liability. You can get an apple to apple comparison that if we had two plans of exactly the same size and one was 86% funded and one was 82% funded, you’d feel better about the 86%. The variability occurs where two plans can both be 84% funded, but one’s big. It has a lot of employers contributing who had a lot of money left out there on the table.

The other one is tiny with only three employers left because there’s been a race to get out of it and the two other employers left. It might be groups that could withdraw and then you, as the last large employer, might be at risk in an additional way. In other words, it can become a bit of a race to the bottom when these funds have withdrawals and when companies can come up with the money to pay out a settlement and completely withdraw from the funds and bargain out of the plan. For example, you don’t want to be the last employer standing holding the bag because you, as the last employer, you’re the one turning off the lights and paying in the remaining underfunding. The answer is yes, it is apples to apples, but two plans at the same funded percentage may not be created equal if there are different sizes and different demographics.

As an owner of a business in one of these multiemployer plans, am I entitled to receive from that pension plan, my withdrawal liability on an annual basis. Can I get that number from the plan?

Yes. You usually can get that number if you contact the fund. I believe it is a periodic thing. I don’t think you’re entitled to get it every month, but if you want, once a year to get a request for partial or complete withdrawal liability, funds will provide that. There can be some debate over those numbers. That is something to think about that even for companies, people in the group may know what that number is. Based on experience, that number may not be the end of the discussion. There may be actuarial assumptions that went into that number that can be challenged or pressed upon.

There can also be a negotiation because withdrawal liability is generally paid over a twenty-year period of time, but many employers that want to get out of a fund might be willing to pay a lump sum upfront to bargain out of a plan and be done. There is somewhat behind the scenes negotiation between the fund and its actuaries and the plan, it’s lawyers and actuaries to try to negotiate a settlement of withdrawal liability. The answer to your question is yes, you can get that number over time, but thinking about working with advisors on, “What does this number mean? Are we stuck with this number? Is there something else we can do?” is probably the best advice.

I’m going to ask an accounting question and if it’s unfair, let me know and we’ll go forward. Most of the time, when I see clients that have a pension withdrawal liability, they didn’t know what it was. They had no idea what the level at which it was at. They were carrying this liability on their books because they didn’t even know they had it or the extent they had it. They thought the fund was fine and there is no issue, then they go to talk to somebody. All of a sudden, they realized they might have a million-dollar withdrawal liability. Is it your recommendation that people carry that liability on their books or not necessary until they get to the point where they’re going to consider withdrawal?

You can always bargain out of a plan, freeze the benefits, and negotiate for something else. Click To Tweet

It’s a bit unfair that my last accounting was at the University of Michigan in the 1990s. I think you raise a good point that most companies consider their ongoing contribution liability and that’s what’s reflected on their books because they intend that. There is no current intent to withdraw or something like that, but it would be a wise thing to think about doing it if it doesn’t destroy the financials. Maybe that’s why I’ve done more often because it can be a large liability to withdraw them from a plan. Normally, companies think about it the same way. They think about it as, “I have an ongoing contribution liability and annual funding. Minimum funding required contributions to this plan.” They don’t think about what’s beyond that and then they request a withdrawal liability figure because somebody in the company or M&A advisor says, “What are we dealing with here?” They’re shocked to see that there’s this sizable liability because the plans underfunded. It’s not about contributing your annual contributions. You’re withdrawing and you essentially have to make up part of that shortfall in proportion to your participation in the plan on behalf of everybody else who’s left in.

You’re leading me down the path to the follow-up question which is in most M&A transactions, the buyers that we come across unless they also happen to be a union shop with a multiemployer plan and they’re used to it, accustomed to it, and prepared for it, most buyers want that liability gone. In fact, most buyers want at the closing table for the business to withdraw from the union pension. I think by law, they have to replace it with a 401(k) plan or a like plan and then have the owner of the business, the sellers, settle up that liability so they don’t keep on racking up future liabilities. Is all of that accurate?

Yes. The challenge is that everything with the union has to be bargained. It’s not technically a legal requirement that it has to be replaced by a 401(k). It’s more of a practical requirement. “You’re taking away our pension, you can’t do that without bargaining with the union to do that.” If you’re bargaining with the union to take away the pension and replace it with something else, usually it not only has to be a defined-contribution 401(k) plan but oftentimes, it has to be a sweetened defined-contribution 401(k) plan to essentially make people whole for what they’re losing under the pension. That becomes a detailed negotiation and what disrupts things like M&A, which moves fast is that’s a process that moves slow. If you’re lucky, it might take 4, 5 or 6 collective bargaining sessions to negotiate and present something like that. They designed it because you might not already have the replacement defined-contribution formula.

You have to design it and then present it to the union and explain to the union why it’s good for their members. If many are allergic to pension, in general, M&A is allergic to the multiemployer pension if they don’t already have the unions for that reason. Even if you wanted to, you might not be able to get rid of it in time for a transaction because you’ve got a bargain and you’ve got to replace versus a private pension, which has the underfunding problem, but you don’t have to bargain for it. If you want that terminated prior to the closing buyer and demand a seller, do that. Aside from the financial commitments and some of the administration of filing with the government and doing some of the things pension lawyers need to do to do that, it’s easy to close a pension plan as long as you had at least about 45 days’ notice.

Let’s talk about that. I’m the owner of a business. I’m in a multiemployer pension plan, and I’m thinking that I might want to sell my business in the next three years. What would your advice be to that owner as far as getting the ball rolling, what should they do in advance? When should they come to talk to you? What can you do in advance of an actual transaction so when they do decide to go to market, the M&A transaction could move quickly and not be held up by this process? Is that possible?

It is possible. In fact, we’re working on a project like that. It’s a seller that essentially has a variety of union groups participating in multiemployer plans and they come up over time the bargaining agreements. They don’t all expire on the same day. That’s how the union agreements work. They each have an expiration date and some are coming up very soon. Two are expiring in the next four months and then a couple over the next eighteen months and then 1 or 2 more that are even longer-term, but they are taking the opportunity, especially with the two coming up soon. They created a consolidated strategy to go to all their unions to bargain for a replacement. It does take a lot of lead time so your 1 to 3-year example is perfect.

They didn’t get an employer in that situation and they want to market themselves for sale but are concerned about the union pension liability. They started to create a strategy to approach the union. If the bargaining agreement is coming up soon, then that’s easy. Even if it’s not, I’m not the labor relations where we have other lawyers in my firm that do that and I cooperate with. They’ve told me that you can always approach a midterm and start building a bridge to what’s going to come up at the next expiration of the bargaining agreement or even try to bargain for something in between. That can be challenging because if the unions got you under contract on something for X number of years, they’re under no obligation to agree to anything else. In making a consolidated strategy, you have to have a legal counsel. That would be smart.

You’d probably also want a consultant and there are consultants we work within the pension space that help redesign formulas. The lawyers can do that as well, but oftentimes it does become a bit of an actuarial exercise to say, “We’re replacing this formula, what would we replace it with? Who are the winners and who are the losers?” Inevitably, a replacement formula might be better for participants in certain situations. Oftentimes, younger participants can grow their assets in the stock market over a long period of time and also worse for certain groups of participants. Those are the more senior ones who get the benefit of the defined-benefit pension.

 

Todd, to be clear here. If an owner does have that window 1 to 3 years, even to 5 years, they can do the work, but not pull the trigger because if there is a liability, most owners are going to want the proceeds from a sale to fund the liability to walk away. You are suggesting they could do all this work, have it laid out, and then know what it’s going to look like when they do go to market.

That’s exactly right and there’s one interim step that we haven’t talked about, which would cover this situation is when you freeze a plan. You can always bargain out of a plan and freeze the benefits. You bargain and negotiate for something else. You negotiate for a defined-contribution replacement and you stop the pension accruals in their tracks where they are. That requires certain notices and certain steps, but it freezes the liability. If you’re underfunded at that time, you have years to make up the liability, but you don’t withdraw from the plan because you’re still contributing on behalf of active participants frozen group benefits. It’s a step between withdrawing and carrying on.

You could freeze your liability as an interim step.

If the union agrees to that, that’s something to be considered.

What’s the likelihood of that? Do you see that more often than not or is it a tough battle?

It is a tough battle. It depends on the negotiations and the status of what the union is getting as wages or defined-contribution replacement formula, but it is an option.

There’s so much to consider as a business owner if you’re in one of these union plans about what to do. Has the pandemic created potentially a sense of urgency for owners to get ahead of this?

Yes. The thing that I think has surprised some people is how the stock market initially took a giant hit, which has a massive impact on pension funding. If you have underfunded plans and then the market drops, that has a huge impact on pension funding liability. The recovery that happened in May 2020 was more positive than certain people were expecting. I think the COVID situation affected these discussions in a couple of ways. One is the funding and the investment performance and the volatility in the markets, which makes pension more undesirable that it’s a desirable benefit to provide employees. It’s a tough benefit to provide employees when you’re not sure you’re going to beat money in the stock market and be able to close that funding gap.

Government pension plans are the backstop for better or for worse. Click To Tweet

The second thing is with the number of layoffs, furloughs, and movements in the workforce that can disrupt withdrawal liability. We’ve been talking mostly about complete withdrawal liability when you try to get out of a fund entirely, but there’s also something called partial withdrawal liability. That is if you diminish your workforce and contribution units as it’s called by a set percentage and you cross that percentage and don’t have as much headcount because you’ve furloughed employees and you want to use them and you’re not contributing to the pension for them, you might trigger a partial withdrawal. That requires payment into the fund to partially make up your underfunding. I had a partial withdrawal question probably in years. Since March 12th, 2020 or whenever we went out of our office for COVID, I’ve had 3 or 4 of them.

That brings up an interesting question with workers getting furloughed. I think about when unemployment rates are going up, I would assume that the number of union workers is probably on the decline as more people pull out of these funds. Does that natural trend create double jeopardy for the people who remain in the funds potentially?

It does because the last one holding the bag kind of problem, that as participation in the funds diminish, whether it’s union groups with solving or participation waning from terminated or furloughed workers, it does create higher anxiety for the ones left in there. Ultimately, if there’s a funding delta and as people withdraw, they’re only making up a part of that. In some cases, they even get favorable settlements when they negotiate out or have withdrawal because the funds need money. It can place a significant burden on the last few employers remaining in the plan. In my experience counseling companies, they do get anxious when multiemployer funds plans are dwindling in there and their membership is dropping because they’re afraid they’re going to get stuck with the remaining liability.

I want to go back to this Pension Benefit Guaranty Corporation. Is it what it means? Are they a backstop to the underfunding potentially that’s out there? I hear that in Illinois alone, our shortfall in these pensions is $270 billion. I don’t know if that number is right or not, but would they be a backstop to that $270 billion shortfalls?

In general, the answer is yes as to pension plans, but government pension plans are different. Government pension plans like the states are the backstop for better or for worse. PBGC governs plans that are governed by a RESA, which is the federal benefits law statute. Government plans are not typically covered by RESA so that example, I don’t think the PBGC would step in there, but PBGC is essentially an insurance government agency that the plans pay in premiums. That’s how the PBGC gets its money was per participant premium or certain other types of calculation of variable premiums where plans covered by the PBGC pay in. If the plan goes belly up and the sponsor of the plan can’t fund it, the PBGC funds it up to guaranteed levels, which is not dollar for dollar, especially for higher paid or larger benefit participants. The problem or the thing that also gives a lot of people headaches is the PBGC is not particularly well-funded and is in significantly difficult financial condition. It’s like having homeowners insurance from the company that you’re not sure if they’re going to be around.

Is PBGC in the green, the yellow or the red? It sounds like they’re teetering between yellow and red.

I don’t know the exact financial condition, but there’s a lot written about the funding of the PBGC and whether there is sufficient fund for all the underfunded pension plans, particularly the union plans. Those are in the worst position.

Todd, I feel like we’re only scratching the surface here. I feel like there’s so much more we could dive into. I’m going to give you the opportunity to provide any high-level closing points or advice that you would give to business owners who are in multiemployer pension plans, things that they should be thinking about maybe considering doing.

 

The primary thing we’ve touched on this is the withdrawal liability calculations. When you see plan sponsors, they got that letter and they’re shocked by it. Don’t be flat-footed requesting a withdrawal liability calculation from a fund to get your sense of what the liability might be out there. It does not trigger a series of problems. It can create some questions from the union and some things you might have to deal with, but it’s not by itself a strange thing to do. Being proactive about what are my liabilities and how can I stay ahead of it instead of having a situation where I’m under the gun and I’ve got to fix this barely giant problem. In months, it would be great to think out over the years and work with advisors about how can we affect the problem and what can we do to address it in a way that is a win-win for both us and the union.

You’re never going to get to yes on any of these negotiations without putting something in front of a union that satisfies it and its members, which can be done. There are a lot of attractive defined-contribution replacement formulas out there that if well-thought-out and well-presented to the union, can get you to resolution. That would be my primary advice is don’t wait for there to be a problem to look at this and talk to advisors about it. Try to stay ahead of the curve and get as much information from the fund. Information is power. Even if it’s a bad withdrawal liability number and it’s higher than you imagined, at least you know about it going in and you can do something about it.

Todd, this has been tremendous. I appreciate all the information. I know you live and breathe this stuff. You’re an expert in this area. A lot of people and business owners are going to be faced with this issue as they look to exit their businesses. If people in the M&A Unplugged Community want to get in touch with you, how could they best reach you?

I’m on our webpage, MWE.com. My email is probably the easiest place to reach me, [email protected]. Anybody’s welcome to phone me directly at (312) 984-7513.

Todd, thanks again. I appreciate you being here.

Thanks, Dom. I appreciate the time.

M&A Unplugged Community, I’ll put a bow on this because Todd put it well in his closing remarks. Our firm has been involved in a good number of transactions where our clients were part of a union pension plan. They were surprised by the liability number. In some cases needed to get out, they were stuck. If they had researched this, done their homework, and gotten in touch with somebody like Todd early on, they could have been ahead of the curve and the outcome probably could have been better. If you’re in one of these plans, don’t wait for the last minute to get in touch with Todd or somebody like Todd and get the proper representation and information so you can move forward with your M&A transaction with peace of mind. If you would like to learn more about the process of acquiring or selling a business, please visit our website at SunAcquisitions.com or feel free to reach out to me at [email protected]. I look forward to seeing you again on the next episode and until then, please remember that scaling, acquiring or selling a business takes time, preparation, and the proper knowledge.

Important Links:

• McDermott Will & Emery
• American College of Employee Benefits Counsel
• Central States Pension Fund
• Pension Benefit Guaranty Corporation
• MWE.com
• [email protected]
• SunAcquisitions.com
• [email protected]

About Todd Solomon

Todd Solomon is a partner at McDermott Will & Emery and serves as global head of the Firm’s Employee Benefits & Executive Compensation Practice Group.Todd focuses his practice on designing, amending and administering pension, profit sharing, 401(k), employee stock ownership and 403(b) plans, as well as non-qualified deferred compensation arrangements. He also counsels privately and publicly held corporations and tax-exempt entities regarding fiduciary issues under the Employee Retirement Income Security Act (ERISA), employee benefits issues involved in corporate transactions, executive compensation matters and the implementation of benefit programs for domestic partners of employees. For more than 20 years, Todd has helped organizations maximize the value of and return on their investments in human capital while avoiding exposure to liability. Todd is a fellow of the American College of Employee Benefits Counsel, which recognizes attorneys who have made significant contributions to the advancement of the employee benefits field for at least twenty years. He is also ranked among the nations’ leading employee benefits and executive compensation lawyers by Chambers USA and The Legal 500 United States.

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