Pension Risk Transfers Increase with Rising Interest Rates
By Mark Johnson, Ph.D., J.D.
U.S. employers who sponsor ERISA-qualified pension plans continue to use a technique called “pension risk transfer” to shift responsibility for their retiree’s pension payments to insurance companies.
A recent Wall Street Journalarticle drew attention to this trend with an in-depth front page storytitled, “Your Pension Check May Soon Be Coming From an Insurance Company.”
We recently wrote about this trend in an October 2016 post titled, “Pension Risk Transfers and Annuity Payout Trends.”
The increasingly popular technique allows employers to limit their pension liabilities, while insurance companies get to expand into a new area of potential growth.
Some retirees are happy to see their benefits passed to insurance companies that have more experience in longevity calculations and claims processing. Other pension plan participants may become anxious when the task of issuing a monthly benefit check is passed to a third-party.
Employers that seek to transfer pension risk frequently go to well-known insurers like Prudential, Metlife, and the British insurer Legal & General Group plc.
Prudential, which has been in the business of pension risk transfer since 2006, is currently the leading insurance company to purchase employer pensions in the U.S. Prudential has assumed the pension obligations of 320,000 retirees totaling almost $45 billion dollars over the course of ten separate deals, according to the Wall Street Journal report, and expects a return on investment of 12% to 13% for this business.
Overall, Prudential claims to work with almost 5,000 pension-related clients, and provides retirement services for approximately 1.8 million people.
As the Federal Reserve Board pursues its plan to raise rates three times in 2017, with an additional three increases each in 2018 and 2019, many employers are looking to transfer pension risk to insurance companies.
When interest rates increase, the higher market rates make it less expensive for employers to transfer their pension obligation to an insurance company. Since the passage of the Pension Protection Act in 2006, pensions are increasingly treated as long term liabilities that need to be tightly funded and accounted for on a short-term basis. Pension plan sponsors that transfer obligations to an insurer seek in part to free themselves of detailed accounting and reporting requirements.
Recent premium increases by the Pension Benefit Guaranty Corp. (PBGC) may be another reason behind the push for pension risk transfers.
Employers seeking to offload their pension responsibilities to an insurer like Prudential are required to hand over significant assets and bonds, as the insurance company will not assume pension risk unless the plan is fully funded.
To fully fund the deal, employers may be required to offer a mix of assets, although bonds are preferred by the insurance companies. Prudential then uses the interest earned on those bonds to pay the retiree’s monthly checks.
In some instances, Prudential has traded those bonds for higher-yielding loans in order to gain a larger profit margin. However, Prudential may need to dip into these profits or other financial resources if the retirees live longer than the insurance company had predicted when the deal was signed. Conversely, Prudential will have higher profits if the retirees do not live as long as originally expected.
These potential profits are also attracting smaller insurance companies to pool together their capital with the hopes of making an offer that is more likely to be accepted by the employers.
Insurance companies use employer-provided demographic data on retirees to estimate future required pension payments. State insurance commissions, which oversee insurers, are increasingly enacting regulations that ensure the insurance companies have enough capital to cover the retirees’ monthly payments. These capital cushions are usually about 5% to 10% of the total risk transferred.
These pension-risk transfers have not been without legal challenge. A group of Verizon retirees sued the company, since their pensions were no longer protected by the Pension Benefit Guaranty Corp. Because these state guidelines have different levels of protections than their plan previously offered under federal law, some retirees are seeking additional compensation. The lower court ruled against those retirees, but the case may soon be reviewed by the Supreme Court.
ABOUT THE AUTHOR: Mark Johnson, J.D., Ph.D. Mark Johnson, Ph.D., J.D., is a highly experienced ERISA expert. As a former ERISA Plan Managing Director and plan fiduciary for a Fortune 500 company, Dr. Johnson has practical knowledge of plan documents as well as an in-depth understanding of ERISA obligations. He works as an expert consultant and witness on 401(k), ESOP and pension fiduciary liability; retiree medical benefit coverage; third party administrator disputes; individual benefit claims; pension benefits in bankruptcy; long term disability benefits; and cash conversion balances.
ERISA Benefits Consulting, Inc. by Mark Johnson provides benefit consulting and advisory services and does not engage in the practice of law.
© ERISA Benefits Consulting, Inc.
Contact ERISA Expert Dr. Mark Johnson
You can reach Dr. Johnson via email or by phone at 817-909-0778. He is available to confidentially discuss a benefits matter.
Click on the link to read about his representative ERISA cases.