Certain companies still sponsoring defined-benefit plans seek to shed their pension obligations and ERISA responsibilities by purchasing annuities from private insurers who then take responsibility for paying monthly benefits. In addition some participants—including deferred, terminated vested participants and retirees already collecting their pensions—are being offered lump sums in exchange for their future pension benefits. The industry refers to these strategies as “de-risking.” These actions in fact transfer plan risks to plan participants without going through standard, more participant-protective and more costly plan termination procedures.
In general, when plans transfer risk to insurers and individuals, the workers and retirees cease to be participants in the pension plan, ERISA ceases to govern the benefits, and the PBGC no longer insures the benefits. The plan’s workers and retirees lose these protections and, among other consequences, could bear the risk of reduced benefits in the event that the annuity provider fails.
Lump-sum buyout offers, especially to retirees in pay status, cause the greatest concern to AARP because they could tempt participants to accept a smaller and less secure form of payment that may expose them to a multitude of risks, such as running out of money, losing out on subsidized benefits like early retirement, and being subject to undue pressure from family members who may want access to those funds.
In particular, understanding how to compare the value of an immediate lump-sum payment to the value and security of a guaranteed lifetime stream of regular payments requires a high level of financial literacy. Participants may be tempted to accept the seemingly large sum today and not realize that the total amount of those lifetime payments may be far greater than the offered lump sum. They also may fail to realize that they are also losing the security of guaranteed lifetime payments.
Defined-Benefit Plan Risk Transfer: Policy
DOL should establish clear rules requiring defined-benefit plan fiduciaries who wish to transfer their pension annuities to private insurance companies to observe their safest annuity obligations, require contracts with insurance annuity providers to contain provisions that replicate ERISA protections to the extent possible, and require the insurer to keep accounts separate and to purchase reinsurance sufficient to cover any losses not potentially covered by state insurance guaranty associations.
Advice and disclosures
Plans that wish to offer lump-sum buyouts should be required to provide clear and complete disclosures, in hard-copy form, regarding:
- the pros and cons of accepting a lump sum,
- the comparative value of a lump sum versus annuity benefits,
- the fact and amount of any loss of early retirement subsidies or other related benefits,
- the loss of spousal pension rights,
- any tax consequences, and
- the loss of PBGC insurance protections.
To assist in the decision-making, plans should be required to make independent, nonconflicted, objective advice available both in written form and in the form of personal counseling.
Plans should also be required to implement protections to prevent undue pressure being placed upon those offered the buyouts.
When retirement plans transfer risk from the plan to others, either by purchasing annuities from private insurers that take responsibility for paying monthly benefits or by offering retirees currently receiving benefits lump-sum buyouts, plan fiduciaries should be required to keep the surviving pension plan funded to at least substantially the same level as it was prior to the changes.