AARP Hearing Center
Background
Some companies sponsoring defined benefit plans purchase annuities from private insurers. These insurers then take responsibility for paying monthly benefits. Doing so allows employers to shed their pension obligations and Employee Retirement Income Security Act (ERISA) responsibilities. In addition, some companies offer lump sums to participants (including deferred, terminated vested participants, and retirees already collecting their pensions) in exchange for their future pension benefits. The industry refers to these strategies as pension risk transfers or de-risking.
These actions do not eliminate risk. They transfer the risks of the plan to participants in the plan. And they do so without employers needing to go through standard, more participant-protective, and more costly plan termination procedures. For example, for lump sum exchanges, participants are required to figure out the relative risk and value of a lump sum versus a lifetime stream of monthly payments. This is a challenging task. Accepting a lump-sum buyout exposes participants to the risk of outliving their assets. Finally, participants may have to withstand undue pressure from family members who may want the participant to take a lump-sum payment so that they can access those funds.
In general, when plans transfer risk to insurers and individuals, the workers and retirees cease to be participants in the pension plan. As a result, ERISA no longer governs the benefits, and workers and retirees lose its protections. In addition, the Pension Benefit Guaranty Corporation no longer insures the benefits. Among other consequences, the plan’s workers could bear the risk of reduced benefits in the event that the annuity provider defaults. Concerns about defaults are growing as annuity providers owned or controlled by private equity firms are playing a larger role in pension risk transfers. These types of providers are sometimes more willing than traditional annuity providers to make high-risk, high-return investments. In addition, they often move their liabilities to less regulated offshore reinsurance companies that are also private equity owned. Reinsurers essentially provide insurance for insurance companies by taking their risks and managing them separately.
There are some protections in place for workers. Companies have a fiduciary duty to choose the safest annuity provider in a pension risk transfer. The U.S. Department of Labor lays out the steps companies need to take and factors they should consider to ensure this choice is made. However, many believe this guidance is not adequate, particularly given changes in the annuity market. In addition, each state has a system in place to deal with potential insurance defaults. However, there is concern that these systems will not be able to handle significant or multiple defaults. Moreover, there is no federal system in place that could help the states if there is a systemic issue.
DEFINED BENEFIT PLAN RISK TRANSFER: Policy
DEFINED BENEFIT PLAN RISK TRANSFER: Policy
Protections for participants
The Department of Labor should establish clear protections for participants in defined-benefit plans when fiduciaries wish to transfer their pension annuities to private insurance companies. These rules should require contracts with insurance annuity providers to contain provisions that replicate Employment Retirement Income Security Act protections to the extent possible. In addition, they should require the insurer to keep accounts separate and to purchase reinsurance sufficient to cover any losses not potentially covered by state insurance guaranty associations. There also should be an effective insurer of last resort, such as federal backup insurance. This would protect participants if multiple insurance and reinsurance companies were unable to fulfill their obligations due to a financial crisis or other widespread issues.
The requirement that fiduciaries take steps to obtain the safest annuity available must be strengthened and strictly enforced.
Advice and disclosures
Plans that wish to offer lump-sum buyouts should be required to provide clear and complete disclosures. These should be in hard-copy form and state the implications of choosing a lump sum. The disclosures should include the following information:
- 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 Pension Benefit Guaranty Corporation insurance protections.
Policymakers should require plans offering lump-sum buyouts to make independent, nonconflicted, objective advice available to plan participants. This information should be both in written form and in the form of personal counseling. Plans should be required to implement protections to prevent undue pressure being placed upon those offered the buyouts.
Funding level
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.