Some companies sponsoring defined-benefit plans seek to shed their pension obligations and Employee Retirement Income Security Act (ERISA) responsibilities by purchasing annuities from private insurers who then take responsibility for paying monthly benefits. In addition, some companies offer participants—including deferred, terminated vested participants and retirees already collecting their pensions—lump sums in exchange for their future pension benefits. The industry refers to these strategies as de-risking. These actions, in fact, transfer the risks of the plan to participants in the plan 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 Pension Benefit Guaranty Corporation 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.
Furthermore, participants face the challenging task of discerning the relative value of and risks associated with a lump sum versus a lifetime stream of monthly payments. For example, participants may not know how to compare the value of a lump sum to the value of a lifetime of payments. 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 to those funds.
DEFINED-BENEFIT PLAN RISK TRANSFER: Policy
The Department of Labor should establish clear rules regarding participant protections for defined-benefit plan fiduciaries who wish to transfer their pension annuities to private insurance companies. These rules should require plan fiduciaries 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 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 PBGC insurance protections.
Policymakers should require plans offering lump-sum buyouts to make independent, nonconflicted, objective advice available both in written form and in the form of personal counseling and 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.