The past five years have seen a growing trend among sponsors of single-employer defined-benefit plans: They are “de-risking” their pension plans by transferring all or a portion of their pension obligations to a life insurance company through the purchase of a group annuity contract. Thereafter, the life insurance company is responsible for paying retirees’ pension benefits. The arrangement is appealing to plan sponsors because it enables them to reduce the risks of funding their pension obligations in a volatile asset and interest rate market. Recent corporate de-riskers include Lockheed Martin, FedEx, Raytheon, and Alcoa.
But, are there any risks to participants? The short answer is “yes,” but the risks may be minimal. When a company transfers all or some of its pension obligations to a life insurance company, the annuity paid by the life insurance company is the same amount as the pension payable under the pension plan. Moreover, like the pension, the annuity under the insurance contract is payable for the participant’s life.
However, pensions are regulated by federal law, whereas annuities are regulated by state law. Are participants better off under the federal laws? Maybe. Maybe not. Under federal law, if the employer sponsoring the pension plan becomes insolvent, the Pension Benefit Guaranty Corporation (PBGC), a federal agency within the Department of Labor, takes over the plan and pays participants’ pensions, but only up to a maximum statutory amount. For 2020, the PBGC maximum guarantee amount is $5,812.50 if the pension commences at age 65; less if the pension commences earlier (e.g., $2,615.63 at age 55). Of course, if your pension under the plan is less than the PBGC maximum guarantee, the PBGC will pay you only that amount, NOT the PBGC maximum guarantee amount.
Although federal PBGC guarantees are unavailable for annuities payable under a life insurance contract, such annuities DO receive a fair amount of protection under state law. State regulators impose financial standards on insurance companies and require corrective measures when those standards are not met.
Insurance companies are also required to belong to “guaranty associations” in the states where they do business. The associations are funded by assessments levied against their member insurance companies to help pay claims when a member company fails. But, there is a statutory coverage limit on claims under an annuity contract. In most states it is the present value of the annuity benefits up to $250,000, although a few states provide much higher coverage limits. If the present value of the annuity is within the coverage limit of the state where the insurance company does business it is fully protected. If the present value exceeds that coverage limit it is not fully protected. While that is certainly pause for concern, the coverage may be unnecessary because, when an insurance company becomes insolvent, its contracts are often purchased by other insurance companies. When this happens, the annuitant receives the same amount of money, just from a different insurance company. The amount is not limited by any maximum PBGC guarantee.
In short, if you learn that your employer (or former employer) will be transferring its pension obligations to an insurance company, don’t panic. The odds are high you will receive the same amount as if your employer had not chosen to de-risk its pension obligations through the purchase of a group annuity contract.
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