Pension De-risking and Risk Transfer, Demystified
- Pension de-risking and risk transfer means that the monthly retirement benefit from one’s defined benefit pension plan has technically become a monthly annuity benefit from an insurance company for the same amount
- In some cases, the insurance company may be more financially sound than the employer, making pensioners better off
- Pensioners, however, should investigate the creditworthiness of the insurance company issuing their annuity, as well as the guaranty fund policies in their state
For many people the idea of pension de-risking and risk transfer sounds ominous, especially when used in the context of companies trying to reduce their pension liabilities. Because most of the resources out there on this topic are consulting and advisory firms offering these services to employers, we wanted to provide resources to help workers understand the impact that pension de-risking could have on their retirement savings. While pension de-risking and risk transfers are highly complex transactions from a corporate finance perspective, they are relatively simple to understand from the consumer one.
In a pension risk transfer or de-risking arrangement, the employer who sponsors the defined benefit plan pays an insurance company to assume the monthly payments of the defined benefit pension plan. The pension plan recipients shift from receiving their monthly income directly from the employer’s pension plan to receiving the same monthly income from the insurance company (in the form of an annuity). In addition, certain customer service and administrative functions are often shifted to the insurer.
At the point of the transfer, some employees may be offered a one-time lump-sum payment in lieu of a monthly annuity. Deciding whether or not you should take a lump-sum distribution is dependent on a multitude of factors, including your health, risk tolerance, alternative sources of retirement income, and bequest motives, among others.
If you elect to continue receiving monthly income, shifting payments from the defined benefit pension plan to a reputable insurer will theoretically have little tangible impact on your financial security. Though the size of the promised monthly payments are expected to remain the same, the creditworthiness, or guarantee, that the insurance company can make promised monthly payments may be different than the financial soundness of the corporate pension plan. Given the widespread underfunding of private sector defined benefit plans, transitioning retirement income to a highly-rated, creditworthy insurance company may benefit the pensioner by reducing the risk of not receiving their earned retirement benefit. Individuals should check on the funded status of their defined benefit retirement plan and credit rating of annuity provider.
Both defined benefit pension plans and annuity providers have consumer backstops to protect pensioners and annuity policyholders in the event that a corporate pension plan or insurance provider goes bankrupt (learn more here). Private sector pension plans are insured by the Pension Benefit Guaranty Corporation (PBGC), and insurance providers are insured by state guaranty associations (learn more here).
In most cases, pension de-risking and risk transfers have no effect on the end consumer as their retirement income is unaffected by the shift in ownership of the pension. It’s only in the worst-case scenarios, where either an employer or an insurance company experience financial strain, that the ownership can impact someone’s pension benefit. People should be mindful of the creditworthiness of the insurance company assuming responsibility, as well as the policies of the state guaranty fund that backs the insurer in the event that the provider is unable to meet obligations. These risks may, or may not, be more favorable than the funded status of their corporate pension plan and adequacy of PBGC coverage.
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