August 10, 2015

Rising costs usher in pension ‘de-risking’ cycle

PHOTO | Lisa S.; shutterstock.com
PHOTO | Lisa S.; shutterstock.com

Many Connecticut workers probably think of a pension as something their parents had, or something they'll never get.

Indeed, as companies have frozen or curtailed their pensions or "defined-benefit" plans, the number of Connecticut private-sector workers and retirees with a single-employer pension (519,000) has plummeted 42 percent over the last decade, federal data shows.

Though the ongoing shift from the guaranteed lifetime income of pensions to the more stock market-reliant 401k has saved companies copious sums, their financial risk from legacy pension programs isn't gone. Connecticut-based companies still have nearly 1.4 million active participants in their pension plans, federal records show, and with plan participants living longer, and other factors increasing plan costs, those liabilities are weighing more heavily on companies' balance sheets.

It's a trend causing many businesses — even those with healthy pension plans — to re-think whether keeping ownership of those liabilities is still worth it, experts say.

"I think now, most private companies don't really want to have the risk of a defined-benefit plan," said Michael Ericson, an analyst at worldwide insurance association LIMRA, which is headquartered in Windsor. "They realize 'this is a lot more dangerous than we thought.'"

Several factors are driving the latest round of pension cost increases for plan sponsors:

• The Society of Actuaries published new mortality tables last year that assume longer life expectancies for both men and women.

• The Pension Benefit Guaranty Corp. (PBGC), which acts as an insolvency backstop for most U.S. private pensions, has increased its premiums from $31 per participant to $57 since 2007 — the result of several large pension insolvencies that have fueled a growing budget deficit at the federal agency. Underfunded plans also face steep variable-rate premiums this year of as much as $418 per head.

• And because pension plans invest their assets in stocks and other securities with the aim of generating returns to pay future liabilities, big market drops like the one that marked the 2008-2009 U.S. recession still pose problems.

"Rising costs are common and it's why a lot of these companies are looking at de-risking strategies," said Shaun Sheridan, a CPA and audit manager at Hartford accounting firm Whittlesey & Hadley, who helps companies with pension compliance and planning.

Reserved mainly for well-funded plans, de-risking strategies — which have their critics — can include offering lump-sum cash payouts to plan participants or paying an insurer to take on the future liabilities and unknowns.

Prior to the 2008 crash, Sheridan said he worked with a corporate client that had a 90-percent funded pension plan and was hoping to unload it through a lump-sum buyout.

"They waited and sat on it and they took a 60 percent hit on their investments," he said. "That moved a $2 million buyout to a $10 million buyout, which was unfeasible."

It may soon be more difficult for companies to make lump-sum offers.

The Internal Revenue Service indicated in June that it would forbid companies from making lump-sum offers to pension plan retirees who are already receiving monthly distributions.

Retiree advocates have criticized the offers, arguing retirees may not be adequately equipped to invest the sum proficiently and make it last a lifetime.

Jumbo deals increase focus on annuities

Though more complex than lump-sum offers, group annuities contracts have become an increasingly popular way for corporate pension plans to unload risk, according to LIMRA, which has tracked the pension risk-transfer market since the 1980s.

Under such contracts, a corporate plan sponsor pays a one-time premium to an insurance company, which then becomes responsible for payments to plan participants.

Ericson said the contracts are typically only feasible for a company with a fully funded pension plan, and that the one-time premium usually ranges from 5 percent to 10 percent of total liabilities.

Prudential, MassMutual and MetLife are three insurers with Connecticut operations who offer such contracts.

Last year, pension annuity contracts brought insurers $8.5 billion in revenue, up from $3.8 billion in 2013, according to LIMRA. Several jumbo deals in 2012 involving General Motors and Verizon set an annual record of $35.9 billion.

Ericson said that most annuity transactions he tracks through an annual survey of insurers involve plans with assets of $250 million and under. Many Connecticut hospitals' pension plans could fit into that category, as could hundreds of other in-state plans.

Ericson's survey does not disclose the identities of pension plans that buy annuity contracts, nor does it collect state-level data. So it's unclear to what extent Connecticut companies are purchasing those contracts. But it's likely there are some, given there were 277 pension buyouts in the U.S. last year and 217 in 2013, Ericson said.

In any case, insurers hope the market grows further. A Prudential report last year found that 25 percent of the 56 executives surveyed were considering moving their pension plan to a third-party insurer in 2015. More than three-quarters said interest-rate movements, which impact plans' funded status and investment returns, would affect their decisions.

CT adds some protection for annuitants

One of the knocks from retiree advocates against annuity contracts is that when a pension plan transfers its obligations to an insurance company, participants in the plan are no longer protected by the PBGC.

Instead, protection falls to state guaranty organizations, like the Connecticut Life and Health Insurance Guaranty Association, which are funded by charging licensed insurers premium assessments.

Connecticut's guaranty association insures lifetime benefits up to $500,000. That is among the nation's highest limits, but the AARP and Washington, D.C.'s Pension Rights Center have said even that amount would fall short of protections guaranteed under PBGC, which promises $60,000 per year for a 65-year-old until he/she dies. Those advocates have also questioned whether the state guaranty system could pay obligations in the event of a major financial crisis.

Connecticut legislators have sought in recent years to study pension annuities and require more insurer disclosures about them and lump-sum distributions.

But insurers have successfully fended off legislation, arguing that pension annuities are a long-standing product with enough legal oversight that requires insurers to maintain a significant capital cushion.

Peter Gallanis, president of the National Organization of Life & Health Insurance Guaranty Associations (NOLHGA), said the view of some that the state guaranty system could be vulnerable is flawed. Far more corporate pension plans than insurers failed during the 2008 financial crisis, he said, though several insurers received federal bailouts.

"The likelihood of a defined-benefit pension plan failing is much higher than the likelihood of an annuity company failing," Gallanis said.

Though it could take a financial crisis worse than the recent recession to truly test the system, Connecticut lawmakers are still being proactive.

With industry support, lawmakers this year passed a provision that protects pension annuity customer's income streams from creditors.

It brings the state in line with a protection already offered by the PBGC.

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