As Insurance Spikes, U.S. Corporate Pensions Aim to Transfer Risk
The prospect of higher Pension Benefit Guaranty Corp. premiums has plan sponsors weighing options like annuities and lump-sum payouts.
Retirement plan sponsors are no strangers to new costs, but one expense is rapidly moving up their list of concerns. As many as two thirds of U.S. corporate pensions may change their plan policies in response to recent insurance rate hikes, according to a recent client poll by NEPC, a Boston-based independent investment consultant.
The Bipartisan Budget Act of 2015 will raise Pension Benefit Guaranty Corp. premiums significantly, boosting the federal agency’s annual fixed rates from $64 to $80 per participant by 2019. The extra fees will add up: With plan sponsors struggling to meet funding goals thanks to low interest rates and tepid economic growth, the PBGC is projected to gather an additional $4 billion through 2025 off the latest hikes.
For pension sponsors, possible changes to offset these costs include higher contributions (32 percent of respondents to the NEPC poll), lump-sum payouts to shift people off a plan (32 percent) and risk transfers to insurance annuities to shrink the number of pensioners in a plan (17 percent).
“This is essentially another nail in the coffin for defined benefit plans,” says Brad Smith, a partner at the Atlanta office of NEPC, whose corporate retirement group advises 107 clients with a total of some $240 billion in assets under administration. Smith expects risk transfer strategies to multiply as more defined benefit pensions close to new participants and it grows more expensive for sponsors to support pensioners in those plans.
PBGC premiums didn’t use to factor much into the cost considerations of plan sponsors, but those fees have risen dramatically in recent years. The PBGC was created in 1974 as a government-backed insurer that draws on premium payments to cover promised benefits if an employer fails. The rate for sponsors is based on the total number of people on pension plans and the overall liability that would have to be paid out in the event of failure.
Since 1980 insurance premiums have been included in the federal budgeting process as government revenue, so Washington gets to double count this money. The payments go directly to the PBGC and sit in a fund for future claims, but the government now treats them as revenue too. As a result, premium hikes routinely show up in budget packages as a revenue offset for spending items like transportation or infrastructure; they’ve increased in size as spending has tightened over the past decade.
There may be relief in sight, at least for one subset of corporate pensions. In President Barack Obama’s budget proposal for 2017, released in February, the White House recommended for the first time that premiums on single-employer plans stay where they are or risk becoming counterproductive. But Congress would have to approve such a measure; until then plan sponsors must assume that more rate hikes lie ahead, prompting them to consider ideas like risk transfers to cut down on premiums.
“Now that many of these defined benefit plans are frozen or closed, there is a push to shrink the pool of pensioners because of the participant premiums,” explains Alan Glickstein, a Dallas-based senior retirement consultant for Willis Towers Watson, a global investment consulting firm. Glickstein says plan sponsors he’s spoken to are looking at more ways to transfer liabilities.
Last December the PBGC released its first study of risk transfer events at pension plans: Of the 3,600 plans included in the survey, more than 500 reported risk transfers during the 2009–’13 survey period. Those moves meant that more than 1 million retirees lost their pension benefits and either got a lump sum payment or were moved onto an insurance annuity. That number is likely to increase with the latest round of premium hikes.
What happens when defined benefit pension plans transfer risk? In the best case, pensioners are put into an insurance annuity that behaves like a pension benefit by providing a steady monthly income. With a lump-sum payment, retirees must find their own options for how to manage that money, often with no clear path toward a steady income. Individuals can choose to go into a 401(k) plan or work with a financial adviser, but these solutions are often at the mercy of market movements and personal discipline.
“The financial crisis of 2008 showed us some of the weakness of having everyone rely on a 401(k) when those balances can literally disappear in one day,” Glickstein says. “Historically, 401(k)s were considered supplemental savings. Now they are being treated as a core option, but all they really do is serve as a vehicle for capital accumulation, not a lifetime income.”
Worries over premiums and liabilities are also driving small businesses to consider cash balance plans instead of a defined benefit plan or a 401(k). Cash balance plans behave somewhat like a traditional defined benefit pension by promising employees a certain return on contributions while also giving employers more options about how they handle those who change jobs.
“One of the big costs for defined benefit plans are people who haven’t retired but are fully vested and no longer work at the employer-sponsor,” explains Meghan Elwell, director of strategy development at Sage Advisory, an Austin, Texas–based asset manager that specializes in cash balance plans. “With a cash balance plan, if someone leaves, the employer can fully end that relationship and just give them the balance of their account, which reduces the long-term liability.”
No matter what option plan sponsors pick, don’t expect a resurgence in defined benefit plans anytime soon. In real terms, this means greater retirement insecurity for individuals. “The irony of this may be that the PBGC by raising premiums ends up with less money to draw from to pay for future claims,” says Glickstein of Willis Towers Watson. •