Risks for Pension Risk Transfers

Welcome to the Retirement Learning Center’s (RLC’s) Case of the Week. Our ERISA consultants regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, Social Security and Medicare. This is where we highlight the most relevant topics affecting your business. A recent call with a financial advisor in Minnesota is representative of a common question on recent trends in plan related litigation.

“I’ve noticed that there have been several pension risk transfer (PRT) cases filed over the last year. What do plan sponsors need to be aware of with this new litigation trend?”

Highlights of the discussion

Move over excessive fees and forfeitures, plaintiffs’ attorneys have a new target – PRTs.

Lumen Technologies is the latest company to be facing a lawsuit over its PRT. Lumen conducted a $1.4 billion PRT with Athene Annuity and Life in 2021. The lawsuit accuses Athene of being a “highly risky private equity-controlled insurance company with a complex and opaque structure.” The plaintiffs allege that by selecting Athene, Lumen violated its fiduciary duty under ERISA to obtain the “safest annuity available.”

Prior to Lumen, AT&T, Inc., Lockheed Martin Corporation, Alcoa Corporation, Bristol-Myers Squibb Co., and State Street also were sued in similar lawsuits relating to their PRTs.

What is a PRT?

Defined benefit pension plans promise guaranteed benefits to plan participants at retirement. In making this promise, the plan sponsor assumes the risk as to whether the plan will have enough money to pay the promised benefits. The plan sponsor mitigates that risk, to the extent possible, by making contributions to the plan annually based on assumptions about events that will occur in the future, such as investment performance, interest rates and how long participants will live. Those assumptions are very unpredictable and are often incorrect. This creates the risk that the plan will either not be able to pay the promised benefits, or the plan will be overfunded and create an unanticipated excise tax situation for the plan sponsor.

Over the past few years, plan sponsors have started engaging in de-risking activities (see our prior Case of the Week Pension De-Risking for more information.) These activities include, among other things, transferring the risk to participants through lump sum windows or to insurance companies through the purchase of group annuity contracts. It is the transfer of the risk to the insurance company that is the “pension risk transfer transaction.”

The decision to engage in a PRT transaction is a settlor (i.e., nonfiduciary), decision made by the plan sponsor and can be based on the plan sponsor’s legitimate business interests. However, the implementation of the pension risk transfer decision, including the selection of the annuity provider, is a fiduciary decision.

The concern for participants relates to the shifting of liability for paying benefits. Most private-sector employers insure the plans’ benefits through the Pension Benefit Guaranty Corporation (PBGC). If a defined benefit pension plan terminates without sufficient money to pay all benefits, the PBGC’s insurance program will pay participant benefits up to the limits set by law. In contrast, when the plan sponsor completes a PRT transaction, the plan sponsor and the PBGC are no longer liable for benefit payments; that responsibility is transferred to the annuity provider. If the annuity provider defaults, state insurance regulation protections vary by state. Consequently, the plan sponsor is obliged to select the safest annuity provider possible.

Interpretive Bulletin 95-1

Interpretive Bulletin 95-1 outlines the fiduciary standards that a plan sponsor must use when selecting an annuity provider for a PRT. The recommendation is that selection decisions are based on “the safest available” rather than the cheapest carrier.

According to Interpretive Bulletin 95-1, fiduciaries are required to evaluate the insurer’s creditworthiness and its ability to pay claims using criteria focused on six factors:

1. The quality and diversification of the annuity provider’s investment portfolio;

2. The size of the insurer relative to the proposed contract;

3. The level of the insurer’s capital and surplus;

4. The lines of business of the annuity provider and other indications of an insurer’s exposure to liability;

5. The structure of the annuity contract and guarantees supporting the annuities, such as the use of separate accounts; and

6. The availability of additional protection through state guaranty associations and the extent of their guarantees.

The heightened concern over the recent years is the increase in private equity (“PE”) involvement in the insurance industry. PE firms have purchased insurance companies and there is a concern that this raises the risk to participants’ ability to receive their promised benefits and the solvency of the annuity companies. SECURE Act 2.0 requires the Department of Labor to review Interpretive Bulletin 95-1, but as of the date of this Case of the Week, no modifications to the bulletin have been published. The DOL did issue a report to Congress in July 2024, where it indicated, “Broader public input is an important next step in determining how Interpretive Bulletin 95-1 might be amended …”

Conclusion

As litigation relating to pension risk transfers increases, plan sponsors must remain diligent in their prudent selection of annuity providers. Interpretive Bulletin 95-1 provides the types of factors a fiduciary should consider. Documentation of the process is critical.