Organizations that are considering these risk-mitigation strategies must carefully evaluate numerous factors to determine whether they are advantageous for both the plan sponsor and the participants. One crucial consideration is the impact on plan participants’ pension benefits due to the transition from the protections afforded by federal standards under ERISA and the PBGC to the state insurance guarantees, which vary.

This article is an introduction to partial pension risk transfers for plan sponsors that are interested in learning more before deciding whether to pursue the strategy, which isn’t right for every organization.

Protection under ERISA and the PBGC

ERISA, the federal law that establishes minimum standards for most retirement plans in the private sector, aims to safeguard individuals participating in these plans by ensuring a consistent level of protection throughout the United States. To enhance protection for private sector DB plans, ERISA established the PBGC.

In addition, the Special Financial Assistance (SFA) Program under the American Rescue Plan Act is funded separately through the Department of the Treasury and is administered by the PBGC. The SFA program is a time-limited program that provides financial assistance to a specific set of financially distressed multiemployer plans.

If a PBGC-covered single-employer plan terminates without enough funds to cover all benefits, or if a multiemployer plan no longer has assets to pay benefits at the level provided for under the plan, the respective PBGC insurance program will fund benefits up to a maximum guaranteed amount according to ERISA provisions. The guaranteed amounts vary for single-employer plans and multiemployer plans.

It is important to note that when plan assets and benefit obligations are transferred to an insurance company in an annuity buyout, as discussed in “How to Know When a Pension Risk Transfer Makes Sense,” these federal protections no longer apply to the affected participants, and PBGC premiums for these participants are no longer required.

Annuity buy-ins maintain PBGC coverage

An annuity buy-in is a risk management strategy that mitigates investment and longevity risks, similar to an annuity buyout (where both assets and financial obligations are transferred out of the plan). However, with a buy-in the plan administration responsibilities (e.g., payments to retirees) and assets remain with the plan sponsor.

During a buy-in, plan assets are used to purchase an insurance contract which transfers the future financial obligations of paying the benefits to the insurer. However, the insurance contract continues to be recorded as a plan asset. Therefore, plan participants remain insured by the PBGC, which means the plan sponsor must continue paying premiums for these participants.

Buy-in contracts can typically be converted to buy-out contracts later with minimal or no transition cost, often serving as an interim step to a buyout.

Insurer selection guidance

Interpretive Bulletin 95-1 (IB 95-1) was published in 1995 by the Employee Benefits Security Administration to provide fiduciary standards when selecting an annuity provider for a DB plan. The guidance sets forth six factors that fiduciaries should consider, including:

• The quality and diversification of the annuity provider’s investment portfolio
• The size of the insurer relative to the proposed contract
• The level of the insurer’s capital and surplus
• The lines of business of the annuity provider and other indications of an insurer’s exposure to liability
• The structure of the annuity contract and guarantees supporting the annuities, such as the use of separate accounts
• The availability of additional protection through state guarantee associations and the extent of their guarantees

Since its release, the landscape for DB plans has changed significantly, including the expansion of the number of plans conducting pension risk transfers.

In June 2024, the Department of Labor (DOL) provided a review of IB 95-1 to Congress stating that the guidance “continues to identify broad factors that are relevant to a fiduciary’s prudent and loyal evaluation of an annuity provider’s claims-paying ability and creditworthiness.”

The DOL did, however, identify new factors, such as data and cybersecurity, enterprise risk management and administrative capabilities, which are important in the decision-making process for plan fiduciaries, but aren't included in the original guidance. The DOL affirmed it will continue researching potential amendments and additional guidance which may be called for in the future, but that no changes will be made at this time. An annuity broker will educate the plan fiduciaries and provide an analysis of each of these factors.

State insurance guarantees after a buyout

When pension obligations are transferred to an insurance company (in a buyout), the annuity contracts purchased to cover the pension obligations fall under the jurisdiction of state insurance regulators and state guaranty associations instead of ERISA and the PBGC. Every state has an insurance guaranty association, funded by insurance company assessments, which provides a safety net for policyholders if an insurance company fails.

The amount of protection offered by state guaranty associations varies by state. Generally, it’s a dollar limit that is compared to the present value of the monthly annuity benefit. For example, many states cap annuity protection at $300,000 per individual covered by the insurer. For someone aged 75, that would be approximately equal to an annual benefit of $33,000 (monthly benefit of $2,750) using IRS 2025 mortality and interest rate assumptions under IRC 417(e).

Depending on the state and the participant’s age, this present-value cap may be higher or lower than the monthly benefits covered by the PBGC. State insurance laws, which provide a level of oversight, are not uniform across states and can vary in effectiveness. This variability can result in differing degrees of security for retirees depending on their state of residence and the present value of their benefit.

The DOL’s report to Congress on IB 95-1 noted that following the issuance of IB 95-1, 100 percent of retirees and beneficiaries involved in a benefit transfer to an insurer have received their full pension benefits. In contrast, a PBGC study of 500 single-employer plans insured by the PBGC between 1988 and 2012 found that benefits were reduced for approximately 16 percent of vested participants due to PBGC benefit limitation provisions. It is important to note that these plans funded by the PBGC are typically already in financial distress (i.e., assets transferred to the PBGC do not fully cover the accrued benefits), resulting in reduced benefits.

Reinsurers and private equity firms add complexity

Before selecting an insurance company for a PRT, plan sponsors should evaluate any reinsurance contracts that may affect the insurer's status as the “safest available” annuity provider. Offshore reinsurers can offer tax benefits to the insurer but often have less stringent reserving requirements and regulations, increasing the insurer’s risk exposure. Therefore, plan fiduciaries should be sure that the insurers have thoroughly vetted their reinsurers’ financials before proceeding with a PRT.

Private equity firms have also increasingly engaged with insurance companies through investment management agreements and acquisitions. This ownership can shift the insurer’s priorities to cost reduction and operational efficiency, impacting service quality for policyholders. Seeking higher returns, private equity firms may adopt aggressive investment strategies, increasing risk exposure, especially if they move operations outside the U.S. to align with different regulatory environments. Publicly traded insurers might also pursue risky investments to satisfy investor demands.

The regulatory landscape for private equity-owned insurers is complex and varies by state, with additional oversight and capital reserve requirements often imposed. International regulations differ, which may result in less stringent protection for policyholders. Insurers owned by private equity may have less liquid and diversified portfolios, making them more susceptible to market volatility and financial instability.

Participant communications

While the financial impact of a PRT is crucial, plan sponsors must also consider participant response. Before executing a transfer, plan sponsors should develop a communication plan to inform participants about changes and explain the implications for their benefits. When choosing an annuity provider, the sponsor must assess the insurer's communication methods post-transfer. Additionally, the sponsor should be ready for increased communication from both transferred and remaining participants.

Making a decision

The decision to implement a PRT depends on the specific circumstances of each plan. Generally, from the plan sponsor’s perspective, implementing a PRT can help reduce the size of a plan, leading to more manageable future costs for the portion of the plan that remains. However, from the participant’s perspective, the level of guaranteed benefits covered within the plan compared to the probability of an insurance company failure and the resulting state guarantee coverage should also be considered. The increased involvement of reinsurers and private equity firms makes this decision even more complex for both parties, necessitating thoughtful consideration by the plan sponsor before taking any action.