What is Pension Risk Transfer?

Our latest blog post explains Pension Risk Transfer and what this means for participants.

May 20, 2024

Pension risk transfer (PRT) is a strategy enabling pension providers to shift their obligation to pay retirement benefits to insurance companies. The plan sponsor can achieve this either by providing a lump sum payment to participants who choose to exit the plan early, or by arranging for an insurance company to assume the responsibility of disbursing the benefits.

For single-employer qualified Defined Benefit plans, the plan sponsor is responsible for most of the risks associated with the plan. This includes investment and interest rate risk which can be major sources of volatility for the sponsor. During economic downturns, the plan sponsor may face higher than expected contribution requirements to address potential funding shortfalls. Alternatively, during economic upturns, a plan sponsor might have a “contribution holiday” requiring little or no contributions, even if participants continue to accrue benefits in the plan.

To protect participants, these defined benefit plans are insured by the Pension Benefit Guaranty Corporation (PBGC). Plan sponsors pay an insurance premium annually to the PBGC for the benefits offered to their participants. The premiums are paid both on:

➢ The number of participants in the plan, called the flat-rate premium, and
➢ The unfunded vested benefits of the plan, called the variable-rate premium.

Over time, both premiums have increased significantly, creating a larger total premium due each year from the plan sponsor.

Many plan sponsors are looking for ways to stabilize the contributions to their Defined Benefit plans while reducing plan expenses, including the premiums paid to the PBGC. One way to do this is to transfer the benefits, and the associated plan obligation to pay those benefits, out of the plan. Two main approaches in transferring risk are:

➢ Providing lump sum payments to participants in lieu of monthly benefits, or
➢ Purchasing annuities from an insurance company.

Annuity Purchase

In an annuity purchase, the plan sponsor contracts with an insurance company to assume the future responsibility for the payment of benefits associated with a selected group of participants. Once the agreement is reached and the contract ratified, all benefits payable to the selected participant group on or after a given date are made by the insurer and not by the plan’s trust. The cost of the annuity purchase is typically based on the value of the liabilities under conservative interest rates known as “annuity purchase rates” plus an additional administrative fee.

Annuity purchase rates have recently become more favorable to plan sponsors. Some plan sponsors have decided to purchase annuities from an insurance company for some or all their retirees. Participant consent is not required for this transaction. After the transaction, the insurance company assumes the responsibility for the payment of the benefits, and the participant count of the plan is reduced. The plan sponsor has a fiduciary duty to assess the financial stability of the insurance company, usually with the assistance of a consultant or broker, to ensure the insurer is likely to fulfill all benefit obligations to the transferred participants.

Lump Sum Payments
Plan sponsors can amend their plan to allow a lump sum as a permanent feature of the plan, or as a onetime opportunity to elect a lump sum during a specified window of time.

Permanent Feature of the Plan
Plan sponsors can allow the election of a lump sum up to any amount or can amend the plan to allow for lump sums up to a certain dollar threshold. For example, a plan can be amended to allow lump sums up to $15,000 or $25,000 to certain participants that have not yet commenced distributions. Any lump sum exceeding $7,000 requires consent from both the participant and the spouse before it can be distributed in that form.

Lump Sum Window
Under a lump sum window, a plan sponsor would offer a portion of the population a limited opportunity to elect the present value of the benefit. To offer the lump sum option, the plan sponsor is required to offer an annuity commencing on the same date as the lump sum, even if this date is earlier than when an annuity could typically be commenced under the terms of the plan.

Participants are given a specified period to consider taking the offer and then either: (1) consent to accept a lump sum payment; (2) commence an annuity; or (3) choose not to commence benefits during the window. If the participant is married, the spouse must also consent to the lump sum. The participant would also decide if the lump sum payment will be rolled over to an IRA or another qualified plan, or if it will be taken in cash. Any amount not rolled over would be subject to taxation at the time of the distribution.

The SECURE 2.0 Legislation introduces new disclosure and reporting requirements for plan sponsors offering lump sum windows. These requirements may restrict the plan sponsor’s ability to promptly implement such an initiative late in the plan year to reduce headcount before year-end.

Finally, the group of participants identified for the lump sum window must be non-discriminatory.

Your BPAS consultant is available to discuss these options or other options for managing your plan and creating brighter tomorrows.

Bill Stuart, Vice President, Chief Pension Actuary at BPAS Actuarial & Pension Services contributed to this blog post.