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Pension guarantee similar for PBGC and annuities, study finds

Pension guarantee similar for PBGC and annuities, study finds

Annuities transacted as a result of corporate defined benefit de-risking transfers are as safe and could be safer than the pensions would be remaining in retirement plans under ERISA and PBGC protection, suggests a study by the National Organization of Life & Health Insurance Guaranty Associations set to be released in April.

NOLHGA believes its study to be the first comparing ERISA and insurance guaranty systems specifically relating to corporate pension de-risking transfers, said Peter G. Gallanis, president of the Herndon, Virginia-based organization, in an interview. “To our knowledge, no other study has presented a comprehensive and objective comparative examination of the protection mechanisms for pension plans and annuities,” Mr. Gallanis said.

NOLHGA hired Willis Towers Watson P.L.C. to assist in the study, using actuaries from both its pension plan and insurance units.

The insurance regulatory and guaranty system has layers of financial safeguards absent from pension plans and their sponsors under the Employee Retirement Income Security Act with its Pension Benefit Guaranty Corp. protection.

“We at NOLHGA do believe that the regulatory safeguards aimed at preventing insurer failures (and mitigating their effects in the rare cases when they occur) are comprehensive, constant and effective,” Mr. Gallanis said.

“One chief thrust of that (statutory insurance company) regulation is to require that all insurers maintain — at all times — high-quality assets in amounts that comfortably exceed the value of their liabilities,” Mr. Gallanis said in an email follow-up. “I do not suggest that solvency is not a concern of the regulatory system applicable to pensions — clearly it is. But neither pension plans nor (more importantly) plan sponsors are regulated for solvency in the same comprehensive and constant manner. The simplest illustration of that fact is that many pension plans are underfunded. An insurance company simply cannot be underfunded and continue to operate without regulatory intervention.”

The “most important level of protection, of course, is preventing program failures from occurring in the first place,” Mr. Gallanis said.

In addition, insurance companies assuming liabilities in pension risk transfers have to also take in assets that cover more than 100% of the obligations, unlike corporate plans that can remain less than fully funded for many years under ERISA, Mr. Gallanis said.

The insurance regulatory protections have resulted in fewer insurance company failures compared to pension plan failures.

“The main conclusion of this paper is that there is very strong protection that is provided on both sides both for pension plans and for annuities,” Mr. Gallanis said.

Mr. Gallanis declined to express an opinion on whether the insurance or ERISA system provides better protection for retirement benefits.

“I’m a believer in both systems,” Mr. Gallanis said.

Participants “are likely to be very well protected if a pension plan formed under ERISA were to fail and the PBGC were to be triggered … but it’s less likely that an insurance company that issued an annuity would fail” in the first place. “If it were to fail, annuitants would also be very well protected,” Mr. Gallanis said.

Historically, there have been few failures companies that issue annuities compared to pension plans under ERISA.

Since the beginning of the financial market crisis, “there were zero failures of insurance companies actively writing annuities,” Mr. Gallanis said.

“Our review of PBGC annual reports indicates that 931 single-employer defined benefit plans failed between Oct. 1, 2007, and Sept. 30, 2015,” he said. Those “failed plans had total assets of $18.24 billion and total liabilities of $31.306 billion.”

“That’s just a consequence of the fact that insurance companies are very highly regulated for solvency. … Companies that write annuities have to report and show that they are more than 100% funded on an annual and quarterly basis to all of the regulators in all of the states where they do business,” Mr. Gallanis said.

“The principal source of funding for ERISA plans, other than assets that are held in trust … is basically the plan sponsor, and the plan sponsors really aren’t regulated for solvency per se,” Mr. Gallanis said.

“The experience of the financial crisis … was itself the most significant, real-world, live-fire stress test that the financial industry has faced since the Great Depression,” Mr. Gallanis said.

Some 400 or 500 banks or thrifts failed during the financial crisis, two of the three largest automakers failed and more than 900 pension plans failed, Mr. Gallanis said.

“In that same period, under those same conditions of stress, we saw no failures of insurance companies that were actively writing annuities. I think that is a consequence of four different factors,” Mr. Gallanis said.

“The first is that insurance companies … have very conservative business models, and they compete with each other on the basis of their financial strength.

“Second, insurance companies are very tightly regulated. … Many pension plans right now are significantly underfunded. You can’t run an insurance company that is only 80% funded. If you do, you are shut down immediately. Every insurance company is required under insurance regulations to be more than 100% funded, all the time.”

“A third factor … is a strong system for handling receivership … of the rare insurance companies that do fail. One of the hallmarks of that system is that the policyholders … become priority creditors when a company fails” for claims that “exceed the guaranteed level of protection provided by guaranty associations.”

“Finally, the last source of strength … is the guarantee system itself. … Since NOLHGA’s founding in 1983, there have been over 100 different insolvencies (40 of which involved companies writing annuities) that have triggered guarantee association protection. The guarantee associations have always paid every penny of the amounts policyholders have been entitled to receive by statute under the laws that establish the guaranty associations.”

Most of the 40 were tiny companies, Mr. Gallanis said. There were four large companies that failed: Mutual Benefit Life Insurance Co. in 1991 and Confederation Life Insurance Co., Executive Life Insurance Co. of California and Executive Life Insurance Co. of New York in 1994.

“The aggregate estimated liabilities of those (40) companies total $14.897 billion, and the aggregate estimated assets total $11.723 billion,” Mr. Gallanis said.

In contrast, “based on statistics in the most recent PBGC Data Book, from 1990 through 2013, a total of 2,812 pension plans failed, with total assets of $49.866 billion and total liabilities of $95.721 billion.”

The PBGC acknowledges the challenges facing its protection sustainability. “PBGC has enough funds to meet its obligations for years, but without changes in PBGC premiums, both the single-employer program and the multiemployer program will run out of money,” the PBGC website states.

As of the end of fiscal 2014, the PBGC single-employer program was 82% funded with $88 billion in assets and $107.4 billion in liabilities.

Reflecting on the PBGC situation, Mr. Gallanis commented in the e-mail, saying, “given the importance of the PBGC’s mission and the obvious goal of Congress to maintain PBGC’s effectiveness, I would expect ameliorative measures of various possible types to be pursued.”

A NOLHGA “modeling exercise demonstrates that both systems can be expected to provide very high levels of protection,” Mr. Gallanis said in the e-mail. “Depending on the specific makeup of the population of participants and the specific assumptions regarding the details of a failure, in some cases annuity owners fare slightly better; in other cases, pension plan participants fare slightly better. In all modeled cases, most participants are fully protected, and the aggregate level of protection provided (compared to the aggregate value of benefit commitments) is quite high.”

NOLHGA is made of the life and health guaranty associations, whose coverage includes annuities, of all 50 states and the District of Columbia.

The “increased number of high-profile pension de-risking transactions in the past several years led us to conduct analysis in the area and, ultimately, to prepare this particular study,” Mr. Gallanis said.

Barry B. Burr writes for Pensions & Investments, a sister publication of Business Insurance.

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