The trend of de-risking corporate defined benefit pension plans calls into question the viability of the insurance companies that assume the obligations, according to a new report from the International Monetary Fund.
In its most recent assessment of the U.S. financial system, the IMF cited similar concerns raised in the Financial Stability Oversight Council’s annual report released in May. The FSOC, established under the Dodd-Frank Act in 2010, is chaired by Treasury Secretary Jack Lew and charged with monitoring interconnected systemic risk in financial markets.
The IMF report notes that insurance companies’ investment reserves have been hurt by the prolonged period of low interest rates.
Insurance companies invest the preponderance of assets in fixed income. A 2013 report from the Federal Reserve Bank of Chicago shows that more than 75%, or more than $2.5 trillion, of the U.S. life insurance industry’s general account assets are invested in bonds.
That’s compared to 2.3% of assets that are invested in equities.
As interest rates have hovered at historic lows since the financial crisis, insurance companies have been forced to assume more risk where possible in search of yield, according to the IMF’s report.
Some firms have increased allocations to private equity, hedge funds, real estate assets and lower rated corporate bonds.
“Large life insurance groups in particular have expanded nontraditional business, provide complex guarantees, and remain exposed to macroeconomic risks,” said the report.
One expansion of nontraditional businesses has come in the form of pension de-risking schemes.
Total annuity de-risking sales reached $8.5 billion in 2014, a 120% increase over the previous year, according to LIMRA’s Secure Retirement Institute’s Group Annuity Risk Transfer Survey.
The total amount of liabilities transferred from sponsors’ books was $128 billion in 2014, the highest ever recorded.
Deals with Bristol-Meyers Squibb and Motorola, both landed by Prudential, represented more than half of last year’s sales, which saw the number of buyout contracts increase to 277, from 217 the year before.
The FSOC’s report said the transfer of pension risk to the insurance industry, “through longevity swaps and other insurance products, increases the interconnectedness” of the financial system, according to the report.
Volatility in sponsors’ pension funding requirements is often cited as a primary motivator of the de-risking movement. Low interest rates have also driven up sponsors’ annual funding obligations, which are set by Congress.
And increasing premium payments to the Pension Benefit Guaranty Corp. are also said to be driving the de-risking trend.
In 2014, sponsors paid $3.8 billion in PBGC premiums, up from $2.9 billion in 2013 and a record amount of premium revenue of the agency, which is charged with insuring sponsors’ pension obligations.
Participants in plans that are de-risked become the responsibility of insurance companies, and no longer enjoy PBGC guarantees once sponsors shed the liability.
That factor is core to plaintiffs’ arguments in Lee v. Verizon, now being considered in the 5th Circuit Court of Appeals.
Verizon employees are challenging the legality of the company’s 2012 pension buyout agreement with Prudential, alleging in part that the deal was illegal because it deprives the 41,000 affected employees of PBGC guarantees.
A ruling on the case is expected any day.