DOL Issues Pension Risk Transfer Guidance, Focuses on PE Ownership of Insurers

Sponsors of defined-benefit pension plans contemplating taking steps to de-risk their plans should consider recent guidance from the U.S. Department of Labor’s (DOL) Employee Benefits Security Administration (EBSA) on pension risk transfer (PRT) transactions.

The DOL issued Interpretive Bulletin 95-1 (IB 95-1) in 1995 to provide guidance concerning certain fiduciary standards under the Employee Retirement Income Security Act of 1974 (ERISA) applicable to the selection of an annuity provider when a defined-benefit pension plan transfers all, or some, liability for benefits to one or more institutions. Annuity purchases are generally required to implement the termination of a defined-benefit pension plan under ERISA, and PRT transactions may be used to de-risk a portion of the plan. EBSA was directed under the SECURE 2.0 Act of 2022^[1] to review, in consultation with the ERISA Advisory Council, IB 95-1 to determine whether any amendments are warranted. In a report to Congress issued June 24 (the EBSA Report), EBSA concludes that it is not prepared at this time to propose amendments to IB 95-1. Although not implementing changes to IB 95-1, the EBSA Report outlines important criteria to consider when structuring a PRT, or pension de-risking, transaction.^[2]

IB 95-1 provides that the “fiduciaries choosing an annuity provider for the purpose of making a benefit distribution must take steps calculated to obtain the safest annuity available, unless under the circumstances it would be in the interests of participants and beneficiaries to do otherwise.” IB 95-1 then sets forth the following six factors that fiduciaries should consider, among other things, in evaluating an annuity provider’s claims-paying ability and creditworthiness:

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

Recognizing that maintaining defined-benefit pension plans is costly and administratively burdensome, the EBSA Report notes the high level of plan sponsor PRT activity in recent years. As noted in the Pension Benefit Guaranty Corporation’s (PBGC) Updated Analysis of Single-Employer Pension Plan Partial Risk Transfers from June 2024, “the number of plans purchasing annuities each year has increased from 91 purchases in 2015 to 225 purchases in 2022.”

The EBSA Report also focused on the increase in private equity (PE) involvement in the life insurance industry in recent years, citing as areas of concern those identified in a U.S. Treasury Department letter from 2022 responding to Sen. Sherrod Brown (D-Ohio):

1. Whether “a potential misalignment” may exist between the shorter-term objectives/strategy of the “alternative asset manager investment model” and the “long-term commitment necessary for fulfilling annuity/life insurance policyholder” obligations.
2. Whether “policyholder interests are sufficiently protected from the effects of potential conflicts of interest” within PE structures.
3. Whether “inadequate levels of transparency” in investment strategies may contribute to insufficient capital and reserves held for unexpected losses, potentially exposing the state guaranty association system to “potential contagion risk.”
4. Whether there are implications for the safety and soundness of insurer obligations in view of the offshore domicile of affiliated and unaffiliated reinsurers involved in the PE-owned insurance business, “which in some instances have resulted in large capital releases” following insurers’ execution of affiliated reinsurance transactions. “This type of activity suggests that these deals could be motivated by regulatory arbitrage opportunities (such as allowing reduced reserves to back policyholder obligations).”

The EBSA Report also acknowledges efforts of the National Association of Insurance Commissioners (NAIC) regarding increased PE involvement in the life insurance industry and the 13 recommendations published by the NAIC Macroprudential Working Group that are intended to “identify where existing disclosures, policies, control and affiliation requirements” should be modified to accommodate the increase in PE ownership of insurers.

In light of these developments, EBSA explains that some stakeholders strongly advocated making “significant changes” to IB 95-1 in order to “protect annuitants’ interests.” Other stakeholders wanted EBSA to retain IB 95-1 without change, saying that state insurance regulators will provide effective oversight of insurance company solvency issues, including any that PE involvement may pose.

The EBSA Report then discusses the following issues as factors raised by stakeholders in evaluating whether to update the guidance in IB 95-1:

• Insurance company ownership structure
• Perceived increase in nontraditional/“risky” investments by insurers
• Nontraditional liabilities, g., those not structured around mortality and morbidity risk, such as funding agreements
• Reinsurance
• Risk-based capital and related metrics
• Insurance company separate accounts as a protection
• Administrative capabilities and experience
• Spousal protections
• Anti-alienation rules — protections against creditors and division of benefits on divorce
• Disclosures to participants on partial buy-outs (so-called lift-outs)
• Loss of PBGC protections
• Availability of additional protection through state insurance guaranty associations and the extent of their guaranties
• Impact of partial PRT annuity purchases on residual funding status of plans

Based on its review, EBSA concluded that, although IB 95-1 identifies “broad factors that are relevant to a fiduciary’s prudent and loyal evaluation of an annuity provider’s claims-paying ability and creditworthiness ... [f]urther exploration into developments in both the life insurance industry and in pension risk transfer practices is necessary to determine whether some of the Interpretive Bulletin’s [IB 95-1’s] factors need revision or supplementation and whether additional guidance should be developed.” At the same time, EBSA concluded that it “is not prepared at this time to propose amendments to the Interpretive Bulletin [IB 95-1] to address” the issue of PE ownership of insurers. “The issues raised by stakeholders are complex and there were few, if any, areas of consensus.”

With regard to a fiduciary’s duties to “take steps calculated to obtain the safest annuity available,” the report notes that EBSA “is not persuaded that additional guidance is needed regarding a fiduciary’s duties in connection with a partial buy-out’s impact on the plan’s funding status.” Noting that the safest annuity available “standard applies equally in the context of a partial buy-out,” EBSA makes clear that if a fiduciary cannot implement a PRT without breaching its duties of prudence and loyalty for all the plan’s participants, “the fiduciary may be compelled to seek additional funding from the plan sponsor.” The EBSA Report concludes by stating that EBSA “will continue to monitor these issues.”

^[1]_{Pub. L. No. 117-328.}

^[2]_{Of note, on Aug. 29, 2023, the ERISA Advisory Council issued a statement, which is appended to the EBSA Report, detailing the views of the ERISA Advisory Council. Six members of the ERISA Advisory Council recommend no changes to IB 95-1 while the other nine members supported certain changes but without any consensus.}