By Joe Anzalone, Michael Clark, and James Walton
As more and more pension benefits are transferred to insurers as part of de-risking strategies or full plan terminations, the question as to the protections backing pension annuities has taken center stage. Are the benefit protections provided by the Pension Benefit Guaranty Association stronger, weaker, or the same as those afforded by State Guaranty Associations that provide the backstop to insurance company provided benefits in the event of insolvency?
In this article we’ll compare the two systems to give pension participants an idea of how these protections work and the considerations that need to be examined to determine the safety of their pension benefit.
When Do Protections Matter
The backstops for protecting pension benefits only apply when the entity providing the benefits is in financial distress. For single employer and multiemployer pension plans, the entity responsible for providing the backstop is the Pension Benefit Guaranty Corporation (PBGC). PBGC benefit protection levels are different for single vs multiemployer plans, but in either case the PBGC only steps in when the sponsoring entity is deemed to be in financial distress to the point where it’s detrimental to the participants for the sponsoring entity to continue to provide the benefits.
In contrast, once pension benefits are transferred to an insurance company as part of a pension risk transfer, those benefits are no longer protected by the PBGC but are instead protected by State Guaranty Associations (SGAs). These associations exist on a state-by-state basis and provide protections to policy holders in the event that an insurance company is deemed insolvent. For insurance companies, this typically means when their assets reach a level of covering around 100% or less of their reserves (i.e. the present value of their insurance and annuity contracts).
Since 2008, we are not aware of any issuer of annuity contracts that has failed, but there have been failures of 931 single employer plans according to data published by the National Organization of Life and Health Guaranty Associations and the PBGC. Of those pension plans that failed and were taken over by the PBGC, approximately 16% of participants had reductions to their benefit with an average benefit reduction of 28%.1
Additionally, insurance companies are tightly regulated and are prevented from taking financial risks that are routine for pension plans. Any analysis of the strength of backstop protections in the event of a failure should first consider the likelihood of failure itself.
How Protections Differ
Forecasting the minimum level of benefits that the PBGC and SGAs guarantee at a point of failure in the future is not certain because guarantees under the two systems are defined differently, and it is misleading to compare the nominal guarantee levels of the two systems. However, both safety nets cover benefits for the majority of participants in a typical pension plan[1]. For a given pension participant who is not fully covered, who goes through an assessment at the point of failure, they will get a larger minimum benefit from one system… in some cases it will be the PBGC and in some cases it will be the SGA[2]. For a pension plan population as a whole, which system provides the stronger benefit protections will depend on the circumstances. The PBGC sometimes has higher maximum guaranty levels, but the workout process involving the SGA is highly likely to provide additional benefits over and above minimum guaranty levels when allowing for anticipated recovery of insurer assets.
PBGC benefits are defined as annuity amounts and are adjusted based on the participant’s age and form of benefit payment. For example, in 2024 the maximum monthly guaranteed benefit for a 65-year-old is $7,107.95 for a single life annuity and $6,397.16 for a joint and 50% survivor annuity.
SGA benefit protections vary by state of residence of the insured life, and the minimum amounts available are defined as a present value for a given covered life (i.e. joint and survivor annuities count as two lives). These present values are meant to provide a minimum value under which no benefit is lost. For annuitants whose benefits are worth more than this minimum value, the amount above the guaranty limit will be funded proportionately to how much the insurers’ assets can cover its policyholder obligations; this is known as the “recovery rate”. In general, based on regulatory requirements, we would expect a high recovery rate of insurer assets. This means that benefits are fully funded up to the guaranty limit, and benefit amounts above the guaranty limit will generally be very well-funded if not fully funded. The guarantees by state vary but are typically not lower than $250,000 in value. Exceptions include California which only covers the lesser of 80% of the present value or $250,000; Puerto Rico which only covers up to $100,000; and New Jersey which covers up to $100,000 in present value for deferred annuities but up to $500,000 for in-pay annuities.
It’s important to note that the SGA guarantees are generally applicable to all policies an individual may have. In the event of an insurer’s insolvency, if a pension participant has other policies with the insurer the limit would be inclusive of all policies.
Comparing the Guarantees
To help understand how the various benefit protections would apply, we’ve provided several examples below for a retiree age 65 receiving a single life annuity using a SGA guarantee of $250,000.
Small Benefit
Medium Benefit
Large Benefit
Extremely High Benefit
Strength of the systems to meet their obligations
The PGBC system is a Federal system, that receives no direct funding from tax revenues. Obligations are not backed by the United States government. The PBGC receives its funding from premiums charged to active pension plans.
The SGA system provides coverages on a state-by-state level, funded from assessments charged to insurers based in that state in the event of an insolvency. The system is isolated from obligations that any particular State has, and is not supported by the State, i.e., neither system is directly funded by tax dollars or benefits from any State, or the Federal Government’s, full faith and credit.
It is possible, but unlikely, that either system will fail to meet its obligations. The SGA has some ‘diversification’ across States in that it is possible certain state systems would fail to meet obligations, but very unlikely that all would simultaneously fail. The SGA systems are funded from a smaller number of entities (i.e., insurers) but these do span different insurance types (i.e., health and life insurers), whereas the single employer PBGC fund is funded from a large number, but shrinking pool, of corporate defined benefit pension plans.
One could envisage extreme scenarios where either system fails. It is beyond the scope of this paper to compare in detail the underlying backing of the two systems, but we do not see compelling evidence that one system has materially stronger or weaker ability to meet their obligations.
Conclusion
These protections only come into play when an entity is in financial distress. While it’s hard to assess which system provides the optimal outcome for a given participant in a given situation, it’s safe to say that both PBGC and SGA systems provide substantial protections to the majority of pension participant benefits.
The notion that PBGC guarantees are more valuable than SGA guarantees, in general, is not an accurate depiction of reality. As can be seen from the examples above, SGA guarantees will tend to cover a high percentage of a participant’s full benefit. This is due in part to the high recovery rates of insurer assets upon insolvency.
[1] CONSUMER PROTECTION COMPARISON The Federal Pension System and the State Insurance System, A report from the National Organization of Life and Health Insurance Guaranty Associations, May 2016
[2] Do pension buyouts help or hurt employees (retirees)?, Journal of Risk and Insurance, February 2023
