Why is IBM transferring billions to an annuity? The surge in pension risk transfers, explained

Last week, IBM announced that it entered into a $6 billion pension risk transfer (PRT) agreement with Prudential Insurance Company. As the retirement industry evolves from pension plans to 401(k) plans, PRTs allow firms to offload the burdensome administration of allocating pension plans.

PRTs have helped firms bridge the transition, however, there have been a rash of class action lawsuits filed by former employees and retirees that claim their employers chose a risky insurer. In 2023, there were a record 773 PRTs, which is expected to grow. Increasingly, private equity firms are seeking to purchase stakes in annuity assets to gain access to a permanent capital stream.

In the last year, Lockheed Martin, AT&T, Alcoa and GE have been sued by employees in class action lawsuits over the PRT deals made with private equity firm Athene, alleging the firm “breached their fiduciary duty,” according to law firm Schlichter Bogard, which is representing these firms.

PRTs are insurance solutions that allow a company to transfer the pension plan’s key risk to an insurer. The PRT process is governed by the Department of Labor and the Employee Retirement Income Security Act (ERISA), which prevents a plan sponsor from structuring pension risk transfers in a manner that reduces pension benefits, in order to ensure retirees’ financial security.

IBM’s PRT deal comes after the technology firm, once a leader in the shift away from defined benefit plans defined contribution plans in the ’80s and ‘90s, switched to a “hybrid pension” plan in 2023. Under the terms of the transaction, IBM purchased a single premium group annuity contract that transfers $6 billion of the company’s Personal Pension Plan’s defined benefit pension obligations to Prudential. The insurer will assume responsibility for making retirement benefit payments to approximately 32,000 retirees and beneficiaries.

This marks the second PRT agreement between Prudential and IBM, which struck a deal with the same insurer in 2022 to cover approximately 100,000 IBM retirees and beneficiaries.

We wanted to get a fresh perspective on IBM moving billions to a Prudential annuity, as well as the rash of PRTs, and talked to Jarred Wilson, VP and Consulting Actuary at Segal, the HR and benefits consulting firm, who is an actuary who focuses on pension risk transfers.

Q: Why is IBM transferring billions to an annuity? 

A: This is a continuation of the de-risking strategy that IBM started on two years ago when they transferred annuities for 100,000 retirees and beneficiaries to Prudential in 2022 and switched to a hybrid cash-balance pension plan for active employees in 2023. These decisions are geared towards reducing volatility in the future cash obligations to their retirement programs.

In IBM’s situation they have a very well-funded pension plan and decided to move their 401(k) to a defined benefit pension plan and that was big news at the time. But if their pension plan wasn’t overfunded I’m not sure that the reduced balance sheet exposure from the risk transfer would be enough to warrant them reopening their pension plan. In terms of the transfer to annuity, keep in mind that this type of transaction does come at a cost. The premium charged by an insurance company will typically be in the 5-10% range.

Q: Why are so many other companies involved in pension risk transfers?

A: Many American companies are carrying legacy pension plans on their books that date back several years and provide little to no value to the current workforce. New CFOs are straddled with the financial burden of funding these old obligations and they are looking for any opportunity to offload them.

Q: Since there are so many PRT lawsuits lately, what is the key issue with these transfers? 

A: They’re an easy target for lawsuits because the headlines can be easily misinterpreted to make it seem like companies are bailing out on their obligation toward former employees. But the reality is the pensioners are mostly unaffected by these transactions. They receive the same monthly benefit they were getting before the transaction, with just a different financial institution name on the check.

Q: What are private equity firms’ involvement with PRTs?

A: There’s been a growing trend of private equity (PE) firms buying insurance companies in recent years, as the PE firms believe they can generate better returns on the large amount of assets held by the insurer.

Related: IBM completes $6B pension risk transfer to Prudential in group annuity buyout

Q: Do PRTs play a pivotal role in the evolution of retirement plans?

A: I would say for years they’ve played a role in the de-evolution of retirement plans, as the majority of companies that embark on this strategy are looking to get out of the pension business.  That said, what IBM has shown us is that there could be a path to utilize the PRT market to offload old debt while at the same time create opportunities to re-open lower risk, hybrid model pension plans for the current and future workforce.