As we all know, Corporate defined benefit pension plans have been off-loading their Retired Lives liabilities for years. One concern that I’ve had has to do with an insurance company default and the impact on pension liabilities that would no longer have the backing of the PBGC. Given the incredible volatility in the markets for both equities and bonds, I was once again wondering about the potential for an insurance company default. I probably shouldn’t, but it is in my nature to do so!
That said, insurance companies have reserves, while pension plans don’t. Ron Ryan, CEO, Ryan ALM, has for years said that pension plans should have the same rules that insurance companies do under the NAIC. The list of rules and restrictions seems to be 1,000s of pages, but the key elements are: 1) assets must be matched to liabilities, 2) they must prove that they are fully funded given a +/-3% interest rate sensitivity test, 3) risky assets are limited to only their reserves, 4) there is no mark-to-market, and 5) the insurance company must maintain a minimum level of reserves.
We still believe that a cash flow matching strategy (CDI) focused on defeasing the plan’s Retired Lives liability is a more cost-effective approach than off-loading the liability to an insurance company. This is especially true at this time given how interest rate spreads on corporate bonds have widened relative to Treasuries. It is clear that DB plan funding has been hurt by the simultaneous and dramatic fall in equity valuations and interest rates, but that combination shouldn’t put major insurance companies in a dire situation given the rules that keep them protected during periods of uncertainty. There are a lot of items that should and do keep me awake at night. The potential collapse of the insurance companies and their pension liabilities shouldn’t be one of them.