After I published my post on pension risk transfer (PRT) in late August on LinkedIn, Mr. Christopher B. Tobe posted a link to his paper in the comment area of my post. In his paper, Mr. Tobe made some strong statements against PRT. However, upon reading the paper and the related reference materials, I found that most Mr. Tobe’s claims are based on past comments with respect to annuity products as an investment choice for 401(k) participants. When applied to defined benefit plans and PRTs, those claims become irrelevant, inaccurate, and in some cases misleading. As an actuary and an investment professional with over 30 years of experience working on insurance ALM (annuity in particular) and pension asset allocation and risk management, I feel obligated to point out the inconsistences between some of Mr. Tobe’s claims and the reality. I also have the responsibility to clarify what PRT is and is not for my current and prospective clients, collaborators, and for those who have been following me on LinkedIn. This is particularly necessary given that Mr. Tobe posted the link to his paper in the comment area of my PRT post.
Here are the key points I would highlight:
- There is a significant difference between defined benefit pension plans (DB plans) and 401K plans (and defined contribution retirement plans in general),
- The insurance industry is highly regulated, and the risk embedded in the annuity products is far lower than Mr. Tobe claimed to be.
- The statement Mr. Tobe made that “the standard PRT is at least 10 times (as risky) as that of a diversified portfolio” seems to be based on claims made by others on a completely different subject which has no relevance to PRT.
I would like to invite Mr. Tobe and everyone who is interested in PRT to join me and explore this topic further, for the benefit of DB participants, plan sponsors, annuity providers, and regulators.
Now let me elaborate these points below.
- There is a significant difference between defined benefit pension plans (DB plans) and 401K plans (and defined contribution retirement plans in general),
As we know, there is a significant difference between defined benefit pension plans (DB plans) and 401K plans (and defined contribution retirement plans in general). Almost all of Mr. Tobe’s comments and related references are on 401K retirement plans, not DB plans.
In a 401K plan, each participant has its own retirement account. Plan sponsors make annual contributions to the participant’ respective accounts. The investment decision of each account is made by the individual participant. The investment risk and the cost are borne by individual participants.
For DB plans, the retirement benefit is defined fixed monthly benefit payments based on the retiree’s years of service and the average salary of the last several years prior to retirement. Investment risk and the costs associated asset management activities are borne by the plan sponsor.
Now when a DB sponsor enters a PRT transaction, the retirees will receive the same amount of respective monthly payments for the same duration. The “fees spread and expenses” mentioned in Mr. Tobe’s paper is paid by the plan sponsor as part of the asset market value calculation for the PRT transaction. It has no impact on the monthly benefits the retirees are receiving. As such, the statement by NAGDCA on the cost of annuity products has no bearing in the PRT contest, contrary to what Mr. Tobe stated.
- The insurance industry is highly regulated, and the risk embedded in the annuity products is far lower than Mr. Tobe claimed to be.
The insurance industry is heavily regulated, and the reserves are calculated based on rigorous scenario testing results. That is why the insurance industry as a whole fared very well during the 2008 GFC. A few insurance companies were severely impact due to their exposure in certain lines of businesses, namely credit defaults swaps and guarantees on variable annuities. The new scenario testing requirement (VM22) makes the scenario testing more comprehensive. (See my post on VM22 for more detail.) The state insurance fund serves as another layer of guarantee in case of insolvency. I do agree with Mr. Tobe that plan sponsors should exercise their fiduciary duty in selecting low risk PRT counterparties. In addition, many DB plan sponsors also require the assets supporting the retiree benefits in the PRT transactions be segregated and managed as separate accounts to add another layer of safety.
- The statement Mr. Tobe made that “the standard PRT is at least 10 times (as risky) as that of a diversified portfolio” seems to be based on claims made by others on a completely different subject which has no relevance to PRT
Mr. Tobe noted in his paper that “the standard PRT is at least 10 times (as risky) as that of a diversified portfolio,” He did not elaborate how he derived that number, nor did he provide any relevant sources. The reference Mr. Tobe quoted is Mr. Frank J. Fabozzi’s 1998 book “The handbook of stable value investments, 1st edition,” where there is a contributing paper by Jacquelin Griffin on evaluating wrap provider credit risk in synthetic GICs (pg272.) I am very familiar with stable value funds as a choice in the menu of 401k fund lineups, and I understand the risk in synthetic GICs. However, this has no relevance to PRTs.
#PRT #annuity #insurance #pension #401k #Fabozzi
==============================================================
Additional detailed comments on Mr. Tobe’s “4 basic reasons” of PRT annuity contracts as fiduciary breach.
Mr. Tobe cited 4 reasons to support his claim that PTA annuity contracts are a Fiduciary breach. I would like to share my comments below.
- On “Single entity credit risk,” Mr. Tobe cited a paper he drafted on March 26 of 2024. However, I did not see any direct proof of the claim in the paper he cited. There were statements there, similar as the ones Mr. Tobe made in the current paper. In my opinion, the default risk of purchasing annuity from a single annuity provider is very different from investing in a single name stock or single name corporate bond. If one invested in a single name stock and the company went bankrupt, the investor would lose all the investments. For corporate bond investors, they would only get the recovery value, which typically ranges from 20 to 40 cents for every dollar in case of default. Annuity contracts, on the other hand, are backed by the reserve assets, where the asset adequacy is periodically stress-tested and reported to insurance regulators, as per regulatory reporting requirement. In case an annuity writer files for bankruptcy, the reserve assets will be the sources to back the annuity payments. Any shortfalls, if any, will be the responsibility of the state regulators. For details on reserve adequacy test, please refer to the NAIC reserve manual @ https://content.naic.org/sites/default/files/pbr_data_valuation_manual_current_edition.pdf.
- On “single entity liquidity risk in illiquid investments,” Mr. Tobe cited some findings in https://commonsense401kproject.com. As I mentioned earlier, retirees of DB plan participants received monthly benefit payments. There are no additional liquidity needs so long as the monthly benefit payments are met on time. For 401K plan participants, they manage their own respective retirement accounts and make periodic asset allocation changes/adjustments. Therefore, liquidity is important for 401K participants. It is not the case for DB plan participants.
- On “hidden fees spread and expenses,” this is an irrelevant concept for DB plan participants, because they are not the party who pays the fees and expenses. DB participants receive pre-determined monthly benefit payments.
- On annuity provider for PRTs, I would agree that sponsors have the responsibility to pick low risk providers. This has been the case for the majority PRT transactions. As Mr. Tobe correctly highlighted in his paper, “(m)ost of the current PRT cases are against Apollo owned Athene.”