Managing unfunded benefits on company balance sheetsNew market research from AM Best looks at the steady decline of DB plans in today’s market. Access the report, Low Interest Rates Leading To Sharp Decline in Insurer Defined Benefit Plans, here.
OLDWICK, N.J., April 5, 2021—Defined benefit plans have been declining for more than four decades, a long-term trend that has been reinforced in recent years as interest rates remain at historic lows, according to a new AM Best report.
The Best’s Special Report, “Low Interest Rates Leading To Sharp Decline in Insurer Defined Benefit Plans,” states that the number of AM Best rating units having defined benefit plans at year-end 2019 was 184, compared with 257 in 2016. In most cases, the decline can be attributed to companies terminating their plan, though in some instances, the benefit obligations were moved off the insurance entity balance sheet and are at the holding company level.
Recognizing Unfunded Benefits
Statutory accounting rules were changed in 2013 to require all insurers with defined benefit plans to recognize unfunded benefits on the balance sheet. Companies had the choice of recognizing the unfunded benefit obligations up front, or amortizing the unfunded obligations for a period no longer than 10 years. Unfunded obligations can vary significantly each year, as changes in economic conditions dictate assumptions used to measure obligations and impact asset performance.
Aggregated insurance company unfunded pension benefits have dropped over the past five years, to $13.9 billion in 2019 from $19.4 billion. Pension obligations and assets have exhibited more volatility over this period, while other post-retirement benefit obligations and assets have been stable at around $16.5 billion. Few assets are held for post-retirement obligations, as they tend to vest much closer to retirement age.
An initial review of year-end 2020 statement filings indicates that benefit obligations will rise sharply as the Federal Reserve kept rates very low to stem the effects of the COVID-19 pandemic. While interest started to rise late in 2020, the baseline discount rate to determine plan obligations is going to average between 2.50% and 2.60%, a drop of 80 to 90 basis points from 2019 levels.
Partially offsetting this are strong returns on the assets backing the obligations, especially for plans more highly weighted in equity securities. There will be a continued decline in the number of defined benefit plans on insurers’ balance sheets, through either plan termination or moving the exposure elsewhere in the organization. As the accounting transition from 2013 winds down, these unfunded obligations will be fully recognized on statutory balance sheets.
To access the full copy of this special report, please visit here.
AM Best is a global credit rating agency, news publisher and data analytics provider specializing in the insurance industry. Headquartered in the United States, the company does business in over 100 countries with regional offices in London, Amsterdam, Dubai, Hong Kong, Singapore and Mexico City. For more information, visit www.ambest.com.