Some large corporations that go through restructuring or liquidation have to address their defined benefit plan, or traditional pension shortages. Pension obligations remain an ongoing concern for a number of corporations and government entities. Annuity contracts enable companies and government agencies to transfer all or a portion of their retirement plan benefit obligations to an insurance company. Participating annuity contracts are a type of annuity contract that allows the employer to participate in any upside.
An annuity contract outlines the terms of an annuity and is an irrevocable agreement typically between an employer and an insurance company. The annuity contract outlines the employee and employer contributions and benefits schedule and any early withdrawal penalties. The insurer agrees to provide defined, specific benefits to the employees or other included beneficiaries in exchange for the payment by the sponsor, typically an employer, of a fixed fee or premium.
Annuity contracts are not standard, boiler-plate contracts. They typically involve some amount of negotiation between the two parties because of the level of responsibility being transferred. When an employer purchases an annuity contract from an insurance company, it transfers its legal obligations to directly provide pension benefits to its employees and the myriad risks associated with that obligation to the insurance company. An annuity contract is not fully, legally enforceable unless the employer expressly transfers the risks and rewards tied to its pension plan assets and liabilities to the insurance company.
Participating Annuity Contracts
A participating annuity contract establishes a close relationship between the provider of the funds — the contract purchaser, namely a pension fund or employer — and the insurance company. Both the insurance company and the employer or pension fund reap the benefits of any investment increases derived from the contributed funds. This is done through the dividends the insurance company pays out to the employer. Typically the cost of a participating annuity contract is higher than a non-participating contract to capture this potential dividend stream.
To allow for the failure of an employer or insurance company, the IRS requires that employers and insurers entering into participating annuity contracts certify certain key points. This includes that the obligation to beneficiaries under the contact is irrevocable and that plan participants have the same rights to an insurer’s assets in the event of insolvency as do traditional annuity participants. This certification must also include that the insurance company’s responsibility to covered individuals are not based on the contract’s performance or adequacy of assets in a separate account.
- New York State Department of Financial Services: Group Annuity Terminal Funding and Close Out Contracts [http://www.dfs.ny.gov/insurance/life/product/tfco_2012.doc]
- Google Books: Accountants’ Handbook, Special Industries and Special Topics [http://books.google.com/books?id=5Vv8cAeAKIQC&pg=RA3-PA24&lpg=RA3-PA24&dq=%22participating+annuity+contract%22&source=bl&ots=oLgwQXJT2n&sig=gSvgzTobWNP1HIvZzKqF7u6D7cM&hl=en&sa=X&ei=pirgUaG1CuXl4APJpoDABw&ved=0CGwQ6AEwBA#v=onepage&q=%22participating%20annuity%20contract%22&f=false]
- Financial Dictionary: Annuity Contract [http://financial-dictionary.thefreedictionary.com/Annuity+Contract]