Dempsey v. Verizon Communications: A Deep Dive into Pension Risk Transfer Lawsuits

New York, NYOn December 30, three former employees of Verizon Communications filed a class-action lawsuit on behalf of 56,000 Verizon Communications, Inc. retirees who formerly participated in either the Verizon Management Pension Plan or the Verizon Pension Plan for Associates. The breach of fiduciary duty ERISA lawsuit is the newest in a series of pension risk transfer litigation – a new twist on a familiar story because it involves old-fashioned defined benefit pension plans rather than 401k plans.

Following the scheme by which fiduciaries allegedly benefitted Verizon, but left pensioners with what could be a worthless promise of benefits takes a little bit of history. It also requires some wading through the shadier corners of the insurance industry.

Thirty-five years of risk shifting – the first shift

Prior to the mid-eighties, most company retirement plans were defined benefit plans. These plans promised a guaranteed income stream beginning at normal retirement age. They were a very good deal for participants because they were very safe. The employer was entirely responsible for making contributions to a trust fund that could pay the promised benefit each year. If it turned out that the employer’s assumptions about investment returns or how many years retirees might collect benefits (based on average life expectancy after retirement), the employer had to contribute more money. Participants were never “out of pocket.”

In the event of disaster – for instance if the employer became insolvent, the federal government would step in, through the Pension Benefit Guaranty Corporation (PBGC), to cover most of the promised benefits. It was a legal “belt and suspenders” formula to protect retirement savers.

These plans became very unpopular with employers because they bore the risk and the plans could be expensive to maintain. As a consequence, employers began to terminate their defined benefit plans. In their place and after the old defined benefit plan was terminated, employers often offered defined contribution plans, especially 401k plans, which shift all investment and actuarial risk to the participant. Benefits under a defined contribution plan are also not covered by PBGC guarantees. That is the first risk shift.

The second risk shift

The benefits that participants had fully earned under a terminated defined benefit plan were legally required to be preserved for the participants’ benefit – generally until their normal retirement age, which could be years off. Rather than maintain that defined benefit plan until the last participant or beneficiary died, many employers chose to buy annuities from an insurance company for those individuals. The employer thus shed the cost of administration and the insurance company assumed the investment and actuarial risk. That is the second risk shift.

If things went smoothly, a retiree might never notice or care about who issued the monthly retirement annuity payment. But there are several fundamental differences:

• A retiree who receives a check from an insurance company cannot sue under ERISA. Their only recourse is to bring a contract-based lawsuit under state law, or in some cases, the law of a foreign jurisdiction. These laws vary and some provide very little protection.
• In the event of an insurance company’s insolvency, like Executive Life Insurance Co.’s bankruptcy in 1991, pensioners have no recourse to a PBGC guarantee.

This second risk shift is what Pension Risk Transfer (PRT) lawsuits are about.

The Dempsey v. Verizon lawsuit

The Dempsey v. Verizon lawsuit challenges the transfer of roughly $5.7 billion in plan assets to the Prudential Insurance Company of America and RGA Reinsurance Company. The plaintiffs allege that Verizon breached its fiduciary duties under ERISA by:

• Selecting unsuitable insurance companies: The plaintiffs contend that the chosen insurers were financially unstable and posed a significant risk to the security of their future pension benefits;
• Failing to adequately investigate the insurers: They argue that Verizon did not conduct sufficient due diligence on the financial health and long-term viability of the insurance companies; and
• Prioritizing cost over the security of pension benefits: The plaintiffs assert that Verizon primarily focused on minimizing the cost of the PRT transaction, disregarding the potential risks to their retirement security.

The role of captive insurers

A key element of the Dempsey v. Verizon litigation involves the role of captive insurers. Captive insurers are insurance companies wholly or partially owned by the entity they insure. In the context of PRT, some of the insurance companies involved in Verizon's transaction had connections to captive insurers operating in jurisdictions like the Bahamas, Barbados, and several “regulation-light” U.S. states.

These captive insurers create a complex web of financial relationships. For instance, a parent company might establish a captive insurer in a tax-advantaged jurisdiction. This captive insurer could then reinsure risks with other insurers, potentially including those involved in the PRT transaction. This circularity raises concerns about potential conflicts of interest and the true financial strength of the insurers ultimately responsible for backing the pension obligations.

A growing trend

Dempsey v. Verizon is part of a growing ERISA lawsuit trend focusing on the complexities of pension risk transfers and the critical importance of safeguarding the retirement security of workers. As companies increasingly turn to PRT to manage their pension obligations, it is crucial to ensure that these transactions are conducted ethically and transparently, with the best interests of plan participants at the forefront.