Background: CDS, spreads and fiduciary/prohibited-transaction relevance
How could you neutralize or hedge the single entity credit risk of an Annuity product and the answer is a Credit Default Swap (CDS). While a high-risk annuity like Athene has a double the default rate of a moderate-risk annuity like Prudential over the next 5 years, the risk differential increases significantly beyond 10 to 20 years, as most annuities have no maturity date.
What is a CDS
A credit default swap is a contractual derivative in which one party (the protection buyer) pays a periodic premium in basis points (bps) to another party (the protection seller) in exchange for a contingent payment if a reference entity suffers a “credit event” (e.g., default, restructuring) on its debt. The “spread” of a CDS (the premium in bps per annum) reflects the market’s assessment of the default-risk (or credit deterioration risk) of the reference entity. Credit default swaps are typically for a certain time, and the market for insurers typically only extends to 5 years for U.S. insurance providers. CDS in general do not exceed 10 years. However, many annuities are evergreen, lasting 20 years or more with no maturity, so these swaps only capture part of the risk.
Why the spread level matters
- A higher CDS spread implies higher perceived risk of default (or higher risk of credit deterioration) for the reference entity.
- For a fiduciary (e.g., under Employee Retirement Income Security Act of 1974 (ERISA)), when plan assets (or investment vehicles) have exposures to insurers, annuities, or other counterparties whose credit risk is elevated, the fiduciary may have a duty to monitor, disclose, hedge, or avoid those exposures (depending on context), especially if the risk was or should have been known and could materially affect the promised benefits or underlying guarantee.
- For prohibited-transaction analysis (e.g., revenue sharing, platform fees, cross-subsidies, insurer compensation layers), evidence that an insurer’s credit risk was materially elevated could support a “should have known” or “imprudent” argument regarding the selection/retention of that insurer, the structure of the product, or the disclosure given to the plan or participants.
- In the context of annuity/insurance products offered inside 401(k) plans, the insurer’s relative credit risk may affect the amortization of the “spread” compensation, the insurer’s ability to honor guarantees, and thus potentially the cost/damages metric. If CDS spreads are widening (i.e., compensation increasingly scarce, market‐perceived risk rising), a fiduciary reviewing a product with a “hidden spread” could argue that the risk component should have been captured and disclosed.
Market Snapshot: Indicative Insurer CDS (bps)
| Issuer | Tenor | Sept.2025 (bps) | As-of Date |
| MetLife | 5Y | 62.0 | Sep 30, 2025 |
| AIG | 5Y | 74.2 | Sep 30, 2025 |
| Prudential Financial | 5Y | 57.6 | Sep 30, 2025 |
| Lincoln National | 5Y | 97.8 | Sep 30, 2025 |
| Athene | 5Y | 111.8 | Sep 30, 2025 |
levels from September 2025 https://www.investing.com/
CDS rates do fluctuate. Prudential’s 5 year CDs rate went up to 62 bps in October 2025, but it has spiked to 86bps as late as January 2025 and was at 117bps in January of 2023.
https://www.investing.com/rates-bonds/prudential-financial-cds-5-year-usd
Why paying attention to CDS spreads is timely
- The spread is an objective market signal; it reflects trading, not just rating‐agency assessments.
- In a higher‐interest‐rate, higher‐spread environment, insurers may pursue riskier assets (e.g., private credit, leveraged finance) to maintain margins (as multiple recent studies show). That, in turn, can increase the tail risk of the insurer.
- From a damages perspective, if an insurer’s CDS spread increased materially after the fiduciary decision point (or was elevated at the time), one could argue that the “cost of guarantee” embedded in an annuity product was understated, or that the residual risk was underpriced. This could also have been seen as a failure to monitor the risk.
- In Pension Risk Transfers (PRT) it could capture the difference between a Private Equity Insurer, Athene, at 118bps and a more traditional insurer like Prudential at 57bps.
The CDS rate quantifies a portion of the risk damages to participants in a particular annuity product. This applies whether it is a fixed annuity or a lifetime income annuity in a DC 401(k) plan or a Pension Risk Transfer (PRT) annuity in a Defined Benefit Plan and creates a floor for damages.
Federal Reserve – Bomfim, Antulio N., Credit Default Swaps (May, 2022). FEDS Working Paper No. 2022-23, Available at http://dx.doi.org/10.17016/FEDS.2022.023
Life Insurers’ Private Credit Investments and Annuity Market Share Capture
By Ralf Meisenzahl , Jackson Overpeck , Andy Polacek https://www.chicagofed.org/publications/working-papers/2025/2025-09
Appendix: Why 5-Year CDS Understate the True Risk of Long-Dated Annuity Promises
1. The Mismatch Between 5-Year CDS Markets and 20–30-Year Annuity Liabilities
Credit Default Swaps (CDS) — the primary market-based measure of insurance-company credit risk — trade almost exclusively in 5-year maturities.
But annuity guarantees are evergreen obligations:
- IPG fixed annuities,
- Stable-Value general-account annuities, and
- Pension Risk Transfer (PRT) annuities
are effectively 20- to 30-year promises (or longer).
Most never “mature” at all — they persist until the insurer fails, is downgraded, or closes the block of business.
This creates a structural distortion: we are measuring a multi-decade promise using a 5-year price of risk.
No informed investor would price a 30-year bond from a single, BBB+/A- insurer based solely on its 5-year CDS cost — but that is exactly how the annuity industry presents itself to fiduciaries.
2. Why Risk Increases Exponentially With Time, Not Linearly
Credit risk does not accumulate in a straight line.
It increases non-linearly, because:
- Probability of adverse events compounds over long horizons.
- Insurer balance sheets change — often deteriorate — across cycles.
- Regulatory forbearance and accounting games increase in long tails.
- A 30-year horizon necessarily crosses multiple recessions, multiple interest-rate regimes, and at least one insurance-industry credit cycle.
This is why life insurers themselves never price long-term mortality risk by extrapolating short-term mortality tables.
But the annuity industry encourages fiduciaries to make exactly that mistake for credit risk.
3. Life-Insurance Pricing as an Analog for Annuity Credit Risk
A clean, intuitive analogy exists inside the same companies that issue PRT and IPG annuities: life-insurance pricing.
Consider a 50-year-old male purchasing:
- A 5-year term life policy (coverage to age 55), versus
- A lifetime policy (whole life or GUL).
The pricing difference is enormous:
- The insurer’s risk of the 50-year-old dying in the next 5 years is small.
- The insurer’s risk of that same person dying sometime between age 55–95 is essentially 100%.
Thus:
Long-dated promises cost exponentially more, not linearly more.
This mirrors annuity-credit economics:
- A 5-year CDS is like a 5-year term life policy:
Cheap, because the insurer is unlikely to fail within a short window. - A 20- or 30-year annuity guarantee is like a lifetime mortality promise:
The chance the insurer encounters a solvency event approaches certainty, not possibility.
4. The “Smoker Effect”: Why Impaired Insurers’ Long-Horizon Risk Blows Up Even Faster
Now assume the 50-year-old is a smoker.
- The cost of the 5-year term policy increases slightly.
- The cost of the lifetime policy increases dramatically.
This is the exact analog for insurers with higher CDS spreads (e.g., Lincoln, Athene, Fidelity & Guaranty).
A 50–100 bps 5-year CDS spread today is:
- A minor uptick over 5 years, but
- A geometric explosion of cumulative default probability over 20–30 years.
This is precisely the dynamic ignored by fiduciaries who use short-dated CDS as if they were long-dated measures of credit risk.
5. From 5-Year CDS to 30-Year Annuity Risk: The Mathematical Intuition
If a 5-year CDS implies a 3–4% cumulative default probability over 5 years (typical for BBB+ / A- insurers like Lincoln or Prudential), then:
- Over 20 years, the cumulative probability compounds to 12–16%,
- Over 30 years, it can reach 20–25% or higher,
- And when you incorporate loss given default, state guaranty cap exposure, and transfer-risk, the participant’s exposure becomes unacceptable for any plan fiduciary who claims prudence.
Thus:
A stable-value annuity or PRT annuity is effectively a long-dated corporate bond without a market exit. No fiduciary would buy a 30-year BBB+ bond as the principal-preservation option in a retirement plan. Yet they buy insurer general-account annuities every day.
6. Why This Matters for ERISA Fiduciaries
ERISA requires fiduciaries to evaluate all material risks, including:
- Credit risk,
- Single-entity risk,
- Liquidity risk, and
- Long-horizon solvency risk tied to the structure of the investment product.
But many fiduciaries — especially in health-system 401(k) plans — look only at:
- Current credit rating, or
- 5-year CDS levels.
This is the equivalent of analyzing a 50-year-old smoker’s mortality risk solely by looking at whether he is likely to die by age 55.
It ignores where the real risk lies.
7. Conclusion: Fiduciaries Should Treat Long-Dated Annuity Promises Like Long-Dated Mortality Promises
A universal rule applies across insurance and finance:
Short-term guarantees are cheap because the risk is small.
Long-term guarantees are expensive because the risk approaches certainty.
The entire annuity industry depends on fiduciaries not understanding this basic fact.
Yet the analogy is unavoidable:
- 5-year CDS = 5-year term life
- Long-dated annuity promises = whole-life insurance
- Higher-risk insurers = smokers
And just as no rational person would conclude that a smoker’s 5-year mortality risk says anything about his risk of dying sometime over the next 30 years,
no prudent fiduciary should treat a 5-year CDS spread as a reliable indicator of long-dated annuity-credit stability.
ERISA requires better. Participants deserve better.
And the data is clear: long-dated annuity risk is exponentially higher than 5-year CDS markets reveal.
November rate updated Lincoln 105bps Prudential 62bps
CDS rates:
Curve Name Equity Ticker CDS Ticker 5Y Aegon Ltd 1379688DNA CAEGO1E5 53.36519 American International Group Inc AIG US CAIG1U5 59.30682 Athene Global Funding 1334319DUS CZ029240 #N/A N/A ING Groep NV INGA NA CINT1E5 49.93183 Lincoln National Corp LNC US CLNC1U5 113.5128 Massachusetts Mutual Life Insurance Co 2137Z US CT661502 #N/A N/A MetLife Inc MET US CMET1U5 62.51335 Principal Financial Group Inc PFG US CX664874 #N/A N/A Prudential Financial Inc PRU US CPRU1U5 63.75882
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