Thursday, July 23, 2015

Derisking Your Defined Benefit Plan or Not

Every couple of years, there is a new trend in the remaining corporate defined benefit plans. Lately, it has been derisking in one sense or another. In fact, the Mercer/CFO Research 2015 Pension Risk Survey says that plan sponsors have been spurred by a perfect storm of events.

I'm not going to argue with there having been a perfect storm of events, but I think that everyone else's idea of what constituted the perfect storm is a bit specific and technical. They focus on falling interest rates, a volatile equity market, and a newly (last year) released mortality table. Instead, I would tend to focus on constantly changing pension rules both in the law and in financial accounting requirements that give plan sponsors a constantly moving target.

But, all that said, the study tells us that 80%-90% of plan sponsors are pleased with the risk management actions they have taken to date. What makes them pleased? Is it that they have cleaned up their balance sheets? Is it that their funding requirements have decreased? Has the derisking decision helped them to better focus on or run their businesses?

Isn't that last one what should be at the crux of the matter? The fact is that 2014 was not a good year to offer lump sum payments to individuals with vested benefits if what you were looking to do was to pay out those lump sums when the amounts would be low. Underlying discount rates were very low meaning that lump sums would be larger. Similarly, the cost of annuities was high, but many chose to purchase annuities for substantial parts of their terminated and retired participants.

What all of these plan sponsors did was to decrease future volatility in pension costs (however they choose to think of cost). For many, that truly was a good thing. But, at what cost?

For some, that cost was significant. For others, it was not.

Defined benefit pension plans used to be viewed as having a degree of permanence. That is, when funding them, calculations assumed that the plan would go on forever. While we know that forever is a very long time, we also know that plans with benefits that are based on participants' pay in the last years of their careers are wise to consider the amounts that they are likely to have to pay out in the future as compared to the amounts that would be paid out if everybody quit today. That is not reality. There used to be what are known as actuarial cost methods that allowed sponsors to do that and frankly, they resulted in larger current required contributions. But, those larger current contributions tended to be very steady as a percentage of payroll and that was something that CFOs were comfortable with.

But, the wise minds in Congress with the advice of some key government workers determined that this was not the right way to fund pension plans. Actually, their real reasons for doing so were to reduce tax deductions for pension plan funding thereby helping to balance the budget.

Sounds stupid, doesn't it? It is stupid if what you are doing is making sponsorship of a pension plan untenable for most corporations.

Risk truly became a 4-letter word for pension plan sponsors. As time went by, it became important for sponsors to find new ways to mitigate that risk.

Unfortunately, many of them have been so eager to do that over the last few years that they likely overspent in their derisking efforts. For others, it was clearly the prudent thing to do.

My advice is this if you are considering your first or some further tranche of derisking. Consider the costs. Consider how much risk you mitigate. Make the prudent business decision. What would your shareholders want you to do?

Then decide whether you should derisk.

Wednesday, July 15, 2015

Get Your 401(k) Design Right

I happened to read a few things today about 401(k) matching contributions. One in particular talked about stretching the match. Apparently that means that if you are willing to spend 3% of pay on your workforce, consider making your match 50 cents on the dollar on the first 6% of pay deferred instead of dollar for dollar on the first 3% of pay deferred. This will encourage employees to save more.

That might be a really good idea ... for some companies. For other companies, it might not be.

First and foremost a 401(k) plan is, and should be, an employee benefit plan. Taken quite literally, that means that it should be for the benefit of employees.

Plan sponsors may look at the plan and say that they get a tax deduction. That's true, but they also get a tax deduction for reasonable compensation. And, there is probably less of a compliance burden with paying cash than there is with maintaining a 401(k) plan.

Where does the typical 401(k) design come from? Usually, it's the brainchild, or lack thereof, of someone internal to the plan sponsor or of an external adviser. Either way, that could be a good thing or a bad thing. Most plan sponsors have plenty of smart and thoughtful employees and many external advisers are really good.

On the other hand, when it comes to designing a 401(k) plan, some people just don't ask the right questions. And, just as important, they don't answer the right questions. We often see this in marketing pieces or other similar propaganda that talk about designing the best plan. We might see that the best plan has all of these features:

  • Safe harbor design (to avoid ADP and ACP testing)
  • Auto-enrollment (to get higher participation rates)
  • Auto-escalation (so that people will save more)
  • Target date fund as a QDIA (because virtually every recordkeeper wants you in their target date funds)
All of these could be great features for your 401(k) plan, but on the other hand, they might not be. Let's consider why.

Safe harbor designs are really nice. They eliminate the need for ADP and ACP nondiscrimination testing. They also provide for immediate vesting of matching contributions. Suppose your goal, as plan sponsor, is to use your 401(k) plan at least in part as a retention device. Suppose further that every year, you pass your ADP and ACP tests with ease. Then, one would wonder why you are adopting a plan with immediate vesting whose sole benefit is the elimination of ADP and ACP testing. Perhaps someone told you that safe harbor plans were the best and you listened. Perhaps nobody bothered to find out why you were sponsoring a 401(k) plan and what you expected to gain from having that plan.

Auto-enrollment is another feature that is considered a best practice. (Oh I despise that term and would prefer to call it something other than best, but best practice is a consulting buzzword.) Most surveys that I have read indicate that where auto-enrollment is in place, the most common auto-enrollment level is 3% of pay. Your adviser who just knows that he has to tell you about auto-enrollment tells you that it is a best practice. Perhaps he didn't consider that prior to auto-enrollment, you had 93% participation and that 87% of those 93% already deferred more than 3% of pay. Since he heard it was the thing to do, he advised you to re-enroll everyone and now, you are up to 95% participation, but only 45% of them defer more than 3% of pay. Perhaps nobody bothered to ask you how your current plan was doing.

In the words of a generation younger than me, this is an epic fail.

I could go on and on about other highly recommended features, but the moral of the story is largely the same. Your plan design should fit with your company, your employees, your recruiting and retention needs, and your budget. That your largest competitor has a safe harbor plan doesn't make it right for you. It may not even be right for them. That the company whose headquarters are across the hall from yours has auto-escalation doesn't make it right for you. It may not be right for them either.

If you are designing or redesigning a plan for your company, ask some basic questions before you go there.
  • What do you want to accomplish with the plan?
    • Enough wealth accumulation so that your employees can retire based solely on that plan?
    • Enough so that the plan is competitive?
    • Something else?
  • Will eliminating nondiscrimination testing be important?
  • What is your budget? Will it change from year to year? As a dollar amount? As a percentage of payroll?
  • What do you want your employees to think of the plan?
    • It's a primary retirement vehicle.
    • My employer has a 401(k) plan; that's all I need to know.
    • My employer has a great 401(k) plan.
    • My 401(k) is a great place to save, but I need additional savings as well.
  • Will any complexity that I add to the plan help my company to meet its goals or my employees to meet their goals? If not, why did I add that complexity?
These are the types of questions that your adviser asked you when you designed or last redesigned your plan, aren't they?

They're not?

Perhaps it's time to rethink your plan.

Wednesday, July 8, 2015

You Run a Business -- Why Do You Choose to be in the Benefit Plan Business, Too?

You've been successful in the business world. You've made your way up through the ranks. Suddenly, because your title starts with the word "chief", you find yourself on the company's Benefits (or some other similar name) Committee.

You're an accidental fiduciary. You have no benefits training. You've never studied ERISA. In some cases, you've never heard of ERISA. What are you doing in this role and why?

Perhaps there is not a single person on your committee with a strong grounding in ERISA issues. But, you know that in order to compete for employees, you have to provide your employees with some benefits. It's likely that some or all of those benefit plans are covered by ERISA. And, ERISA coverage brings with it a myriad of rules and requirements.

Oh no, now I have you panicking. What should you do?

Let's consider one of the most common benefit plan offerings in 2015, the 401(k) plan. What is your committee responsible for? Do you know?

While one could argue that the list might be slightly different, here is a pretty decent summary:

  • Plan design
  • Selection of plan investment options
  • Compliance (with laws, regulations, and other requirements)
  • Plan administration
  • Communication to participants and education of those participants
That's a lot to swallow. Look around your committee. Presumably, since the committee has responsibility for all of those elements, at the very least, you can find people in the room who, between them, have expertise in all of those areas,

You can't? 

Do you really want the responsibility that comes with being a member of that committee when you have just realized that the expertise to handle the committee's roles doesn't reside on the committee?

You have choices, or at least you might. You could resign from the committee. Frankly, that usually doesn't go over well.

You could engage an expert. Suppose you could find an individual who could function in the role that a committee Chair would play in a perfect world. We're likely talking about someone who doesn't work for your company. This person will bring you peace of mind and essentially serve as the quarterback for the committee. He or she won't have a vote, but will guide you through the processes so that 

  • Your plan is well-designed for your population and budgets, 
  • It has investment options for plan participants that are prudently chosen and monitored according to an Investment Policy Statement (sometimes called an IPS), 
  • It gets and stays in compliance with applicable rules, 
  • Is administered properly and the firm that administers it is well-monitored, and
  • Is communicated to participants in a clear fashion that properly educates those participants as to the benefits of plan participation.
That sounds great, doesn't it?

If you don't currently have such a quarterback for your committee, perhaps you should. I can help you find one.

Tuesday, July 7, 2015

DOL Weighs in Again on Top-Hat Plans

ERISA contemplated so-called top-hat plans. In fact, it spelled out exactly what was contemplated in providing this opportunity for nonqualified deferred compensation so clearly that the legislative intent could never be misconstrued.

No, it didn't.

As is often the case when bills go from staffer to staffer and then to the floors of the houses of Congress, the bills tend to emerge with run-on sentences often punctuated by a myriad of commas making Congressional intent something upon which otherwise knowing people cannot agree.

Perhaps, some day they will learn.

No they won't, not in my lifetime anyway.

In any event, in a case (Bond v Marriott) concerning top-hat plans in front of the 4th Circuit Court of Appeals, the Department of Labor (DOL) wrote an amicus brief providing its opinion on the statutory wording around top-hat plans.

So, I know that those not familiar are just itching to find out. What does the statute say?

Congress gave us an exception to certain provisions of ERISA for a "[p]lan which is unfunded and is maintained by an employer primarily for the purpose of providing deferred compensation for a select group of management or highly compensated employees."

What is the primary purpose of a top-hat plan? Is it to be primarily for providing deferred compensation to a select group that is composed of management or highly compensated employees? Or, is it to be for providing deferred compensation to select group that is composed primarily of management or highly compensated employees?

It's one of those great questions that has confounded us through the ages. No, actually, it's a question that has confounded a select group of us since the passage of ERISA in 1974. To add to that confounding just a bit, everyone who practices in this field knows what a highly compensated employee is. The term is well defined in Code Section 414(q). But wait, Section 414(q), as written, has only been around since 1986 (added by Tax Reform) meaning that perhaps for these purposes, we don't even know what a highly compensated employee really is.

In its amicus brief, the DOL gives us its opinion, one that it claims to have held at least since 1985 and perhaps longer. The DOL tells the court that the primary purpose should be the provision of deferred compensation [for this select group] and that other purposes might include retaining top talent, allowing highly compensated individuals to defer taxation to years with lower marginal tax rates, or avoiding certain limitations applicable to qualified plans in the Internal Revenue Code. DOL further tells us that it does not mean that the select group may be composed primarily [emphasis added] of management or highly compensated employees or that the plan may have some other secondary purpose which is not consistent with its primary purpose.

The brief goes on to give us the judicial history around the provision and of course informs us which case law got it right and which did not. But, the DOL is clear in its claims and steadfastly denies that exceptions should be allowed.

I may be missing something here regarding the DOL. I think that the DOL has regulatory purview over ERISA. While the DOL has ceded that purview most of the time to the IRS where the Internal Revenue Code has a conforming section, that does not seem to be the case here. Could the DOL not have written regulations in 1975 or 1985 or 1995, or 2005 clarifying who, in fact, is eligible for participation in a top-hat plan? Or did they think it so clear that it was not worth their effort, despite being befuddled by decision after decision handed down by federal courts?

I know that when I got into this business, coincidentally in 1985, the more experienced people who taught me instructed that top-hat plans were to be for a group that was primarily management or highly compensated. In fact, it is difficult, in my experience to find practitioners who learned otherwise.

Perhaps that's wishful thinking. Perhaps, on the other hand, it's wishful thinking on the DOL's part. Perhaps the case will go to the US Supreme Court eventually so that nine wise jurists can put their own spin on it and settle this argument once and for all.

Until then, ...