A Less Expensive Way to Provide Better Retirement Benefits -- DB

I've been pushing defined benefit (DB) plans hard lately. I still believe in them. The problem as I have noted is that regulators don't. They have done everything they can to kill them. Many are gone, many remain.

Yesterday, I happened upon a brief from Boston College's Center for Retirement Research. If you want, you can get the full brief here. In the brief, based on 23 years of data, Alicia Munnell, Jean-Pierre Aubry, and Caroline Crawford -- all from the CCRC -- demonstrate that returns on assets in DB plans actually are better than those in defined contribution (DC) plans.

When you combine this with the inability of many to defer enough to their 401(k) plans to get the full company match, you can see why many will never be able to retire well with a 401(k) as their core retirement plan.

For years, though, the cry has been that people understand 401(k) plans, but don't understand DB. But, suppose I gave you a DB plan that looked like a DC plan, provided returns for participants like a particularly well-invested DC plan, provided better downside investment return protection than a DC plan, and cost the employer less than a DC plan. What would you think?

In the Pension Protection Act of 2006 (yes, that was more than 9 years ago), Congress sanctioned what are now known as market return cash balance plans. What they are are DB plans that look like DC plans to participants, provide more and better opportunities for participants to elect annuity forms of distribution if they like, and provide the opportunity for plan sponsors to control costs and create almost a perfect investment hedge if they choose.

Suppose you had such a plan. Suppose to participants looking at their retirement website, the plan just looked like another account any day they chose to look. Suppose the costs were stable. Suppose the plan provided you as a sponsor more flexibility.

That would be nirvana in Xanadu, or something like that, wouldn't it?

Women's Pension Protection Act

Without much fanfare, on September 30, Senator Patty Murray (D-WA) introduced the Women's Pension Protection Act of 2015. Thus far, all of the co-sponsors are Democrats (or caucus as Democrats) and until Senator (and Democratic Presidential hopeful) Bernie Sanders (I-VT) signed on, all of the co-sponsors were women.

The bill is intended to address what a fairly large number of us view as an issue, that women are often not as prepared for retirement as men. And, there is no real thought here that this is because women choose to not prepare, but instead that their life circumstances (women bear children and men don't) are often different.

With no Republicans signing on, it seems unlikely that this bill will become law on a stand-alone basis, but it could become a negotiating point and get tossed into another bill of type or another that has broader support.

Generally, the bill would make two key changes:

• Require spousal consent for lump sum distributions from defined contribution plans unless those distributions are made as part of a direct rollover (to another plan or IRA)
• Change the coverage rules of ERISA Section 202 and analogously Code Section 410 to require broader coverage under qualified retirement plans for part-time workers who customarily work at least 500 hours per year

Fundamentally, what this bill would attempt to do is a step in the right direction. However, the implications of this bill from an employer standpoint would be to increase the cost of employing part-time workers. For many businesses that do employ such low-hour (10-20 hours per week or seasonal) workers, their choices would seem to come from among these:

• Absorb the additional costs of employing these part-timers
• Employ fewer part-time workers
• Not have a qualified retirement plan

Two of those three options are not good for women (or for men, for that matter). And, this appears to be part of a trend in legislation that increases the cost of part-time, seasonal, and temporary labor.

Proponents of the bill would say that something needs to be done and that this would be a good start. They would tell you that minimum wages need to be raised and there needs to be a place in the workforce for less than full-time workers who will eventually be able to retire.

As I said, I would be very surprised if this bill were to move anywhere on a stand-alone basis, but it could be a bargaining chip as part of a larger piece of legislation.

Pension Risk (where to) Transfer

I opened my Plan Sponsor News Dash this morning and staring me in the face was the headline "Pension Risk Transfer Decisions More Than Financial." It was catchy enough that I decided to click on the link. What I found was that the attendant article was based on a white paper published by Prudential.

Think about that. One of the insurers that seeks business from companies looking to transfer their pension risks is warning plan sponsors that there may be more than meets the eye. While I give Prudential credit for laying out some of the issues, their doing so would certainly make me if I were a plan sponsor think twice.

Prudential focuses on what they describe as the three pillars of service delivery:

• Retiree communication and education
• Transaction and transition
• Consultation and commitment

This is good stuff and it is important.

There are a few other elements that get less notice in the white paper (and perhaps it is Plan Sponsor's analysis of it). Prominent to me among those elements are the irreversibility of a decision to annuitize obligations of the plan and that such a decision is fiduciary in nature. Without commenting on whether they will have merit, what this commentator smells is litigation.

That's right. Not all annuity purchases will provide the same levels of security and service as plan sponsors expected. Without offering a legal opinion as I am not qualified to do so (I am not an attorney and do not and can not practice law), plan sponsors would appear to be well protected by following guidance from the Department of Labor (DOL) regarding "safest available annuity providers." But, as in many transactions that take time, that status could change during the process.

Consider insurer EL (those who were in this business 25 years ago may recognize a thinly veiled reference). At the time that defined benefit sponsor DBS makes its decision to annuitize certain of its obligations under the plan, EL has solid ratings from all of the major ratings agencies. DBS makes the decision based on a financial analysis to annuitize those obligations with EL. As we know, the process takes significant time and after a number of months, there are rumblings that EL may not be as solid as had been thought. Its ratings begin to slip.

Is DBS required to rethink its decision to annuitize with EL? Does it matter how far along in the process they are? Do the rumblings have to be substantiated? Do ratings have to have changed? Does anybody really know?

It's not unlikely that some attorney somewhere will find some potentially wronged participant or conversely and that the participant will decide that it's the right time to engage that attorney to litigate the matter. The fact is that even when you are fairly certain as a defendant that you will prevail in litigation, the defense is expensive. Did you factor that cost into your analysis of the financial effects of pension risk transfer (PRT)?

Suppose there was a better way. Suppose there was a way to intelligently transfer pension risk without making potentially questionable fiduciary decisions. Suppose you could leave the decisions that you really don't want to make up to your plan participants.

I'm not suggesting that you make the PRT process a democracy. No, I'm not suggesting that you assemble a quorum of participants and put the decision to a vote. But, there might be ways to give participants a say in the matter. And once a participant makes the decision for you, aren't you alleviating the burdens of litigation risk and front page of the newspaper risk?

If you are looking to go down the PRT road, annuitizing might be the right decision. On the other hand, it might not. 

Shouldn't you let someone else apprise you of other options? Isn't this the discussion you should be having as you start the new year?

Are You Missing Out Because Your Company Uses an actuary not an ACTUARY?

Okay, your company sponsors a defined benefit (DB) plan and you have an actuary and of course, your actuary is the best. Having been in this profession for 30 years, I've learned that most companies and their actuaries develop a mutual trust.

The reason is not as obvious as you think. How do I know that? It's because I have seen it in action. You see, actuaries produce numbers and results that most people don't understand. It seems magical. And because those numbers and results are often important to plan sponsors and the people who work for them, they develop a trust for the people who bring them those numbers.

Are those numbers correct? Almost always, they are.

So, tell us, John, what's your point? We should trust those actuaries, right?

In short, you should trust the numbers that they produce. Today, with sophisticated actuarial valuation software that is relatively uniform in the industry, most actuaries produce about the same bottom line numbers in an actuarial valuation.

So, what's the problem? It's just a commodity, isn't it?

Frankly, the problem may be in what your actuary doesn't tell you that an ACTUARY would. What I'm not being specific about here are things that would take up far too much space for this blog. But, how well do you understand the true financial effects of your plan? Are there opportunities that you are missing out on because your actuary hasn't told you? Is the problem that your actuary just hasn't thought about these things?

Honestly, it doesn't matter why you're not getting that kind of information, but just that you're not getting it.

An ACTUARY could show you what you're missing out on.

Contact me here or after January 1, contact me here.

It couldn't hurt, not even a little bit.

October Three

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The firm consists of many of the innovative consultants from the firm formerly known as Chicago Consulting Actuaries and CCA Strategies.

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Another Argument for Defined Benefit

I know, defined benefit (DB) plans are dead. Actually, while there aren't as many as there used to be, I'm going to give you one more argument why they make more sense as a retirement vehicle.

Yesterday, I wrote about managing the risk in active pension liabilities. Way back in 2010, I wrote about generally managing risks and noted that plan sponsors tend not to manage defined contribution plan risks. Most of those risks that I have considered have been financial risk. Today, I am going to focus on the intersection of financial risk and compliance risk and make a case to have a DB plan as your primary retirement vehicle rather than a 401(k) plan.

In the world of 2015, we see consolidation in many industries. We also see companies, often private, being gobbled up by private equity firms. Either of these actions will usually create a larger controlled group. And, people who focus on retirement plan compliance know that most retirement plan compliance testing must be done on a controlled group basis.

Before working to point out a solution, let me give you an example to help focus on the problem.

BPE is a big private equity firm. Their general approach to retirement plans (and other benefits) has been to ignore them and let each company do what it wants. But, as BPE get bigger, its controlled group gets more complex. Having multiple industries represented in its portfolio, BPE is ultimately the sponsor of all kinds of 401(k) plans. Their engineering company (EC) has an extremely generous 401(k) plan that matches 150% on the first 8% of pay that an employee defers. Their pork rinds company (PRC) has a 401(k) plan that matches 10 cents on the dollar on the first 2% of pay that an employee defers.

BPE never saw this as a problem. But, then one day, an inquisitive Principal (IP) at BPE was reading my blog (of all things) and came across this. He saw that BPE might have a compliance problem in its controlled group because of the disparate nature of its 401(k) plans.

Ring ring ring -- that's my phone as IP calls me. He wants to know how to fix the problem. He says that surely this problem can't be real. After an hour on the phone, we have inventoried all the plans at BPE and found that they have failed to satisfy various compliance tests (coverage under Code Section 410(b), for example) for several years.

IP has a solution though. He tells me that BPE will force some of its companies to retroactively cut the employer match in some of these more generous plans.

Bzzz!

You can't do that. In fact, if BPE were to choose to fall on its sword and approach the IRS for a negotiated retroactive solution, we would suspect that the IRS would only be receptive to increasing benefits for nonhighly compensated employees (NHCEs) in the less generous plans.

IP is not happy about this. PRC runs on very low margins, but because they make more pork rinds than any company in the world, they do throw off a lot of cash. However, increasing benefits would eliminate most of that free cash that is being generated. There is stunned silence on the other end of my phone.

While the story is fictitious, the gist of the scenario is not. I've seen this happen. By being a serial acquirer, companies run into compliance problems and with 401(k) plans not being the easiest to prove nondiscriminatory, either costs escalate or they get cut at the portfolio companies that tend to employ more higher paid individuals.

What sort of plan tests better? A few weeks ago, I wrote about some. Suppose BPE had a defined contribution looking cash balance plan. One of the nice things about these plans is that they test well. Designed properly, and proper design truly is a key, financial risk is manageable. And, with that as their primary plan, the secondary 401(k)s can be managed so that compliance there will no longer be an issue.

Unfortunately, the benefits world has been resistant to this whole concept. But, you have an open mind, don't you?

We need to talk.

Managing the Risk in Active Pension Liabilities

If you work with defined benefit (DB) pension plans at all, or if you happen to be among those responsible for them at a company that still sponsors an ongoing DB plan, you know that de-risking has been all the rage in recent years. And, this is not to say that this is not without good reason. With the inherent volatility in cash flow and accounting expense that has been added to the DB world by what some (including me) would consider poorly conceived funding and accounting rules, risk mitigation is often critically important.

So, let's consider what have been the trends in de-risking. There have been a mass of so-called lump sum windows in which former employees have been offered one-time opportunity to take a single sum distribution of the value of their remaining benefits thereby removing those liabilities from the plan's 'balance sheet' and thus eliminating the company's future liabilities with respect to them. And, there has been lots of liability driven investing (LDI). That is, companies look to invest assets in fixed income instruments of durations similar to the liabilities in the plan. By doing this, liabilities in the plan tend to move roughly in lockstep with the underlying assets intended to support those liabilities.

All this is great, especially for well-funded plans, but how about all the rest of those plans? And, these strategies tend to look at the liabilities that currently exist. How about the liabilities that will exist in the future (we used to consider those in actuarial valuations, but the law changes made them irrelevant in the annual valuations)? What do I mean by that? Consider an example.

The XYZ Pension Plan currently has its funding target (liability for accrued benefits). We can split that out among three groups of participants, two of which are composed of former employees. Suppose they are broken out as follows:

Retired participants: 100,000,000
Terminated Vested participants (former employees who are not yet in pay status, but are entitled to a benefit in the future): 30,000,000
Active participants: 70,000,000

for a total funding target of $200,000,000.

What do we know about the liabilities that compose this funding target? We know that the amount attributable to current retirees will generally decrease because for each year that a retiree lives, there are 12 months fewer of benefit payments that the retiree will receive in the future. This might tend to imply that this group represents a diminishing risk.

We know that the terminated vested group will become retirees. Generally, these are former employees with smaller benefits (they didn't work for the company until a retirement age). In the usual profile, they represent a far smaller liability than do retirees or actives. For a given vested term, the liability with respect to their benefit will generally increase as they approach retirement and then decrease. Lump sum windows were designed to target this group and have been quite successful. But, because their accrued benefits, and therefore attendant liabilities are smaller, the effect of having done this has not been as significant as it would be with a group of active employees.

The active employees currently accruing benefits are the most important group to de-risk. Why is this? There are several reasons:

• In our example, and typically, their accrued benefits represent a meaningful liability to the plan and plan sponsor.
• With each year that an active employee remains with the company, they are one year closer to retirement meaning that the discounting period until retirement has shortened.
• In an active plan, these employees continue to accrue benefits (more on this to follow).

Yes, active employees continue to accrue benefits. Suppose we consider a concept that used to be paramount to actuarial valuations of DB plans -- the actuarial present value of projected benefits under the plan (PVB). This is the actuarially determined amount that if it sat in a pool of assets today would be sufficient to eventually fund the benefits of that individual. 

For retirees and vested terms, the PVB and the accrued liability or funding target or accumulated benefit obligation (ABO in accounting parlance) are, save differences in actuarial assumptions, the same as each other and the same as the PVB.

For active participants, they are not. In fact, for a mid-career person, the PVB may be more than twice as large as the liabilities we are consider. And, if we are de-risking, isn't it really the eventual benefit liability that needs to be de-risked? 

If you agree, you're correct, and if you're a plan sponsor, we need to talk. 

If you disagree, you're likely not correct, and if you're a plan sponsor, we need to talk.

There is a really easy approach to this that many companies have taken and that is to freeze benefit accruals under the plan. But, not everyone wants to do that. Some companies actually philosophically like the concept of DB plans. But, the funding and accounting rules have made it more difficult to get comfortable with sponsoring them.

Suppose I told you that you could mitigate the risk in the active PVB. And, suppose I told you that you could do that without freezing accruals. 

You'd be interested, wouldn't you?

Let's talk. You won't regret it. Here is one way.