Fixing Retirement Inequality

Just last week, I suggested that retirement inequality is nearing an apocalypse. It's an awfully strong statement to make as both the US and the world have plenty of problems to deal with. Since this one is US-centric (I have nowhere near sufficient expertise nor do I have the requisite data to offer an informed opinion outside the US), I thought I would step up and make some suggestions.

First, the problem: according to the most optimistic data points I have seen, somewhere between 60 and 70 percent of working Americans are "on track" to retire. And, these studies, when they are nice enough to disclose their assumptions use pretty aggressive assumptions, e.g., 7 to 8 percent annual returns on assets (the same people who tout that these are achievable condemn pension plans that make the same assumptions) as well as no leakage (the adverse effects of job loss, plan loans, hardship withdrawals, and deferral or match reductions). The optimists don't make it easy for you by telling you that even their optimistic studies result in 30 to 40 percent of working Americans not being on track to retire (a horrible result). They also tend to pick and choose data to suit their arguments using means when they are advantageous, but medians when they are more so.

Yes, we do have a retirement crisis and as the Economic Policy Institute (EPI) study was good enough to make clear, it is severely biased against the average worker.

The EPI study presented data on account balances and similar issues. It did not get into interviewing actual workers (if it did, I missed that part and apologize to EPI). But, I did. I surveyed 25 people at random in the airline club at the largest hub airport of a major US-based airline. People who wait in those clubs at rush hour are not your typical American worker; they tend to be far better off. I asked them two questions (the second only if they answered yes to the first):

• Are you worried about being able to retire some day? 19 answered yes.
• Would you be more productive at work if you felt that you could retire comfortably? All 19 who answered yes to the first question answered yes to the second as well.

While I didn't ask further questions, many groused about fear of outliving their wealth. Some talked about issues that fall under leakage. A few, completely unprompted remarked that if they only had a pension ...

For at least the last 13 years and probably more than that, retirement policy inside the Beltway has been focused on improving 401(k) plans with the thought that pensions are or should be dead. Even the Pension Protection Act of 2006 (PPA) was more about making 401(k)s more attractive than about protecting pensions. Yet, 13 years later with an entire decade of booming equity markets, even the optimists say that one-third of American workers are not on track to retire.

We've given every break that Congress can come up with to make 401(k)s the be all and end all of US retirement policy. They've not succeeded. 

Think back though to when the cornerstone of the US retirement system was the pension plan. The people who had them are often the ones who are on track to retire. 

Yes, I know all the arguments against them and here are a few:

• Workers don't spend their careers at one company, so they need something account-based and or portable.
• Companies can't stand volatility in accounting charges and in cash contribution requirements.
• Nobody understands them.
• They are difficult to administer.

PPA took a step toward solving all of those problems, but by the time we had regulations to interpret those changes, the "Great Recession" had happened and the world had already changed. Despite now having new pension designs available that address not just one, but all four of the bullet points above, companies have been slow to adopt these solutions. To do so, they need perhaps as many as three pushes:

• A cry from employees that they want a modern pension in order to provide them with usable lifetime income solutions.
• A recognition from Congress and from the regulating agencies that such plans will be inherently appropriately funded and therefore (so long as companies do make required contributions on a timely basis) do not pose undue risk to companies, to the government, to employees, or to the Pension Benefit Guaranty Corporation (PBGC) (the governmental corporation that insures corporate pensions) and therefore should be encouraged not discouraged.
• Recognition from the accounting profession in the form of the Financial Accounting Standards Board (FASB) that plans that have an appropriate match between benefit obligations and plan assets do not need to be subjected to volatile swings in profit and loss.

Give us those three things and the pensions sanctioned by the Pension Protection Act can fix retirement for the future. As the EPI study points out, we'll make a huge dent in the retirement crisis and we'll do in a way that makes the problem far less unequal.

It's the right thing to do. It's right for all working Americans.

S&P Implies Hospital Pensions Are Not a Problem -- I'll Be the Judge

I read two excellent articles on the same topic recently. Both Rebecca Moore for Plan Sponsor and Jack O'Brien for Health Leaders Media wrote about an S&P study that implied that pensions are not a problem for not-for-profit hospitals in the US. I found the different perspectives interesting as Rebecca is a retirement plan journalist who was covering a hospital retirement issue while Jack is a hospital journalist who was covering a retirement issue with regard to hospitals.

In summary, here is what I learned:

• The U.S. not-for-profit health care sector has benefited from an increase in the median funded status of its pension plans in fiscal 2018—increasing from 80.6% to 85%, according to S&P Global Ratings;
• S&P measures the underlying pension liabilities using a "conservative municipal bond rate;"
• S&P applauded that many hospitals have focused on de-risking liabilities;
• S&P views the following as positive with respect to hospital pensions:
• Full funded status;
• Any sort of de-risking; and 
• No pension plan at all.

I'm not going to spend a lot of time dissecting what S&P thinks is good. As a firm, they employ many excellent economists while my formal economic training is quite sparse. But, I'd be remiss if I did not comment on the use of municipal bond rates. While they are not far from the measures typically used for corporate pension plans, I'm not sure how movement in yields on municipal bonds should affect the measurement of obligations in hospital pensions.

Let's return to the initial premise that being that hospital pensions are well-managed (I said not a problem in my title, but the words that were actually used were well-managed). Are they? Is 85% a good funded status? Are the hospitals managing frictional overhead costs? Is de-risking the right approach for a plan that is 85% funded? If so, which type(s) of de-risking should they be using?

While it's not the case for all of them, the majority of hospital pension plans are either [hard] frozen or they are soft frozen (no new entrants). This implies that the goal is to eventually terminate those plans. A plan that is 85% funded cannot be terminated. In fact, generally speaking, a plan that is 100% funded on the basis that S&P uses cannot be terminated (annuities have some level of built-in costs as compared to a traditional actuarial measurement of pension obligations). 

Getting from 85% funded to just a bit more than 100% funded is a tall task. There are a number of ways to make progress on this, some passive and some active. They include watching discount rates increase, investing more aggressively (and hoping that produces better returns), contributing more money to the plan, and cutting the overhead costs of the plan.

Let's attack those in order.

Unless a hospital has more control over the economy than I think it does, it cannot affect the yields on municipal bonds.

Investing more aggressively works well when it works well meaning that if you can beat your bogie, you improve your funded status and get closer to being able to terminate the plan.

Contributing more money to a plan is an easy concept. All it requires is having money to contribute. In 2019, hospitals, generally speaking, don't seem to have that kind of money laying around. On the other hand, hospitals do have lots of assets many of them not pulling as much weight as they might were they re-deployed into the hospital pension plan. I have some ideas in this vein, and would be happy to tell you about them.

Finally, for the last three years, October Three has published a report on PBGC premiums. The report has found that hospitals, compared to any other industry, are consistently paying more in needless PBGC premiums than any other industry. In other words, there are techniques available to them to lower those premiums that as a group, they are not using.

So, with all due respect to S&P, the judge has ruled. Hospital pension are a problem and generally speaking, hospitals are not managing those pensions well. The judge thinks those hospitals should contact him.

District Court Affirms Withdrawal Liability Calculations, But Appears to Leave an Opening

Working right before the holiday, New Jersey District Court Judge Kevin McNulty issued a lengthy opinion late on July 3 in Manhattan Ford Lincoln, Inc. v UAW Local 259 Pension Fund. The case concerns the withdrawal liability assessed against Manhattan Ford, a withdrawing employer from a multiemployer pension plan and the actuarial assumptions used for the calculations. While this is far from the first case on this topic, it may be instructive to contributing employers who are considering withdrawing from multiemployer plans and for consultants and actuaries who work with these plans.

Before diving too deeply into the case, we need some background for readers who do not work in the multiemployer plan world on a daily basis. As the background is geared toward the more casual reader than to the multiemployer expert, we've intentionally omitted some details.

In 1980, Congress passed and President Carter signed into law the Multiemployer Pension Plans Amendments Act (MPPAA). In part, MPPAA established the concept of withdrawal liability as a means of ensuring that employers who choose to leave those plans pay their fair share of any unfunded liabilities.

For years, one of the frustrations of many who are involved with multiemployer plans has been the lack of guidance on actuarial assumptions particularly the discount rate to be used in determining the vested benefit liability (VBL) under a plan. That said, the statutory language that provides much of the guidance that we have in this arena and the language that the fund's actuary looks to in determining the discount rate to be used in annual actuarial valuations are somewhat instructive.

Quoting from a footnote in Judge McNulty's opinion, "The main upshot, for our purposes, is that under current law, 'each' actuarial assumption must be reasonable for the purpose of minimum funding, whereas they must be reasonable 'in the aggregate' for purposes of withdrawal liability." The language here is strikingly similar yet as we will discuss later, the calculations are often very far apart.

In this particular case, the plan's Enrolled Actuary (EA) used the Segal Blend (a method developed by the Segal Company in the early days of MPPAA) as a means of discounting in order to determine the fund's VBL and therefore the unfunded vested benefits (UVB) as well. To understand this case and the distinctions we will make later, we'll have to get hypertechnical (yet still oversimplified) for a moment to explain the Segal Blend. The Segal Blend essentially does two calculations and blends them. It considers that liabilities that can be settled by plan assets are assumed to have their risk transferred and therefore use PBGC rates (the rates inherent in insurance company annuity settlements) to discount the liabilities. But, for the portion of the liabilities not covered by plan assets, it acknowledges a risk premium and uses the funding interest rate (the EA's best estimate of future investment returns).

In Manhattan Ford, the fund's calculation performed by the EA showed that the withdrawing employer owed a roughly $2.5 million withdrawal liability based on the Segal Blend. The employer challenged the calculation and an arbitrator found in favor of the fund. Manhattan Ford appealed to the District Court.

Judge McNulty found that two essential questions were raised [quoting]:

1. As a matter of ERISA law, must a pension plan's actuary use identical actuarial assumptions to calculate the plan's satisfaction of minimum funding requirements and its unfunded vested benefits ("UVB") for withdrawal liability?
2. Assuming the answer to question 1 is "no," did the Arbitrator err in this case when he found that the discount rate applied by the Pension Fund's actuary to determine Manhattan Ford's withdrawal liability, the Segal Blend, did not render the actuarial assumptions "in the aggregate, unreasonable (taking into account the experience of the plan and reasonable expectations)"?

The Judge found that answer to both questions to be "no" and granted summary judgment to the Pension Fund. Summary judgment is granted only when the Court finds that the movant shows that there is no genuine dispute as to any material fact and the movant is entitled to judgment as a matter of law. Stated differently and from an extremely non-legal perspective, the Court found that even if all of the facts claimed by Manhattan Ford were true, it still had no valid case.

Thinking about this as a consulting actuary or even putting us in the lens of a withdrawing employer, this would appear to leave little room. And, this would appear that based on the fact pattern in this case that at least in the District of New Jersey that the Segal Blend produces results that are not unreasonable (note that the burden of proof here by statute is on the withdrawing employer).

What this opinion specifically does not say, however, is that the EA's judgment is infallible or indisputable. While the opinion did not address this, that the statute gives withdrawing employers the ability to challenge withdrawal liability calculations suggests that ERISA contemplates that there are, in fact, valid challenges.

What might they be?

We've seen a number of calculations of withdrawal liability where all of the discounting is done using PBGC rates. To understand the significance of this, note that in recent years, PBGC rates for this purpose have often been less than 3% while funding interest rates are often in the vicinity of 8%. Conservatively, changing the discount rate from 8% to 3% could increase liabilities by anywhere from 40% to more than 100% depending on the demographics of plan participants. For purposes of an example, let's use 60% and further, for extreme simplicity, let's assume that all liabilities of our hypothetical multiemployer plan are vested.

Suppose our plan has assets of $1 billion and liabilities discounted at 8% of $1 billion. Then, the unfunded liability at 8% is $0. However, decreasing our discount rate to 3% increases our liabilities to $1.6 billion and increases our unfunded liability from $0 to $600 million. That helps us to illustrate the extreme leverage inherent in many of these calculations.

So, to return to some of the questions at hand, let's suppose that the 8% discount rate applied in the annual valuation of the plan is the EA's actuarial assumption. In fact, when he has put it on the Schedule MB to Form 5500, he has asserted under penalty of perjury that it is reasonable. And, he has similarly asserted under penalty of perjury that each of his other assumptions is reasonable. Finally, he has asserted that, in combination, these assumptions offer his best estimate of expected future experience under the plan.

Now, the EA is asked to perform a withdrawal liability calculation. In performing that calculation, he keeps all assumptions except for the discount rate the same as they were for minimum funding. But, he changes the discount rate from 8% to 3%.

If each assumption is individually reasonable, one can extrapolate that the set of assumptions, in the aggregate, is reasonable. 

Given that the unfunded liability has increased from $0 to $600 million and even conceding that the purpose of the measurement is different, this begs the question as to how the revised assumptions (only one is revised), in the aggregate, can also be reasonable.

Withdrawing and potentially withdrawing employers should weigh these issues carefully when withdrawing. In combination with counsel and with other experts including actuaries, they should also weigh these issues when appealing a determination of withdrawal liability.

How Big Does Your ROI Have to Be? You Can Get It Here

Let's make believe it's 2018. Let's further make believe that the Tax Cuts and Jobs Act (TCJA) or whatever it's long-winded name turned out to be was signed into law late last year. And, let's finally make believe that you hold a corporate position where you get to weigh in on corporate investments and deployment of capital.

Just how big of a return on investment do you need to be able to project in order to pull the trigger?

8%? 10%? 12%? 15%?

For most of you, I'm guessing that I've finally surpassed or at least hit your target. You'll definitely want to read on. For those that need a bigger number, give me a chance. But, I didn't want to scare away those people who think that really big numbers are only found in Fantasyland.

For those of you that really want to get into the technical details, I'm going to refer you to an excellent piece written by my Partner, Brian Donohue. Some of you may not want to get into that level of gory detail and you just want the big picture and a summary to convince you, you've come to the right place.

First off, you need to sponsor a defined benefit (DB) pension plan. It's fine if it's of the cash balance or some other hybrid variety. So, let's suppose that you do because if you don't and you have no plans to, unless you just really love my writing or just have a strange desire to find out what you are missing out on, you can probably stop reading now.

I don't want to put this in terms of dollars because if I talk about billions and you are a $100 million company, you may not think this is for you. And, conversely, if I talk about millions and you think millions go away in rounding, you won't think it's for you. So, let's talk about units.

Suppose your DB plan is fully funded on a Schedule SB basis. In other words, your funding target and your actuarial value of assets both equal 1000. Then your minimum required contribution, generally speaking, is equal to your target normal cost, probably not a big number compared to what we are talking about here.

Despite not having to, contribute 200 units. Go ahead. Do it. Trust me. I wouldn't sell you snake oil.

Here are your benefits from having done so before September 15, 2018 (assuming calendar year plan year and tax year):

• The 200 units are tax-deductible under Code Section 404 for 2017 when your corporate marginal tax rate was likely 35% (yes, there are unusual circumstances where they may not be or where the deductions may not be of value to you, but for most sponsors, this is the case) as compared to 21% beginning in 2018. Savings of 14% of 200=28 units.
• Your PBGC variable rate premiums may come down by as much as 8 units, But that could be as much as 8 units per year for multiple years (let's call it 5 years for sake of argument). Savings of 8 units times 5 years=40 units.

That's 68 units of savings on a 200 unit deployment of cash. That's 34%.

Now, I'm not going to claim that your ROI here is actually 34%. Yes, you will contribute these amounts more than likely in future years and when you do, you will take a tax deduction. But, you'll take it in the future (you remember time value of money) and you'll only get a 21% deduction when you do. And, yes, you may not get those full PBGC savings and some of them will be in the future, but your savings are likely to be significant.

And, then there is the other really key benefit -- your plan will now have a surplus on a funding basis meaning that you almost certainly don't have to contribute and deal with volatility of minimum required contributions in the near future.

I'd be doing you a disservice, of course, if I didn't give fair consideration to the downsides and perceived downsides of this strategy. So, I'm going to shoot straight with you.

Yes, you will have 200 units of cash tied up with no immediate means of accessing it. However, it's getting you a pretty good and rapid ROI, so in most cases, I think you'll get over that one.

Pension surplus is considered to be a bad thing. In fact, prevailing wisdom is that pension surplus is worth only pennies on the dollar. Well, sometimes prevailing wisdom shouldn't prevail.

If your DB plan is ongoing, this is just advance funding, plain and simple. It's money that you would have to contribute and the future when you could take your deductions at a 21% marginal tax rate.

If your DB plan is frozen, the argument is a little trickier. But, for most sponsors, if you do have a frozen plan, the cost to terminate is likely going to exceed your funding target. In fact, it's likely to exceed your funding target by a fair amount. So, those 200 units will be put to use.

But, let's take the extreme scenario where your investments do well, interest rates rise, and those 200 units really start to look like trapped surplus. 

Do you sponsor a defined contribution (DC) plan? It may not fit your current DC strategy, but generally speaking, your DB surplus upon termination can be used to fund a "qualified replacement plan" (think profit sharing or non-elective contributions) for up to seven years. So, in that case, you would be getting an advance deduction for future DC contributions.

Convinced this is worth looking into?

Yes, I've simplified things and there are potential tax and legal issues here, so I leave you with this:

Nothing in here should be construed as tax or legal advice which can only be obtained from a qualified tax or legal professional. If you need tax or legal advice, you should consult such a professional. And as with any strategy of this sort, your mileage may vary.

HR Practices and Their Funding Similar Within Industries

This shouldn't come as a revelation, but HR practices, particularly benefits and compensation tend to be similar within industries. It makes sense. They tend to be competing for the same talent and, therefore, they benchmark against each other.

What may be a little bit less obvious is that allocations of capital to benefits and compensation also tend to follow patterns within industries. Reasons for this may not be quire as clear, but in a lot of cases, if what you are providing is the same, the way you pay for it and the amount that you pay for it may also be pretty similar.

Again, it makes sense. If Company A pays me $50,000 per year or Company B pays me $50,000 per year, the cost of my cash compensation during that year will be $50,000 (ignoring taxes). If each company further offers me a 401(k) plan that matches 50 cents on the dollar up to 6% of pay and very similar health plans, their costs for the year for me remain pretty similar. There aren't a whole lot of choices there.

So, now you may be asking why I am writing this. I haven't told you anything useful yet and you may be thinking I won't. But, wait, there's more!

Certain rewards elements can be paid for differently. Primarily, those are incentive compensation (can be paid relatively immediately or deferred) and defined benefit (including cash balance) pension plans. There you as an employer have options.

Let's consider briefly some of what those might be. You can fund the minimum required contribution (MRC) exactly on the statutory schedule. It's easy. You follow the rules. You do no more and you do no less. You can fund to the greater of the MRC or to 80% on whatever is the current funding basis. You can fund to the greater of the MRC or to 90% on that same current funding basis. Or 100%. Or, you can fund to the point at which you eliminate PBGC variable rate premiums.

Sure, there are other levels to which you can fund, but that's enough to illustrate. The point here is that behaviors within industries tend to be pretty similar.

Why does that matter?

Let's consider the health care industry. Not insurers, but hospitals, clinics, and other similar organizations. Lots of them have pension plans of one flavor or another (many are frozen cash balance plans) and most of them fund those at the minimum on the statutory schedule. That is following the law, so from a compliance standpoint, it's fine.

Where it's not as fine is from a financial sense standpoint.

Suppose you looked at all of the companies that sponsor defined benefit plans and then among that group, you considered only those who are paying more in PBGC variable rate premiums than they need to (this is important because for a typical company like this, those variable rate premiums may represent a 1% or more "drag" on plan assets).

What industry would predominate in that group?

You guessed it -- health care.

If you've made it this far and you are in the health care industry and you still have a pension plan, you probably want to see if you are facing that drag on assets. You probably are.

I would encourage you to check and when you find out that you are experiencing that drag, there are strategies that can be employed that will save you on that drag without depleting valuable cash from other needs.

Overpaying PBGC Premiums -- Money You'll Never See Again

Earlier this week, October Three released what may have been the most comprehensive study ever on payment of PBGC premiums. The study analyzed premium payments of nearly every mid-sized or large defined benefit plan in the country over the period from plan years 2010 through 2015 (leaving out plans with fewer than 250 participants).

The key results were shocking:

• During that six-year period, companies overpaid variable rate premiums by more than $700 million in the aggregate. That is, using techniques designed to lessen variable rate premiums, they could have paid $700 million less.
• For the 2015 plan year, more than 65% of plans that paid variable rate premiums, and did not have their premiums limited by the so-called per participant cap, paid more than they needed to.

If we think about this particular pension expenditure, one could consider it among the worst of all sins. For example, if you contributed more than you needed to in 2015, then your future required contributions will be lower, your PBGC premiums may have been lower and your pension expense will have been lower. So, while you may have had other uses for the money, at least you got some benefit from those contributions.

On the other hand, suppose you paid a larger variable rate premium than you needed to. What benefit have you gotten or will you have gotten from that overpayment? Zero. Zilch. Nada. Nihil. Niets. Niente. Rien. They're all the same. You will have received absolutely no benefit from your overpayment and neither will your employees. In fact, the only beneficiary of your overpayment will have been the PBGC.

Don't get me wrong. There are some good people, some nice people at the PBGC. I have friends at the PBGC. But, that said, there is no reason to give them more money than you need to under the law.

If you've made it this far, I'm going to leave you with an analogy. PBGC premiums are a lot like taxes. You pay money to a quasi-governmental corporation (PBGC) as a condition of sponsoring a defined benefit plan. Similarly, you pay taxes to the federal government when your company turns a profit.

Here is where they diverge. Your company probably has a Tax Department. If it does, its primary function is to ensure that your company properly pays its taxes, but in as small amount as legally allowable. That is, their job is to reduce your tax burden.

Your Tax Department may be pretty big. How big is your PBGC Premium Department? Oh, you don't have a PBGC Premium Department? You know you could.

Don't Make the Federal Government Your Company's Favorite Charity

You work at a decent sized company. That company has a Tax Department. The primary jobs of the Tax Department are to handle the company's taxes legally, and in doing so, to recommend and implement strategies that generally minimize those tax obligations.

Gee, everyone knows that, don't they?

Why do you want to minimize your tax obligations? Well, once you pay out money, you don't get it back. And, if for whatever reason, you happen to view the IRS as your favorite charity, you, the individual (or individual corporate) taxpayer don't get any more or better services for having given them extra money.

It doesn't work that way. In fact, the Internal Revenue Code is a ridiculously complex set of rules that, in total, generates revenue for the federal government. The federal government doesn't check to see who failed to take deductions that they could have and either call them out as being wonderful citizens or provide them with extra goods or services commensurate with the additional taxes that they paid. It doesn't work that way.

During the course of running a business, companies will find that they have large number of payments that they make to governmental or quasi-governmental agencies. For example, banks pay premiums to the Federal Deposit Insurance Corporation (FDIC). They do this so that their customers can feel secure in knowing that their deposits are backed by the United States government (to a point). Premium amounts differ by being in different risk categories. In other words, to some extent, a bank can control the amount of FDIC premiums that it pays.

Similarly, sponsors of defined benefit pension plans pay premiums to the Pension Benefit Guaranty Corporation (PBGC). Those premiums fall into two categories -- the fixed amount per person and the variable amount related to how well the plan is funded. Both of those amounts can be managed, and companies by and large either have been advised to or figured out on their own how to manage the fixed part. The variable rate premium is another story. While there has been a lot of press telling companies to borrow to fund their plans thereby reducing variable rate premiums, there are other techniques that exist.

It all comes down to paying the amount that the law requires you to or paying more. Paying more doesn't get you a trophy. Paying more doesn't get your employees trophies either -- not even participation trophies..

Suppose I told you that you had been overpaying your PBGC premiums by, let's call it, 15X per year. And, suppose I told you that by spending X one time, you could stop doing that. Would you do it?

Multiemployer Law Fails to Work for the Plan it was Most Likely Developed For

In mid-2014, Congress enacted and the President signed into law the Multiemployer Pension Reform Act (MPRA) sometimes known as the Kline-Miller Act (for its original sponsors). MPRA was unique in modern political circles as it was sponsored by John Kline, a Republican from Minnesota and George Miller, a Democrat from California. It was also unique in that it had support from unions, from companies that employ union workers, from affected government agencies and from industry groups specializing in multiemployer plans.

All that makes it sound like a law that was practically perfect.

Some background for those who don't spend their days in the multiemployer plan world is useful. Generally, multiemployer plans exist in industries where an individual working in that industry may provide services to many different employers. In the Teamsters Unions (primarily truck drivers), for example, drivers may drive on behalf of many different employers. Each employer agrees to contribute an amount to the plan based on the amount of service provided to it by each worker under the agreement. So, for example, in the case of a Teamsters Union, contributions could be set at some number of dollars per thousand miles driven. Retirement benefits are set based on the levels that the trust can support.

Benefits under multiemployer plans are insured (to some extent) by the Pension Benefit Guaranty Corporation (PBGC). One of the reasons for the passage of MPRA was to protect the PBGC. This was to be accomplished by allowing plans that met a set of requirements (more later) to reduce benefits that had already accrued. As many of the industries often covered by multiemployer plans dwindle, the plans themselves are unable to support the levels of benefits that had been promised. There are just not enough dollars coming into the plans.

Based on data published initially by the Center for Retirement Research at Boston College, the single plan that was viewed as potentially most problematic was the Central States, Southeast, and Southwest Areas Pension Plan. With more than 400,000 member, a funded ratio just barely above 50%, and nearly 5 times as many inactives as actives (all as of 2012), the plan was estimated to become insolvent in 12 years. Many plans were projected to become insolvent sooner, but not represented nearly the liability of the Central States Plan.

As MPRA should have, it placed a strict set of conditions (see Code Section 432(e)(9)) on such suspensions. Cutting back retirement benefits had essentially never been permitted in an ERISA plan. Such a cutback needed to be in everyone's best interests.

The process for determining that was generally to be that the Trustees of a Plan would apply to the Treasury Department for such a suspension (the technical term for such a reduction). The application would need to demonstrate that the suspension met all of the conditions referenced above.

In the case of the Central States application, Special Master Ken Feinberg determined that some of those conditions were not met.

Specifically,

• The suspension must be reasonably estimated to avoid insolvency
• In making its projections, the Trustees or the outside consultants used by the Trustees assumed a rate of return on plan assets that for every asset class in the plan exceeded the 75th percentile (according to survey data) for that class
• The entry age for new participants under the plan was assumed to be 32. While data shows that 32 is the average age, that is misleading because a group of new entrants at age 32 would have no new retirees in the next 20 years. On the other hand, a group with average age 32, including some who are much older, would have new retirees representing cash outflow from the plan far sooner than that.
• The suspension of benefits must be equitably distributed meaning that a particular class of participants is not adversely affected more than other classes
• The Trustees sought to make use of participants who are or were UPS employees under the plan. UPS had completely withdrawn from the plan and made withdrawal liability payments under the plan. In doing so, UPS had fulfilled its obligations with respect to the plan.
• But, UPS made those participants whole under a different plan. In its application, the Trustees considered only the portion of UPS benefits attributable to the make-whole agreement. This was judged not to be an equitable distribution.
• Upon application for suspension of benefits, notices must be distributed to participants explaining the suspension and the reasons for it
• The notices must be understandable by the typical participant, but in fact contained lots of technical jargon.
• In the notice's worst blemish, it contains a 98-word sentence with 4 technical terms not defined anywhere in the notice.

For all these reasons, the application was denied.

What does this do?

It leaves the Central States Plan in a position where it is likely within roughly 7 or 8 years of becoming insolvent. This means that the PBGC will become responsible for an extremely large liability for which its multiemployer fund does not have sufficient assets.

Who wins? Nobody.

Who loses? The PBGC, the plan participants, and the multiemployer system.

We might as well say that Americans are the losers.

Who Put the Dagger in the Heart of Defined Benefit

What happened to defined benefit (DB) plans? We, at least those of us who can remember those times, saw a rise of them from the passage of ERISA in 1974 until the Tax Reform Act of 1986 (TRA86). They were viewed as an affordable way for companies to provide an excellent retirement benefit to their employees, especially ones that showed loyalty to those companies. In fact, most current retirees who have been retired for at least 10 years retired in part because they had those DB plans. And, companies that sponsored them and did so responsibly did not go out of business because of them.

Unfortunately, the number of DB plans has dwindled significantly. There was not a single killer, though. The list is long. It includes:

• Congress
• The Pension Benefit Guaranty Corporation (PBGC)
• The global economy
• The e-commerce economy
• The temporary worker for hire economy
• The Financial Accounting Standards Board (FASB)
• The Securities and Exchange Commission (SEC)

Congress

What did Congress do that was so bad? Frankly, that crew of 535 individuals that changes in makeup from time to time did a lot. Between them, they rarely have anyone among them that knows much about DB plans. And, today, because their staffers who give them what they think is excellent guidance tend to be young, the advice that they actually get is colored by propaganda of the last 30 years or so. 

Nevertheless, Congress passed laws ... lots of them. And, lots of them included DB provision and each one was worse than the last. More than anything, though, because Congress intermingled retirement policy with tax policy so intimately, it eliminated plan sponsors' ability to fund DB plans responsibly.

Back in 1987, just one year after passage of TRA86, Congress, in its infinite wisdom, decided that the status quo, having existed for about a year, needed change. Included in that necessary change was limiting the amount that companies could contribute (and deduct on their tax returns) to DB plans. We were switched from a regime that was sound actuarially to one that never was and never will be.

Think about. Suppose you agree to pay someone an amount in the future. Shouldn't you be setting aside money regularly to pay for those future benefits? Of course, you should. And, DB funding used to be based on funding methods that allocated costs intelligently to the past, present, and future. But OBRA 87 began the path to dismantling those methods as Congress thought it better that DB deductions would be limited so that it could spend more money elsewhere. Thus was limited the ability of companies to responsibly fund their plans. And, as a result, as interest rates fell and there were a few significant downturns in equity markets, DB plans became [often] severely underfunded. Finally, the way these regimes worked, companies had no room to make deductible pension contributions in years that they could afford to, but were required to make large contributions in years that they could not afford them.

PBGC

For those that don't know, the PBGC is a corporation, run under the auspices of the Department of Labor, that was established by ERISA to protect the pensions of participants in corporate DB plans. The PBGC was and is funded by premiums paid by plan sponsors. 

While the purpose of the PBGC has always been to protect pensions, it has behaved over the last 30 years or so as if pensions should be in place to protect the PBGC. To the PBGC's policymakers, nothing would be a greater tragedy than the PBGC projecting that it would run out of money.

So, the PBGC lobbied Congress. And, with that lobbying, the PBGC got increased ability to intervene in business and in corporate transactions. It got increased premiums. It got even high premiums for underfunded DB plans, often ones to which the sponsors wanted to make contributions when business was good, but were precluded from doing so.

What happened?

The PBGC tried to commit suicide.

You see, as the PBGC helped to make DB plans less attractive for employers, employers froze entry to or terminated DB plans. This meant that there were fewer participants in DB plans on whom premiums were paid to the PBGC. Companies that couldn't terminate DB plans were the ones that had plans that were so underfunded that they didn't have enough money to fully fund them. Often, the PBGC had to assume responsibility for those plans. So, as the PBGC incurred more liabilities, it also got less premium revenue. It's awfully tough to run  a business that way.

Various Economies

As the US economy has become more global, more electronic, and more temporary, DB plans have lost some of their appeal, When a company was competing primarily with other US companies, providing excellent retirement benefits was important to attracting and retaining good employees. But, non-US companies didn't have to do that and as competition from offshore became fierce, retirement benefits became less of an issue.

And, as employers began to show less loyalty to their employees and were less worried about retaining them, retirement benefits lost some of their appeal. The prophecy was somewhat self-fulfilling; as retirement benefits lost some appeal, they continued to lose appeal.

FASB

Accounting for DB plans use to be more cash based than accrual based. In 1985, the FASB gave us Standards Number 87 and 88 that instructed companies how to account for DB plans. Previous to then, companies used Accounting Principles Bulletin (APB) 8, under which most companies expensed as part of P&L their cash contributions. The FASB saw this as incorrect.

So, we moved from a regime under which pension expense was somewhat controllable (a company by building up a surplus in good times could contribute less in bad times and thereby have some control over their pension expense) to one that had components that became quite volatile as the economy did. CFOs abhor volatility and thus had one more reason to not want DB plans.

SEC

The SEC didn't get deeply involved in pensions until recent times. But, when they did, they got them all wrong.

Primarily, the SEC's involvement with pensions has been in corporate proxies. For the last 10 or more years, companies have been required to provide as part of their proxy materials a table of Summary Annual Compensation for (generally) their top five paid employees. Included in compensation is the increase in actuarial present value from one year to the next of defined benefit pensions both qualified and nonqualified. 

Often times, that increase is largely due to a decrease in underlying discount rates or more recently, to a change in mortality assumptions. Yes, according to SEC rules, when the Society of Actuaries publishes a new, more up-to-date mortality table, that represents compensation to executives. And, of course, the media loves to look at those numbers as if someone had written checks for those amounts in those years to those executives. And, some investors look at those numbers and want to use them to explain how the companies in which they invest overpay their executives. (This is not to say that they don't overpay their executives, but when a large piece of the overpayment is simply due to year over year changes in actuarial assumptions, the logic is bad.) 

There are better ways. Actuaries understand them. And, actuaries, in some cases, have tried to explain them to the SEC. But, the SEC has chosen to listen more to attorneys, accountants, lobbyists, and unions. They carry more sway and are more emotional about this issue, but generally speaking, they don't get it.

I'll write about a better way in another post soon.

But, in the meantime, now you know where the dagger came from. DB plans use to allow people to look forward to retirement. For most, they don't anymore.

Proposal to Provide for Increase in PBGC Premiums

"The proposal is both good government and better for business," according to Pension Benefit Guaranty Corporation (PBGC) Director Joshua Gotbaum. "It protects retirement security while encouraging and rewarding responsible business behavior."

I've been in the benefits and compensation consulting business for more than 25 years. I've counseled clients to implement defined benefit plans, redesign defined benefit plans, freeze defined benefit plans, and terminated defined benefit plans. I think this makes me an educated commentator on Director Gotbaum's quote. Yet, I don't get it.

The proposal coming out of the Obama Administration would allow the PBGC, in addition to its current structure of charging both fixed-rate and variable-rate (for plans that it views as underfunded) premiums, to charge premiums related to the financial health of the company. Now, tell me, how does this protect retirement security?

What it will do instead is convince more and more companies to freeze or terminate their defined benefit pension plans, thus reducing or eliminating their prospective premium obligations. This does not protect retirement security. What it actually does, instead, is destroy the pension promise that participants thought they had.

Take note: every time that the government makes the provision of pensions more cumbersome, fewer companies sponsor defined benefit plans. How can this possibly protect retirement security? What it does is protect the PBGC against its own questionable judgment. Time and again, the PBGC has pushed for changes in pension legislation until we got to the point that plan sponsors are required to fund long-term obligations on a short-term basis. Therefore, when assets or liabilities behave poorly, the plan is left 'underfunded' and owes the PBGC more money. Note that a plan that is significantly overfunded gets no relief in its flat-rate premiums. Further, under the vague proposal from the Administration, a plan sponsor of a very well funded plan who has a short-term financial downturn could owe extra premiums to the PBGC.

Tell me again: what does this have to do with protecting retirement security?

IMHO: Does the PBGC Understand Why it Exists?

The Pension Benefit Guaranty Corporation (PBGC) was formed by ERISA in 1974. While I wasn't in the benefits business then, my understanding is that the agency was formed to protect private pensions in much the same way as the FDIC protects certain bank accounts.Similar to the FDIC, the PBGC protects pensions up to certain limits.

Yesterday, an American Benefits Council consultant, Kenneth Porter, testified before the Senate Health, Education, Labor and Pensions Committee (HELP) that the PBGC may be doing just the opposite. I largely agree with Mr. Porter's testimony. You can read a brief summary of it here: http://www.plansponsor.com/Some_PBGC_Policies_Shoot_its_Own_Foot.aspx .

I will preface by saying that I have a number of friends who work at the PBGC. If they happen to read this, some will certainly not like my comments. But, it's MY blog, and that gives me the opportunity to express my opinion.

At the same times that private pensions have been very well funded, the PBGC has reported little or no shortfall in its annual report. When pensions have been poorly funded, the PBGC has reported larger shortfalls. DUH!!! (sorry for the 14-year old interlude there). Shouldn't this be the case? And, if this is the case, shouldn't the PBGC be hedging against this sort of obligation? Instead, again in my opinion, the PBGC has become part of the problem.

To my understanding, each major pension reform since 1987 has had major PBGC influence. Look at some of the additions to the Internal Revenue Code and or ERISA:

• The deficit reduction contribution and additional funding charge
• The concept of current liability
• The variable rate premium (a good addition, in my opinion)
• The elimination, in my opinion, of reasonable actuarial cost methods by the Pension Protection Act (PPA) of 2006. 
• The imposition of participant notices (not very useful, in my opinion as a plan participant) under ERISA 4011
• The burden or ERISA 4010 notification

Does it really protect pensions to continually increase the maintenance burden on plan sponsors? Or, does it protect the PBGC by having fewer participants in fewer private pensions accruing benefits?

As a participant, I'd rather have the opportunity to accrue additional benefits even if those additional accruals don't have PBGC protection. Perhaps I won't ever get them, but at least I have a chance.

Shortly after the passage of PPA in 2006, I wrote to one of my US senators who was one of the co-sponsors of the Act and was instrumental in getting certain provisions into the Act that did help to preserve pensions and jobs in my current home state. I praised him for his work on behalf of that significant employer and others like it. But, I asked him in the same letter about how the Act actually preserved pensions. His reply focused on how PPA would serve to strengthen the PBGC.

Say what?

Four plus years later, my observation is that companies continue to freeze and terminate private pensions. To me, "pension protection" is not just about protecting accrued pensions, it's about protecting future pensions, and in my opinion, PPA under PBGC's influence has failed miserably at that.

Before departing for a different topic, I must give praise to the PBGC where it's due. In recent years, the PBGC has much more aggressively taken over private pensions to assure that most participants will get the benefits that they have earned. But, that is little solace to all those participants who are no longer accruing benefits because legislation over the last 20+ years has convinced their employers to cease providing those pensions.

DOL Proposes Rules on Annual Funding Notices

Today, the DOL published rules on the defined benefit plan annual funding notice requirement in the Federal Register. Those with severe cases of insomnia can read the proposal here http://edocket.access.gpo.gov/2010/pdf/2010-28890.pdf

Who Furnishes the Notice? The administrator of an PBGC covered defined benefit plan (single employer, multiple employer or multiemployer).

To Whom do they Furnish the Notice? The PBGC, each plan participant and beneficiary, each labor organization representing any of those participants or beneficiaries, and for multiemployer plans to each sponsoring organization with an obligation to contribute.

Who will find the Notice useful? No one that I can discern. This is another example of Congress adding stuff to an already overburdened statute known as ERISA largely for show. Perhaps the PBGC will find value in this, but I expect that for Notices that are distributed in the workplace on paper that the trash and recycle bins will be particularly filled on the days of distribution. Participants just don't know what this stuff means, and generally, they just don't care.

What goes in the Notice? A lot of stuff like:

• Name of the plan
• Name, address and telephone number of the administrator and the principal administrative officer if different
• Each plan sponsor's name and EIN and the plan number
• Whether the plan's FTAP (funding target attainment percentage) (single-employer plans only) is at least 100% for the plan year and for each of the two preceding plan years, and to the extent that it is not, the actual FTAP for those years.
• Multiemployer plans must do the same thing for funded percentage
• Single employer plans must specify for the current plan year and each of the two preceding plan years
• plan assets separating out and prefunding balance and any carryover balance
• plan liabilities under PPA (at risk measure if the plan is at risk)
• Single employer plans must also specify assets and liabilities as of the last day of the plan year
• Multiemployer plans must similarly specify the assets and liabilities for the current plan year as well as the two immediately preceding plan years and as of the last day of the current plan year
• Certain demographic information, mostly counts by active, retired, term vested, etc
• Statements of the plan's funding policy, investment policy and asset allocation
• Multiemployer plans must disclose whether they were in endangered or critical status
• A disclosure of the nature of and the effect of any material events (e.g., plan amendments or assumption changes) that could materially change the plan's funded status by the end of the year following the plan year
• A summary of the rules governing plan termination (single employer) and reorganization (multiemployer)
• A general explanantion of PBGC guarantees
• If applicable, a notice that a 4010 filing was required
• Any other information that the administrator thinks would be helpful in understanding the rest of the notice

Plans that had more than 100 participants on any day of the plan year must furnish the notice within 120 days after the end of the plan year. Smaller plans have until the extended due date for filing the Form 5500 for the plan.

There are limited exceptions to the filing requirement for particularly well-funded plans or plans without significant unfunded liabilities, as well as certain special cases like commercial passenger airlines and airline caterers.

So, I must ask: are these notices useful? In my opinion, they are not. Do they create significant burden for plan  administrators? Of course, they do. Is this just another example of how the Pension Protection Act only served as an additional nail in the coffin for private pension plans? Do I really need to answer that question?