What steps can a company take to de-risk a pension plan?

July 21st, 2014 No comments

By Javier Sanabria

A recent webinar organized by PlanSponsor asks sponsors if pension de-risking is right for their company. The webinar, sponsored by Prudential, features Milliman consultant Stuart Silverman discussing a three-step approach that can help chief financial officers make an informed de-risking decision for their company.

Here is an excerpt from his presentation:

We’ve been advocating a stepwise approach to decision making, and the first step is that the corporation needs to understand all their risks, not just the asset risk but also understanding the liability-related risk.

The second step, once we understand all these risks is helping the corporation understand what their risk tolerance is. Some corporations might have a wide risk tolerance and some may have a very limited risk tolerance.

…After we know what the risks are and what their tolerance is, we want to find the most cost-effective solution to bring their risk into a tolerable range.

In his article “The risks of de-risking pension plans,” Zorast Wadia also provides perspective concerning the risks associated with de-risking a defined benefit plan:

…While every plan sponsor and advisor should be thinking about pension risk management, it is important to exercise care in the strategy that is chosen and in the timing of implementation. Every pension de-risking strategy has its own pluses and minuses and most have an embedded cost associated with them, whether implicit or explicit. Risk management strategies must be customized for organizations depending on their risk tolerance and cash flow requirements. Once a strategy is selected, periodic refinement should also be considered. It’s not a one-size-fits-all approach. Before proceeding down a particular direction, plan sponsors must equally be made aware of both the risk reduction opportunities and the risks of de-risking.

If you are interested in learning more about pension risk management considerations, read Zorast and John Ehrhardt’s four-part PlanSponsor series.

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Why DB plans should still be relevant

July 18th, 2014 No comments

By Kevin Hart

Hart-KevinFor well over a decade now, defined contribution (DC) plans have been all the rage. Most new retirement plans are DC plans, a lot of which are 401(k) plans. And some defined benefit (DB) plans that do exist are being frozen or terminated and replaced with new or enhanced DC plans. Throughout these changes in retirement plan types, a common question is arising: Is there any room in the retirement benefit world for DB plans?

The answer should be a resounding “Yes.” DB plans should continue to remain relevant because they provide benefit features that can’t be offered in DC plans. This doesn’t mean that DB plans make sense for every employer, but they should make sense for certain employers.

Let’s start with the most obvious difference between DB plans and DC plans. Under a DB plan, employees generally do not bear the investment return risk. Certain employers could see this as a benefit. By offering their employees a DB plan, employers are providing a “guaranteed” benefit that is generally defined by a specific formula. Employees could see this as a much more attractive option than a DC plan.

Some employers may be looking to provide significant retirement benefits. It is possible to allow employees to earn a retirement benefit of up to 100% of their compensation in a qualified DB plan. This level of retirement benefit is not generally available under a qualified DC plan, which is due to the limits on annual employer contributions.

DB plans can be used by employers to better manage their employee workforce. They can be used to either encourage early retirements or incentivize longer tenures, whereas DC plans cannot do either. DB plans can have early retirement eligibility provisions that provide for subsidized early retirement benefits. A typical early retirement provision would allow for subsidized early retirement benefits to be available at age 55 (provided enough years of service have been earned). This allows employees to receive retirement benefits beginning at age 55 and provides an incentive for employers that want a certain portion of their workforces to begin terminating and retiring prior to age 60. In addition, DB plans have the opportunity to offer voluntary staff reduction programs. Employees can be encouraged to retire earlier than they were possibly considering through an early retirement incentive program. DB plans usually provide more valuable benefits for employees that have a longer tenure with their employers. So providing a DB plan incentivizes employees to stay with their employers for a longer period because of the typical benefit structure in DB plans. And employees that are planning on staying with their employers for a long period may seek out an employer that offers a DB plan.

A DB plan may not be the best choice for every employer. However, DB plans should still remain relevant because they can provide features and benefits that cannot be provided by DC plans.

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Google+ Hangout: Pension Funding Index, July 2014

July 15th, 2014 No comments

By Javier Sanabria

The funded status of the 100 largest corporate defined benefit pension plans increased by $14 billion during June as measured by the Milliman 100 Pension Funding Index (PFI). The deficit improved from $266 billion to $252 billion at the end of June, primarily due to investment gains. As of June 30, the funded ratio rose from 84.5% to 85.3%. However, the funded ratio is still down for the year from 88.3% as of December 31, 2013. June was the first month in 2014 when discount rates increased, but only by 0.02%. Fortunately, the strong year-to-date asset performance has mitigated deeper funded status erosion.

Index co-author Zorast Wadia discusses the results on Milliman’s monthly PFI Google+ Hangout with Jeremy Engdahl-Johnson.

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Regulatory roundup

July 15th, 2014 No comments

By Employee Benefit Research Group

More retirement-related regulatory news for plan sponsors, including links to detailed information.

MAP-21 pension extension moves in highway trust fund bills from congressional panels
The House Ways and Means Committee has approved by voice vote a bill (H.R.5021) that would provide highway funding through May 2015 in part by using about $6.4 billion from an extension of the MAP-21 pension funding stabilization provision. The House is expected to vote on the “Highway and Transportation Funding Act” next week.

Regarding the pension smoothing provisions, the House bill, as described by the Joint Committee on Taxation:

Applicable minimum and maximum percentages and annual funding notice

The proposal revises the specified percentage ranges (that is, the range from the applicable minimum percentage to the applicable maximum percentage of average segment rates) for determining whether a segment rate must be adjusted upward or downward. Under the proposal, the specified percentage range for a plan year is determined by reference to the calendar year in which the plan year begins as follows:

• 90 percent to 110 percent for 2012 through 2017
• 85 percent to 115 percent for 2018
• 80 percent to 120 percent for 2019
• 75 percent to 125 percent for 2020
• 70 percent to 130 percent for 2021 or later

In addition, for purposes of the additional information that must be provided in a funding notice for an applicable plan year, an applicable plan year includes any plan year that begins after December 31, 2011, and before January 1, 2020, and that otherwise meets the definition of applicable plan year.

To read the Congressional Budget Office’s report on the bill, click here.

PBGC issues moratorium on 4062(e) enforcement
The Pension Benefit Guaranty Corporation (PBGC) has announced a moratorium, until the end of 2014, on the enforcement of 4062(e) cases. The moratorium will enable PBGC to ensure that its efforts are targeted to cases where pensions are genuinely at risk. The six-month period will also allow the PBGC to work with the business community, labor, and other stakeholders.

During the moratorium, from July 8 to December 31, 2014, PBGC will cease enforcement efforts on open and new cases. Companies should continue to report new 4062(e) events, but PBGC will take no action on those events during the moratorium.

For more information, click here.

GAO report: Private pensions – targeted revisions could improve usefulness of Form 5500 information
In a two-phase online GAO survey, stakeholders identified problems with the usefulness, reliability, and comparability of data from the Form 5500 (see table). Despite longstanding concerns with the Form 5500—the annual report that employee benefit plans file with the federal government—agency officials have made only minimal changes over the last 3 years.

Key challenges identified with Form 5500:

• Weaknesses in the format
Plan asset categories break out plan assets differently from the investment industry, and provide little insight into plan investments, their structure, or the level of associated risk. In particular, the majority of respondents indicated that the “other” plan asset category in the form is too broad because it can include many disparate types of investments. Respondents also indicated challenges in identifying the underlying holdings of plan assets invested in indirect investments.

• Challenges in finding key information
The form lacks detailed information on plan investments because there is no structured, data-searchable format for attachments to the form and the filing requirements on plan investments is limited for small plans, which have less than 100 participants.

• Inconsistent data
Naming conventions and identification numbers may be inconsistent, making it difficult to collect and accurately match records.

To read the entire GAO report, click here.

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Corporate pension funded status improves by $14 billion in June

July 10th, 2014 No comments

By John Ehrhardt

Milliman today released the results of its latest Pension Funding Index (PFI), which consists of 100 of the nation’s largest defined benefit pension plans. In June, these plans experienced a $3 billion decrease in pension liabilities and an $11 billion increase in asset value, resulting in a $14 billion decrease in the pension funded status deficit.

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If you want to understand why pension funded status is down this year, consider the fact that June was the first month in 2014 with rising interest rates—and it’s not like we saw a massive swing. Interest rates continue to be the story with these pensions.

Looking forward, if the Milliman 100 pension plans were to achieve the expected 7.4% median asset return for their pension portfolios, and if the current discount rate of 4.08% were maintained, funded status would improve, with the funded status deficit shrinking to $228 billion (86.7% funded ratio) by the end of 2014 and to $173 billion (89.9% funded ratio) by the end of 2015.

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Regulatory roundup

July 7th, 2014 No comments

By Employee Benefit Research Group

More retirement-related regulatory news for plan sponsors, including links to detailed information.

IRS issues final rules on the use of longevity annuity contracts
The Internal Revenue Service (IRS) issued a final rule relating to the use of longevity annuity contracts in tax-qualified defined contribution plans under section 401(a) of the Internal Revenue Code (Code), section 403(b) plans, individual retirement annuities and accounts (IRAs) under section 408, and eligible governmental plans under section 457(b).

These regulations will provide the public with guidance necessary to comply with the required minimum distribution rules under section 401(a)(9) applicable to an IRA or a plan that holds a longevity annuity contract. The regulations will affect individuals for whom a longevity annuity contract is purchased under these plans and IRAs (and their beneficiaries), sponsors and administrators of these plans, trustees and custodians of these plans and IRAs, and insurance companies that issue longevity annuity contracts under these plans and IRAs.

To read the entire final rule, click here. For the Treasury news release, click here.

PBGC report shows improvement in single-employer plans, but underscores increased risks to some multi-employer plans
Despite substantial economic and market gains, multiemployer pension plans covering about 1.5 million people are severely underfunded, threatening benefit cuts for current and future retirees, according to the FY 2013 Projections Report recently released by the Pension Benefit Guaranty Corporation (PBGC). By comparison, the financial situation for private single-employer plans, which cover about 30 million participants, is projected to improve.

To read the entire report, click here. To read the entire news release issued by the PBGC, click here.

IRS updates webpage on top mistakes in VCP submissions
The IRS has updated its webpage regarding the top mistakes made in voluntary correction program (VCP) submissions.

To view the updated web page, click here.

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Target date funds – a fiduciary the review process is crucial

July 2nd, 2014 No comments

By Jeff Marzinsky

Jeff_MarzinskyRetirement plan participants are often told that target date funds (TDFs) are a “set it and forget it” investment. Many sponsors have similar feelings when selecting a TDF series. Still, it is important for them to constantly monitor the fund series subsequent to its initial review. Sponsors need to focus on fees, asset allocation along the glide path, performance, and expenses. Looking at a combination of indexes and peer groups can offers sponsors better perspective on a suitable investment philosophy.

Plan Sponsor recently published an article focusing on four areas to re-valuating TDFs. In the following excerpt from the article I discussed the importance of reviewing a fund’s investment strategy.

That sort of analysis is especially important because some target-date funds have made significant changes in recent years. Look for issues such as alterations to the glide path, a move from active management to enhanced index or indexing strategies, or switches in the underlying funds, suggests Jeff Marzinsky, a principal at consultant Milliman Inc. in Albany, New York. He has seen sponsors actually replace their target-date funds, mainly in cases of investment underperformance or changes in the funds’ underlying philosophy.

I also provided perspective regarding an increased interest in custom target date funds which offer sponsors control over investment options and asset allocation changes.

…It may be less about many having an employee base different enough to warrant a custom glide path than sponsors seeing it as “a better way to pick the investments,” because sponsors have more control than with off-the-shelf funds.

In a prior article “Considerations in choosing a target date fund” I explored some key aspects of TDFs and issues plan sponsors should bear in mind when selecting and the ongoing monitoring of a TDF series.

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Regulatory roundup

June 30th, 2014 No comments

By Employee Benefit Research Group

More retirement-related regulatory news for plan sponsors, including links to detailed information.

High Court rules in retirement plan fiduciary presumption of prudence in stock drop case
The U.S. Supreme Court has unanimously ruled that the fiduciaries of an ERISA-covered retirement plan that includes employer stock as an investment option are not entitled to any “presumption of prudence” in the investment decisions made by the plan administrator (Fifth Third Bancorp v. Dudenhoeffer, (no. 12-751, 6/25/2014)). In overturning the 2012 ruling by the U.S. Court of Appeals for the Sixth Circuit, the high court said that the fiduciaries are subject to the same duty of prudence that generally applies to fiduciaries under ERISA.

The Court remanded the case, directing the Sixth Circuit to reconsider whether the participants stated a claim under precedents established by the high court. The Court said that a fiduciary’s conduct should be evaluated in the context of publicly available information and that fiduciaries cannot be found imprudent for failing to buy or sell stock in violation of insider-trading securities laws. In addition, the high court said that a complaint must plausibly allege an alternative action that the defendant could have taken when plaintiffs state a claim for fiduciary imprudence.

Retirement plan and other provisions moving in transportation/highway trust fund bill
Senate Finance Committee Chairman Ron Wyden (D-OR) has modified his proposed transportation/highway funding legislation, which now includes changes to the retirement plan required distribution (“stretch IRA”) provision. The revised bill alters the beginning date for employees who become 5% owners after age 70 1/2 and eliminates rules in the earlier proposal relating to rollovers of distributions from employer-sponsored plans with a delayed effective date – i.e., governmental plans and collectively bargained plans.

Currently, the Internal Revenue Service has indicated that a plan under which a participant’s normal retirement age changes to an earlier date upon completion of a stated number of years of service typically will not satisfy vesting and accrual rules. According to the Joint Committee on Taxation’s description of this provision:

An applicable plan is a defined benefit plan that currently provides such a normal retirement age. A plan is generally an applicable plan only with respect to an individual who (1) is a participant in the plan on or before January 1, 2017, or (2) is an employee at any time on or before January 1, 2017, of any participating employer and who becomes a participant in the plan after January 1, 2017.

A plan does not fail to be an applicable plan solely because the normal retirement age described above currently applies only to certain plan participants or certain employers participating in the plan. In addition, subject to the limitation described above relating to participation or employment on or before January 1, 2017, if application of this normal retirement age is expanded to additional participants or participating employers, the plan will be treated as an applicable plan with respect to those participants and participating employers.

Finance Committee members have proposed dozens of amendments in advance of the markup. Among them are changes that would:

• Extend the parity for employer-provided transit benefit with parking benefits
• Allow for the continuation of an NRA of 30 years in service for currently existing defined benefit pension plans
• Require appropriate worker/independent contractor classifications in professional services organizations
• Temporarily repeal the Davis-Bacon “prevailing wage” rates for highway projects

Census Bureau: Summary of quarterly survey of public pensions for the first quarter 2014
This quarterly survey of public pensions provides national summary data on the revenues, expenditures, and composition of assets of the largest defined benefit public employee retirement systems for state and local governments. This survey currently consists of a panel of 100 retirement systems, which comprise 89.4 percent of financial activity among such entities, based on the 2007 Census of Governments.

To access the survey, click here.

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Post-retirement benefits: Three new exposure drafts from GASB

June 26th, 2014 No comments

By Ken Friedman

AlexKaplanPhoto.comOver the past two years, the Governmental Accounting Standards Board (GASB) has been working on a project to modify accounting for post-retirement benefits that covers both “other post-employment benefits” (OPEB) and pensions that are not funded through a trust. The new GASB 67 and 68 rules for pensions published in 2012 apply only to pension benefits funded through a trust.

That project has reached fruition and the GASB has published three new exposure drafts. The first describes new requirements for the external financial reports of OPEB plans. The second proposes new accounting requirements for governmental entities that provide OPEB benefits to their employees. The third establishes requirements for defined benefit (DB) pension plans not funded through a trust, which are therefore not subject to GASB 67 or 68. It also contains some minor amendments to GASB 67 and 68.

The timeline for this project is:

• August 29, 2014: Comment deadline
• September 10-12, 2014: Public hearings
• First half of 2015: Final statements

The new accounting for OPEB and pensions not funded through a trust are largely based on the same principles as those found in GASB 68. Especially for an entity that provides OPEB benefits to its employees, this represents a significant change from the requirements of GASB 45. In particular, the use of the entry age normal funding method will be required and liabilities will be valued using an interest rate that is representative of a combination of the rate to be earned on invested assets and the rates in a government bond index. Perhaps more importantly, the plan’s unfunded accrued liability (i.e., the entire accrued liability for unfunded plans) will be placed on the balance sheet of the entity sponsoring the plan. For many small local entities such as towns and school districts this liability may exceed the entire size of their annual budgets.

The proposed effective dates of the new standards are as follows:

• For OPEB plans, the fiscal year beginning after December 15, 2015 (2016 for calendar-year plans)
• For an entity that provides OPEB benefits to its employees, the fiscal year beginning after December 15, 2016 (2017 for calendar-year plans)
• For pension benefits not funded through a trust (i.e., not subject to GASB 67 or 68), fiscal years beginning after June 15, 2016 (June 15, 2015, for the minor amendments to GASB 67 and 68)

To read Milliman’s PERiScope series on technical and implementation issues surrounding GASB 67 and 68, click here.

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What steps can Millennials take to enhance their retirement security?

June 25th, 2014 No comments

By Javier Sanabria

The millennial generation has developed a reputation for not placing an emphasis on retirement, preferring to live for the moment. In the most recent issue of Benefits Quarterly, Milliman’s Jinnie Regli discusses several actions Millennials should consider to help them accumulate retirement savings. Here is an excerpt:

Taking retirement mobile
Millennials’ lives are fast-paced, hopping from an early morning yoga workout to nine hours of work, straight to a book club meeting, down the street to a softball doubleheader and then on to a late-night fraternity reunion happy hour. Retirement accounts are finally catching up with our mobile world. Recordkeepers and administrators have started to create mobile apps for smartphones and tablets to help keep up with busy lifestyles. For some, choosing to defer or increasing your deferrals is as easy as one quick touch of the screen or scanning a quick response (QR) code. When you have time to play with apps that shoot cartoon birds dressed like Darth Vader across the sky, then the excuse “I just don’t have time to save for retirement” simply won’t fly anymore.

Let your interest compound
You hear over and over again that the longer your contributions are invested in a retirement plan, the more time they’ll have to take advantage of compounding interest. But what does that really mean? Let’s look at three different savings approaches. For purposes of this example, let’s assume I make $30,000 every year until I retire:

• Strategy 1: I decide to save 6% of my compensation, or $1,800, in a jar every year from the ages of 25 to 65.
• Strategy 2: I don’t want all of the space in my basement taken up by jars and instead enroll in my company’s 401(k) plan, contributing 6% from the ages of 25 to 45. I receive 5% interest compounded annually.
• Strategy 3: I want a new car and can’t afford to contribute now. Twenty years later, I turn 45 and realize retirement is right around the corner and decide to contribute 6% until the age of 65. I receive 5% interest compounded annually.

Which strategy will result in higher retirement savings at the age of 65?

My initial investment ($36,000) is the same in each strategy. While Strategy 1 will guarantee my contributions will not suffer any market gains or losses, it may not be the most secure retirement savings strategy. Strategy 2 more than doubles my final account balance when compared with Strategy 3 just by giving my money an extra 20 years in the market to accumulate that compounded interest. (See the figure)

Compounding interest

To read the entire article, click here.

Reproduced from the Second Quarter issue of Benefits Quarterly, published by the International Society of Certified Employee Benefits Specialists.

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