Archive for the ‘Pensions’ Category

Life after the Death Master File

April 18th, 2014 No comments

Benbow-DavidOn March 26, the U.S. Department of Commerce’s National Technical Information Service (NTIS) released interim final rules regarding access to the Death Master File (DMF). The DMF is the file that allows people to research whether someone is living or dead. It’s very useful for people who administer defined benefit (DB) pension plans because it’s really not prudent to continue paying people after they’ve died. The new rules were published in the Federal Register (Vol. 79, No. 58).

As I mentioned in an earlier blog, the DMF was a playground for identity thieves, so Congress decided to restrict access to only “certified” individuals. The new interim final rules provide instructions to become a certified user of the DMF.

The rules essentially split the DMF into two groups:

• The “Limited Access DMF” includes people who have died within the last three calendar years.
• The “Open Access DMF” includes people who have died more than three years ago.

As the name implies, the Open Access DMF will be available to anyone and will not require certification. This will allow genealogists to track down long-lost relatives and (in theory) will not be of much use to identity thieves.

The Limited Access DMF will require certification because it is of much interest to identity thieves, pension administrators, and other unsavory characters.

The certification process
To apply for certification, you must:

• Complete a “Limited Access Death Master File Subscriber Certification Form” and a “Limited Access Death Master File Subscriber Agreement.” These forms are available at the NTIS website.
• Promise to behave yourself. You may not provide the information obtained from the DMF to people with no legitimate use for it. Once you have been certified, you are required to maintain a list of all employees, contractors, or subcontractors to whom you pass on the information.
• Safeguard all information obtained from the DMF.
• Pay a $200 processing fee. The certification lasts for one year and can be renewed annually for up to five years.

But wait… there’s more!
The NTIS can conduct regular and unscheduled audits of the user’s systems, facilities, and security procedures. Failure to safeguard the information can result in a $1,000 fine for each disclosure or use, up to a maximum of $250,000 in penalties per calendar year.

Sound complicated?
Most day-to-day administrators will not be willing to endure the time and expense necessary to become certified and maintain documentation for NTIS audits. Fortunately, there are still vendors available who make a living doing address searches and death audits. These vendors still have access to the DMF by completing a license agreement for use and resale, which involves a much larger fee.

What should pension sponsors include in their benefit statements?

April 9th, 2014 No comments

Pension sponsors await model benefit statements from the Department of Labor (DOL) as required by the Pension Protection Act (PPA). Until guidance is issued, sponsors are to comply with new disclosure requirements in good faith. In the latest issue of DB Digest, David Benbow explains what sponsors should include in their benefit statements pending DOL guidance:

Be sure your statements contain the following required items:

• Accrued benefit
• Vested benefit, or the date the participant is expected to become vested
• A description of permitted disparity or a floor-offset arrangement if they are used in your plan

Make sure your statement is understandable to your average participant. You should check with your legal counsel to ensure that you’re in good faith compliance with the interim guidance regarding your delivery method and frequency.

Issuing benefit statements provides sponsors the opportunity to communicate a plan’s value to participants. Milliman’s Lily Taino offers more perspective in her article “Defined benefit plan statements: Getting by or adding value?

Can variable annuity pensions offer more retirement security?

April 4th, 2014 No comments

Senator Tom Harkin proposed the Universal, Secure, and Adaptable (USA) Retirement Funds Act intending to improve retirement security for individuals. In their article “Variable annuity pension plans: An emerging retirement plan design,” Milliman’s Kelly Coffing and Mark Olleman discuss how the variable annuity pension plan (VAPP) can address four principles Harkin proposes for reform.

Here’s an excerpt from the article:

The VAPP design responds to Harkin’s four principles as follows:

• Although not universal, the reallocation of risk allows more employers to maintain the “three-legged stool,” which includes pensions.
• By changing the focus from a “guaranteed” dollar benefit to a “lifelong” benefit, more people are able to have the certainty of a reliable stream of lifelong income without the fear of outliving their assets.
• Retirement risk is shared more evenly among participants. Risk is shifted from employers and active participants to all participants including retirees.
• Because retirement assets are pooled and professionally managed, larger benefits can be provided per dollar contributed.

In addition, some level of inflation protection may be provided.

So how exactly does this work? Figure 1 provides an example. The participant is hired on January 1, 2002 and enrolled in a VAPP with a 4% hurdle rate. For simplicity, the illustration shows the participant earning $30 per month of benefit each year, but benefits could be based on a percent of contributions or a percent of each year’s pay (a career average formula). The illustration uses actual historical returns based on a portfolio that is invested 60% in large company stocks (S&P 500) and 40% in long-term high-grade corporate bonds.

Figure 1 shows that at January 1, 2003 the participant has earned a benefit of $30 during 2002. The $30 earned in 2002 is adjusted at the end of 2003 for the trust’s investment return of 19.3% in 2003. The adjustment is 119.3%/104.0% = 114.7%, which increased the $30 to $34.41. Therefore, at January 1, 2004 the participant’s total accrued benefit is $34.41 plus another $30 earned in 2003, for a total of $64.41.

After 11 years, at January 1, 2013 the benefit accrued in 2002 has grown to $43.37, the benefit accrued in 2003 has grown to $37.82 and the total of the benefits accrued in all years has grown to $395.33. Although all benefits decreased by 21.8% after 2008, by January 1, 2013 the benefits earned in all years are larger than the original $30 accruals.

Figure 1 - VAPP benefit accrued example

Milliman consultant Grant Camp describes VAPP benefit features that can provide security for both retirement plan sponsors and participants in his blog “A balanced approach to retirement risk.” Ryan Hart also highlights the advantages that VAAPs may offer employers and employees in this blog.

The tontine pension plan: A defined benefit panacea?

March 14th, 2014 No comments

Bradley_JeffConsider a retirement plan with the following characteristics:

• The plan provides an adequate stream of lifetime payments to plan participants
• Plan sponsors have a fixed contribution to the plan (just like a defined contribution plan)
• Plan sponsors have no investment, longevity, or other actuarial risks
• The plan is always fully funded

Sounds too good to be true doesn’t it? It turns out that the tontine pension plan has all of these characteristics. This paper by Jonathan Barry Forman and Michael J. Sabin discusses the inner workings of such a plan and how the above four characteristics come to fruition. The paper goes on to suggest that the tontine pension plan can solve the public sector pension underfunding crisis.

Never heard of a tontine? Then you are not alone. Simply put, a tontine is a financial arrangement where each member (usually the same age) contributes an equal amount. The total is awarded entirely to the sole survivor. Tontines were actually quite popular prior to the 19th century. In the early 1900s, however, the state of New York passed legislation that all but outlawed tontines, and other states followed.

While the paper doesn’t suggest that we lobby to resurrect pure tontines as financial instruments, it does suggest that we use the tontine concept to create a type of pension plan—the tontine pension plan.

The concept is simple. An employer contributes a fixed amount per year to an employee’s account; this account, managed by the employer, accumulates to a fund which, upon retirement, is converted to an annuity benefit payable to the employee. When the employee dies, the remainder of his or her “fund” or “reserve” is then redistributed to the remaining retirees. Actuarial principles ensure that amounts annuitized and subsequently redistributed upon death are done in a fair and equitable manner. Age is used to compute life expectancies, probabilities of death, and the associated fair transfer values.

Participant accounts are adjusted upward or downward based on the trust’s investment earnings. Adjustments are also made to the accounts for mortality gains and losses. Thus, the participants bear all of the investment risk as well as the longevity and other actuarial risks. All the plan sponsor has to do is contribute the fixed amount per annum.

While there are certain issues that would need to be worked out for the tontine pension plans to work in an ERISA environment—mandatory qualified joint and survivor annuity (QJSA), qualified optional survivor annuity (QOSA), or qualified preretirement survivor annuity (QPSA) benefits, for example—most of these issues generally do not exist in public sector plans.

Can such a plan solve the public sector pension funding crisis? Not by itself. In order to accomplish that objective, existing underfunded levels would need to be shored up through increased contributions, investment earnings, and/or cuts to benefits. However, once the underfunding is shored up, the tontine pension plan would prevent such deficits from happening in the future. Going forward, the tontine pension plan may be just what the doctor ordered.

PBGC variable premiums: Standard vs. alternative premium funding target

February 11th, 2014 No comments

Peatrowsky-MikeAs part of the Pension Protection Act of 2006 (PPA), plan sponsors have two options for calculating their “unfunded vested benefits” (UVB) to determine the variable premium owed to the Pension Benefit Guaranty Corporation (PBGC) each year. The amount by which the vested liability, called the funding target, exceeds the fair market value of plan assets determines the plan’s unfunded vested benefits. The required variable premium for 2014 is $14 per $1,000 of UVB.

The plan’s UVB is determined under one of two different methods: The standard premium funding target or the alternative premium funding target.

So what’s the difference?
The only difference in the two methods is the discount rate used. All other assumptions (mortality, turnover, etc.) are the same for both calculations. However, the discount rate plays a vital role in determining the plan’s funding target.

The standard premium funding target is the default method. The discount rate used for the calculation of the standard method is based on spot rates for the month prior to the plan year (i.e., a one month of average of such rates).

The alternative premium funding target is the other method. The calculation of the alternative method is based on the rates used to calculate a plan’s funding target for the premium payment year, before reflecting Moving Ahead for Progress in the 21st Century Act (MAP-21) stabilization rules. Typically, the discount rates used for the purpose are a 24-month average of the current spot rates.

When a plan sponsor elects to switch from one method to the other, they are locked into that election for five years.

Why is this important for 2014?
In a declining interest rate environment, as we experienced from the end of 2008 through the beginning of 2013, the trailing 24-month average produces higher interest rates than current monthly spot rates. Higher discount rates produce a smaller plan liability for PBGC purposes, resulting in smaller variable premiums. Many plan sponsors who had underfunded plans in 2009 elected to move to the alternative method. Over the past 12 months, we are in an increasing interest rate environment, making current monthly spot rates higher than a 24-month average.

So the question becomes: is 2014 the year to switch back to the standard method? Depending on funding status of the plan, it could decrease variable premiums by a significant amount. With the passage of the budget accord, as stated in Tim Herman’s blog, the amount of variable premiums is expected to increase significantly over the next few years. If the plan sponsor believes interest rates will continue to rise or stay flat over the next couple years, it may be time to make the switch. The flip side is that, if you switch and interest rates decline, you could be required to pay higher PBGC premiums and would be locked into this method for five years.

Retirement plans: Key dates and deadlines for 2014

January 31st, 2014 No comments

Milliman has published 2014 retirement plan calendars for single-employer defined benefit (DB) plans, multiemployer defined benefit plans, and defined contribution (DC) plans. Each calendar provides key administrative dates and deadlines.

2014 single-employer defined benefit plans calendar

2014 multiemployer defined benefit plans calendar

2014 defined contribution plans calendar

Along with downloading each calendar, be sure to follow us at where we tweet upcoming dates and deadlines for plan sponsors.

Employees saving, not “consuming,” their lump-sum distributions

January 14th, 2014 No comments

Moen-AlexA recent study by the Employee Benefits Research Institute (EBRI) showed that 48.1% of employees, who took a distribution in 2012, rolled over a portion of their lump-sum to a tax-qualified saving tool. And 45.2% rolled over the entire distribution. This same statistic was just 19.3% in 1993. Using the entire lump-sum distribution for “consumption” (i.e., car, medical, or other spending) was down to an all-time low of 7.5% in 2012 from 22.7% in 1993. These dramatic changes are encouraging signs in a slowly improving economy.

The study looked at plan participants’ distributions upon most recent job changes and identified five major actions:

• Participants transferred to tax-qualified financial savings accounts such as individual retirement accounts (IRAs), rollovers to existing IRAs, or individual annuities
• Established non-tax-qualified financial savings tools (taxable savings account, other taxable financial investments)
• Reduced personal debt for businesses and homes
• Invested in education
• Used funds for personal consumption

The results when looking at “any portion” of the lump-sum distribution were a little murkier. Overall, saving has increased significantly from 1986, but slowed from 2006 through 2012. One might speculate the numbers from the more recent years would be stronger absent the recession. Those who did not roll over their funds to a tax-qualified plan were more likely to improve personal finances by paying off some form of debt than to spend the funds. Another positive in the report is the trend that the higher the dollar amount of the distribution, the more likely the recipient was to use the funds for tax-qualified savings. (For balances of $37,500 or more, 70% used the entire portion for tax-qualified savings).

Some reasons for the increase in savings may be attributed to enactment by the U.S. Congress of the 20% withholding on lump-sum payouts starting in the early 1990s, improvements in retirement savings education over the last approximately 30 years, and dependence on retirement plan benefits as the major retirement savings method, which is due to Social Security funding issues weakening that avenue of retirement income.

Age does play a factor in the likeliness of an employee rolling over a benefit or leaving it in the plan. Results show younger employees still do not appreciate the benefit and are easily swayed by cash-out opportunities of smaller lump sums, below $5,000. Cash-out rules are great for plan sponsors, but the results of this latest EBRI study show they’re not so great for the young employee.

With smart investing, any balance in a defined contribution plan can provide a valuable benefit in the total retirement savings portfolio.

Thanks again, identity thieves!

January 10th, 2014 No comments

Benbow-DavidOnce again, the bad deeds of a few are making it more difficult for many honest people to do their jobs. Remember the Social Security Death Index? It was a free and extremely useful site that allowed you to look up people and determine if and when they had died. A nice thing to know if you happen to pay pension benefits for life.

But security concerns caused the free lookup service to be taken offline. Searches can now be conducted for $10 each or an unlimited subscription to the “Death Master File” can be purchased for $995. For most pension administrators, the price tag is too steep (unless you’re aware that a few groups used their unlimited subscriptions to provide free lookup services again), but an identity thief can get enough information from the Death Master File for it to be a very profitable business model.

This situation caught the eye of U.S. Senator Bill Nelson (D-FL), who related the story of a child who died just before her 5th birthday, only to have her identity stolen from the Death Master File and used to file for a bogus tax refund. This led to a line item in the budget deal that was signed last month calling for further restrictions to the Death Master File.

The U.S. Commerce Department, which administers the Death Master File, has been tasked to create a process to certify individuals with legitimate needs for the file within three months. Meanwhile, all the pension administrators, insurance companies, and genealogy buffs who use the information legitimately can look forward to navigating the new certification process, and the identity thieves can figure out how to steal the identity of someone who’s already been certified.

Pension poetry

November 15th, 2013 No comments

Benbow-DavidI’ve been administering pension plans for over 25 years, but there are a few unforgettable gems that stand out in my memory. This one, from very early in my career, is both amusing and a very good example of how important a pension plan is to the participant.

We’ve all received calls and letters from people who believe their pensions have been miscalculated. Often, a retiree has a buddy who’s getting a larger pension. You do the research, only to find that the buddy has 10 years more service or made more money. Occasionally, it turns out that there was missing data and the person actually was short-changed and the calculation can be corrected.

In this particular instance, a participant was sure that his income from an overseas subsidiary should have been included in his U.S. pension. He wrote an angry letter, ending with this:

You can mess with my girlfriend,
You can mess with my wife,
But when you mess with my pension,
You mess with my life.

I wish I could remember the participant’s name. All these years later, I’d like to thank him for those words (maybe his wife wouldn’t be as appreciative as I am). Even though he ended up being wrong about his overseas earnings (he had another overseas plan that accounted for it), his words have been a lasting reminder about how the work I do affects someone else’s livelihood.

I may not have chosen a very glamorous career. I don’t save lives in the operating room or rescue children from burning buildings. I don’t write novels or cure diseases. But I know that the work I do is very important to someone—a lot of someones after a quarter century—that I’ll never even meet, and I hope that I’ve made a difference in their lives, even though they may not realize it.

And as long as I’m bringing a little culture to the Retirement Town Hall readers, I’ll show you how easy it is to rhapsodize about pension plans. From the limerick:

In avoiding the perils of pensions,
You must follow the legal conventions.
Before actives arrive
At the age sixty-five
You may need to warn them of suspensions.

To the haiku:

As winter frost falls
I think of my pension plan.
It is frozen too.

To the traditional:

Shall I compare thee to a pension plan?
Thou art more complex and regulated.
For of the feeble fortunes made by man,
So few are at the same time loved and hated.

Now that I’ve brought culture to the pension community, I’m sure I’ve inspired our readers to write some of their own. Either post your replies to this blog or send your pension poems here.

Flexible pensions: Giving control back to employers

November 4th, 2013 No comments

Iacoboni-MichaelVolatility. Risk.

The word “pension” can mean so much more: recruitment, retention, reward, retirement.

In the “new” millennium this word has been rebranded, and has now become firmly linked to volatility and risk. Can pensions be duly unchained from this stigma?

What if year-to-year cash flows could be stabilized? What if the investment risk could be eased?

I know. I know. Hypotheticals are little more than devilishly idle hands. Corporations operate within practical realities.

But what if this was not hypothetical? Seriously: What if the volatility and risk could be significantly drawn down?

The challenge with a defined benefit (DB) plan is just that—the benefit is defined. The economy is fluid. Industries are dynamic. Yet “traditional” pension plans are intractable. Because the plan design does not respond well to an ever-changing business environment, a formidable challenge is left to the employer. Thus, corporations become exposed to volatility and risk.

One natural conclusion is that employers (and by extension, employees) need a pension plan in which the benefit is not so obstinately defined. In other words, the plan and the benefits it provides need to be flexible; they need to be able to adjust to the seemingly whimsical undulations of modern macroeconomics.

It turns out there are pension plan designs that do accommodate some flexibility, and some plan sponsors have started taking good, hard looks at these alternatives. There are a few variations on these new designs, which go by many names, including:

• Variable annuity pension plan
• Adjustable pension plan
• Variable benefit plan

Milliman’s work in this area includes the white paper “Variable annuities: A retirement plan design with less contribution volatility” and the blog article “Variable annuity plans may benefit employers and employees.”

Within a variable annuity pension structure, each participant’s total benefit annually rises or decreases based on the overall fund’s asset performance (this applies to both active and retired participants). This feature naturally results in a significant degree of pension responsiveness in adverse markets and imparts some inflation protection for retirees when returns are high.

Rather than varying the annual payment a retiree receives each year, a pension plan may change the amount that active participants accrue each year. Again, this adjustment in accrual rate would be based on asset performance in the prior year(s).

Under the variable accrual model, the plan document could even include a provision under which asset returns that are sufficiently poor (i.e., the portfolio return was negative for the prior year) would result in zero accruals that year. In this case, the plan would effectively be frozen during tough economic conditions. (This is similar to employers suspending 401[k] matches during the first years after the global financial crisis in 2008.)

With these alternative designs and the resulting responsiveness, a pension plan can keep up with the business needs of the employer and becomes much less volatile from a sponsor’s point of view.

Keep in mind that reduction of volatility is truly achieved on a plan-by-plan basis. The finer points of the plan design will vary depending on the needs and priorities of each plan sponsor. Details to consider include: investment allocation, size of the plan, maturity of the plan’s population, and specific plan sponsor concerns (i.e., financial reporting, contributions, Pension Benefit Guaranty Corporation [PBGC] premiums).

Whatever the particulars, a key takeaway is that within a defined benefit plan framework, risk can be shared between employer and employee. This seems a happy medium between the “all or nothing” risk distribution under traditional pensions and 401(k)-type defined contribution (DC) plans.

Over the last decade the question has been asked often and hotly debated: How can we get DC plans to “behave” more like DB plans? Usually this “behavior” refers to the lifetime income guarantee and retirement security that participants receive from a traditional pension.

To be fair, defined contribution plans have their own desirable qualities. Employer contributions to a 401(k) are typically a fixed percentage of salary each year, and with a 401(k) the employer is completely insulated from investment losses. Here we are back at volatility and risk.

Perhaps an equally poignant thought is: How can we get DB plans to behave more like DC plans? What would this entail? Answer: Give the plan sponsor more control over its cash flow responsibilities to the pension and lessen employer exposure to investment or interest rate risk. We can achieve both of these and also provide an adequate lifetime benefit by making pension benefits more flexible.

When external forces change, businesses adjust. So can pension plans. So should pension plans.