Category Archives: Pensions

Weighing income options can prepare individuals for retirement

Pushaw-BartPension plans are providing an ever-decreasing portion of retirement wealth as wave after wave of Baby Boomers reach retirement. In and of itself, this is neither surprising nor remarkable. What is remarkable, though, are two typical characteristics of what we are being left with regarding retirement wealth.

First, the jettison of pension plans means relying on defined contribution plans as the provider of principal retirement wealth. This is suboptimal inasmuch as these plans are typically 401(k) savings plans, originally introduced as a sideline fringe benefit scaled for purposes less than what they’re now required to deliver on. This is mostly a benefit-level issue of which we have seen recent hints of amelioration—namely, the industry recognizing that in an all-account-based retirement world, saving 16% of annual pay is in the ballpark, not the historical mode of 6% employee deferral (plus maybe 6% employer match totaling 12%). This relates to the second endangered characteristic, which needs to be brought into brighter focus: an in-plan solution for generating guaranteed retirement income.

Pension plans are wonderful for participants in that everyone is automatically a participant, automatically earning benefits on a meaningful trajectory, and automatically having the ultimate retirement wealth delivered on a lifetime guaranteed basis. Yes, 401(k) plans are trending this way on the first two, and the third is quickly emerging as another area where we need more pension-like alternatives.

One may generalize by saying that retirees take their 401(k) balances and roll them over when they retire. An economic conundrum baffling academics is that none or very few of these folks take advantage of insured annuities even in the midst of robust studies identifying them as an optimal solution for retirement income in face of investment uncertainty and longevity risks. This raises two subtle yet important points.

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Changing public pension investment landscape

The global financial crisis shrunk the funding status of many public pensions. Some sponsors are beginning to cut their expected rate of return, and change the way they invest and handle portfolio risk. In this Reuters article, Milliman consultant Tamara Burden provides perspective on how sponsors can better manage their pension investment risk.

The growing recognition that short-term volatility can have a devastating impact on mature pension plans in the $4 trillion sector could herald a sea change in the way public funds invest in the future.

“There is this shift to recognizing risk is a relevant piece of the discussion, it’s not just about how you get the highest returns over a long period of time but that short-term fluctuations in asset levels can be incredibly detrimental,” said Tamara Burden, an actuary at consulting firm Milliman….

Burden is seeking to persuade public pension managers to use Milliman’s risk management strategy to reduce equity exposure in portfolios by shorting stock index futures. This means they don’t have to sell their fund’s equity holdings.

The strategy is being applied to about $70 billion in portfolios with variable annuities, retail mutual funds and collective investment trusts used by 401(k) plans, but so far not in the public pension sector.

Interest, Burden says, has increased this year with about 15 public pension administrators considering a shift versus five during the same period last year.

Calculating postemployment benefits in Indonesia

In Indonesia, there are two types of retirement plans used to fund postemployment benefits: defined benefit pension plans (PPMPs) or defined contribution pension plans (PPIPs). These plans are usually referred to as hybrid plans when liabilities for postemployment benefits are calculated. In this article, Milliman’s Danny Quant and Amelia Enrika discuss the most effective way to calculate benefits between the offset method and the asset method.

Sticky contribution rate can enhance public pension funding status

Alternative funding approaches can help public defined benefit (DB) plan sponsors stabilize contribution rates and maintain a healthy funded status. In this article, Milliman actuary Daniel Wade discusses how a fixed, or “sticky,” contribution rate approach helped one large DB retirement system maintain a strong funded ratio.

Here is an excerpt:

While policymakers have the discretion to recommend a change to contribution levels when deemed necessary, the funding and benefits policy has guidelines and metrics to assist those policymakers with the difficult decisions required. The policy has a relatively wide (but not too wide) zone for maintaining the status quo. When the funded ratio is between 95% and 120% and certain other parameters are met, the policy advises that no action should be taken.

Note that the “no action” zone is not symmetric around 100%. This is by design, which is due to the belief that actions required to increase the funded ratio when it dips below 100% are more urgent than taking actions that could decrease the funded ratio as it exceeds 100%. Reserves over 100% may be needed for future rate stabilization. The funded ratio is a useful measure, but it is based on the assumption that best estimates are met. A cushion above 100% is welcomed when assumptions are not met.

Often in the public sector, there are significant governance issues once there is a “surplus” as measured by a funded ratio above 100%. Permanent benefit improvements can be made based on temporary highs in asset values.

… Note that in the System’s policy, the term “funding reserve” is used instead of surplus when the funded ratio is above 100%. While this is only terminology and does not directly influence anything, it reflects a mindset that having a funded ratio above 100% does not mean that you have extra money that must be spent; instead there is a reserve for rate stabilization.


Longevity risk poses long-term solvency issues for GCC public pensions

Longevity risk is a primary exposure for state-managed pensions within Gulf Cooperation Council (GCC) countries. In this Middle Eastern Insurance Review article, Milliman’s Simon Herborn, Khurram Mirza of Osool, and Fahad S. Alajlan of the General Organization for Social Insurance (GOSI) discuss how refinements to benefit structures can improve the sustainability of GCC pensions.

With a framework that delivers a meaningful view of life expectancy, we can prepare better forecasts of future financing requirements. As previously mentioned, this analysis is likely to reveal the schemes are not self-sustaining—that is, co-contributions will be required from the state. If these are deemed too onerous, the next recourse is higher contribution rates from the participants or employers. Failing this, the natural progression is refinements to the benefit structure to reduce costs.

One route could be raising the retirement age. All else being equal, this would shorten the time span for which benefits will be paid and thereby lead to a reduction in costs (though it should be noted that the full cost implications are deceptively complex and careful consideration is required to achieve the desired effects). This type of intervention has been very common in other parts of the world, among both state- and employer-sponsored schemes.

There are many other ways in which the benefits can be refined to help manage costs – for instance, changing the definition of salary for determining benefits (for example, an average of salaries over the individual’s career rather than just at retirement age), limiting cost-of-living increases, making dependent benefits less generous (though this coverage often has significant importance, particularly in this region), and penalising early retirements. These changes do not directly target longevity exposure but can still be very effective in reducing the overall quantum of exposure.

What changes will you make to help increase your employees’ retirement confidence?

Regli-JinnieThe 2015 Retirement Confidence Survey, published by the Employee Benefit Research Institute, continues to highlight the rise of retirement confidence in American workers. An increase in retirement plan participation (14% in 2013 to 28% in 2015 for those with a retirement plan) seems to closely correlate with the rise in the percentage of workers who are confident about having enough money in retirement (13% in 2013 to 22% in 2015).

The survey findings seem to indicate that more American workers are taking retirement planning into account and they are feeling very confident about having enough money in retirement, both of which may be related to the increase in availability and accessibility of online retirement calculators and a growing confidence in the overall economy. Yet at the same time, the percentage of American workers who report having saved for retirement has stayed fairly consistent at 63%, indicating that more may need to be done in order to assist workers in saving. Here are a few standout figures from the 2015 survey results:

• 80% of current workers believe personal savings will play a large role in their retirement incomes
• 71% of employed workers report their employers offer an employer-sponsored retirement savings plan
• 12% of those without a retirement plan reported feeling very confident
• 50% of those asked what they would do if they were automatically enrolled at 3% said they would raise their contribution rate; only 2% said they would stop it altogether

It seems that, as the economy strengthens, many American workers are comfortable making retirement savings a priority, so what better time to encourage them to make the most of it?

As plan sponsors, what can be done to help keep retirement confidence on the rise for years to come? Here are some ideas.

• If you don’t offer an employer-sponsored plan, consider offering one. Behavioral finance has found that inertia makes humans their own worst enemies when it comes to retirement savings, making it all that more difficult for the 29% of employed workers without an employer-sponsored retirement plan to save for their retirement. Open the door for them to begin saving today!
• If you already offer an employer-sponsored plan, think about offering additional employer-sponsored plans. Employee stock ownership plans (ESOPs), nonqualified retirement plans, cash balance plans—there are a variety of options available that could be used to supplement your current 401(k) plan.
• Or continue to drive participation by considering plan design changes that will promote additional plan participation. Speak with your consultant about the best options for your company.
• Educate participants. Make sure your employees have sufficient information and tools to assist in their retirement planning.

What changes will you make to help your employees’ retirement confidence increase?

Retirement risks side by side: DB vs. DC vs. VAPP

In this video blog, I discuss the retirement risk allocation between a plan sponsor and the plan’s participants in a variable annuity pension plan (VAPP) structure compared with risks associated with traditional defined benefit (DB) plans and defined contribution (DC) plans. I also explain how a VAPP can reduce risks of inflation, portability, and interest rate.

View our VAPP video blog series here.

For more information on VAPPs, click here, or visit our VAPP reading list.

Four-step DOMA repeal compliance process

The U.S. Supreme Court’s repeal of Section 3 of the Defense of Marriage Act (DOMA) makes same-sex spouses eligible for the same protection that opposite-sex spouses have regarding retirement benefits when the marriage is legal in the state in which they were wed. How does this decision affect pension plan administration?

In her article “Same-sex marriage and defined benefit plans,” Milliman’s Emily Stadheim offers perspective on the following four steps plan administrators should take to ensure that their pensions are legally compliant with the repeal of Section 3.

1. Review plan documents and summary plan descriptions.
2. Review policies and procedures for spouses and domestic partners.
3. Review retirement packages and forms for compliance with post-DOMA regulation.
4. Communicate changes to benefit plans and policies and obtain same-sex marriage information from participants.

UK pension reform reading list

The UK’s retirement landscape has changed significantly. Pension reform now provides retirees with broader access to their retirement savings. However, reform has also shifted more post-retirement risk to the individual. This reading list highlights some of the issues at hand.

“Blended retirement solutions” (subscription required)
Individuals need financial plans that offer income solutions and address key retirement risks. This FT Adviser article  highlights a retirement framework development by Milliman and AXA Wealth that help advisers assess their clients’ needs based on a well-known psychological theory. The framework is detailed in a report entitled “Retirement planning: Bespoke retirement solutions are ‘the new black’ in 2015” by Milliman consultants Colette Dunn, Chris Lewis, and Emma Hutchinson.

One model which can be used to determine at-retirement choices in the context of these risks was set out by management consultancy Milliman along with Axa Wealth. It is based on US psychologist Abraham Maslow’s famous ‘Hierarchy of Needs’, which placed people’s innate requirements in order of priority to ensure psychological health. Axa Wealth transposed this hierarchy on to retirement spending ‘priorities’, to differentiate between essential and more discretionary costs.

In the retirement hierarchy, the money set aside to feed oneself, pay for a roof over your head and meet essential bills is defined as ‘essential’. Income to meet these needs would be subject to a very low attitude to risk.

More ‘discretionary’ spending, which could include everything from running a car to holidays, is less set in stone and so open to greater risk. Often objectives here might require significant investment growth to be fully realised.

The more important given needs are considered, the less risk your client will be willing to take. This could result in possibly several layers of risk needing to be met.

A final element is ‘legacy’, or the wealth your client may wish to pass on when they die. This is classified as the most aspirational of the needs and thus subject to the highest risk.

Once ranked, these income requirements can be placed into a framework.

• “Actuaries warn of retirement cash running out
Many experts believe retirees run a higher risk of depleting their retirement incomes, which is due to pension freedoms. Colette Dunn comments on results from a survey of industry experts at Milliman’s Forum.

• “Calculating pension income
Advisers need to develop new approaches to help their clients manage new retirement risks. Milliman’s Dunn and Russell Ward discuss solutions that address market risk and inflation risk.

• “A retirement planning model for the new pensions world
In this article, Dunn and Chris Lewis highlight a retirement framework that advisers can employ to match a retiree’s income needs to specific levels of risk.

• “Reform spells healthy future for advice
Reform offers advisers and providers an opportunity to innovative solutions that may help participants navigate the new retirement environment. Milliman’s Dunn and Ward provide their perspectives.

• “Blurred lines of retirement saving
In this article, Dunn highlights important conversations advisers need to have with people at different stages of their retirement planning.

The Dutch General Pension Fund, a new pension vehicle

Wouda-MartinThe total of assets of Dutch pension funds is over 150% of gross national product and still growing. The number of Dutch pension funds, however, keeps falling: from 800 to less than 400 in the past 10 years.

The attention of the press on pension issues has increased from close to zero to daily reports. At the same time, the political and public debate has intensified—especially when it became clear that some pension funds had to cut benefits because the insufficient funding could not be solved over time. Until the day that the actual cuts were announced, this risk was quite underexposed. One of the last items that gets the attention of the press, politicians, and the public is the obligation to account for the cost per participant in the annual reporting.

The reaction of the supervisor is to aim for more control, more regulations, and more compliance. The Dutch Central Bank (DNB) has recently sent out a note to all small pension funds, asking them to consider their reasons for future existence and to contemplate their sustainability.

Regulations are relatively tight compared to other countries. For example, the discount rate to be used to value liabilities is prescribed and published monthly by the Dutch Central Bank. Also there are standard formulas to calculate the solvency buffer. This is in contrast to one of its neighboring countries: Belgian pension funds choose the discount rate and solvency buffer themselves and need to submit it to the supervisor (well documented).

New pension fund board members are heavily tested on capacities and integrity by the supervisor. Some of the candidates that have been rejected have shared their stories with the press, but in most cases the DNB silently advises the candidates to step down before actually refusing to let them join a board of trustees.

Many of the smaller pension funds have transferred all accrued benefits to an insurer in the past 10 years. The disadvantage of this option is clear. The security one gets from an insurer comes with a price. The pension funds are used to taking some investment risk: the indexation depends on how the investment returns turn out. In case of really poor investment returns, there is in some cases the possibility of extra contributions by the sponsor. Pension funds also have the emergency brake of cutting benefits. The insurers, on the other hand, would be bankrupt, so their pricing of annuities is more prudent. The insurers do have the advantage of cost efficiency, which is due to the larger scales of their operations. An alternative for the smaller pension funds is to join a larger sector-wide pension fund. Joining a sector fund means joining the scale and risk pooling of the pension plan in the sector and can be attractive if there is indeed a sector pension fund active and large enough in the sector of the particular employer.

For multinationals with operations in more than one European country, there is the option of a cross-border pension fund. There is a small number of successful cross-border pension funds with Dutch plans. It appears to be a time-consuming road, as many parties need to be convinced. That is not always based on rational arguments: How would the average American employee react if his or her pension moved to Canada? There are Dutch pension vehicles (PPI’s) that can execute pension plans for foreign entities, but by law they can only do defined contribution (DC) plans. The PPI’s are not allowed to carry biometric risks. The Dutch may believe their pension system is the best in the world, but there is less confidence that it is convincing enough to attract foreign plans. Becoming able to execute cross-border plans is not the driver for the latest development.

The law will be changed to allow establishing pension funds that execute more than one plan for any employer. It will be allowed to ring fence the assets for different (groups of) contracts. Up to now, having multiple employers within one pension fund is only possible either for employers that are connected (legally or historically) or without the ring fencing (e.g., the sector funds). The new vehicle will be called the General Pension Fund (GPF, or APF in Dutch). It will allow for options that can be situated between insurers and the classic pension funds. If done well, it combines the best of both worlds: economy of scale, optimizing the investment returns, good governance without being too time-consuming, and risk pooling that is acceptable to members. In our opinion, it opens the door for new and innovative pension solutions.