Archive for the ‘Pensions’ Category

Is pension outsourcing right for you?

August 5th, 2014 No comments

Benbow-DavidThere has been much discussion about the relevance of the defined benefit (DB) pension plan. For decades, people have bemoaned the demise of DB plans, saying they are too costly to administer and too expensive to maintain. Others have suggested that there is no other type of plan that will provide a sufficient and stable source of retirement income. There has been a growing trend of top employee benefit providers shifting their DB outsourcing service models by partnering with firms such as Milliman, while others have opted to exit the DB outsourcing business completely, as recently announced by Vanguard.

Does that mean DB outsourcing is no longer relevant?

Outsourcing is more relevant than ever, but it’s become so specialized that it’s best handled by experts who do it as their core business. DB plan outsourcing was once very expensive, but technology and economies of scale have made outsourcing much more affordable. Here are a few reasons why DB plan sponsors should consider outsourcing.

The changing of the guard
Many employers have a person (call her “Betty”) who has single-handedly administered a DB plan for years, maybe decades. Betty is friendly, she is dedicated, and she knows everything about the pension plan—including when to look people up in the big red binder. Betty is 62.

Not only is Betty going to retire someday, but she hasn’t trained anyone to take her place. Betty is very dependable, but has she stayed current on all the new pension legislation, and would her work stand up to an audit by the Internal Revenue Service or U.S. Department of Labor?

Because a change is imminent, someone else should also be considered with at least as much experience as Betty, someone who is familiar with the challenges of automating the information that’s in Betty’s head (and in the big red binder), and who keeps abreast of the latest pension rules—namely, a DB outsourcing provider.

Participant convenience
We’re more than a decade into the 21st century and, thanks to our laptops, tablets, and smartphones, we’ve gotten used to having information available instantly. Participants meeting with a financial planner will want to look up their pension benefits online as well as model a few different retirement dates to see what works best for them. Some outsourcing providers have this capability, which renders the annual pension statement obsolete (participants never bothered to look at them anyway).

Providing self-service options for participants also cuts down on requests to human resources departments (and Betty is pretty overloaded with requests for estimates).

For participants who still prefer human interaction, an outsourcing provider may include a call center of friendly DB experts, who have full access to the participant’s information. They can field questions ranging from plan eligibility to the ever-popular “Where is my check?”

Plan sponsor convenience
As mentioned earlier, DB plans have become much more complicated to administer. In order to calculate benefits consistently and efficiently, a dedicated system is required for all but the simplest plans.

Plan auditors are more confident with calculations produced by a pension system instead of hand calculations or clunky spreadsheets. System results can be stored indefinitely along with evidence that calculations were reviewed. In addition, many outsourcing providers are independently audited and can provide plan auditors with a Statement on Standards for Attestation Engagements No. 16 (SSAE 16 Type 2) report for additional reassurance.

With a dedicated pension system, plan sponsors can also have a wealth of data at their fingertips. Regular reports can be generated for compensation and benefits committees and data extracts for plan actuaries. Mailing lists for summaries of material modifications (SMMs) or annual funding notices are made much simpler.

Finally, with the day-to-day pension operations off its hands, the benefits department can focus on other, more urgent matters.

It takes a village
It takes quite a few people to administer a DB plan: Actuaries to measure plan funding and forecast liabilities, administrators to calculate benefits, representatives to answer participant phone calls, and payment processors to work with the trustee. A full service outsourcing firm houses all these roles under one roof, creating a seamless team of professionals to make life easier for plan participants and plan sponsors.

If you’re wondering whether Milliman can help with the administration of your DB plan or would like to see a demo of our administration system or participant website, feel free to contact me or visit

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

July 21st, 2014 No comments

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.

Post-retirement benefits: Three new exposure drafts from GASB

June 26th, 2014 No comments

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.

Boosting retirement confidence

June 4th, 2014 No comments

Bleick-TimThe Employee Benefits Research Institute (EBRI) recently issued its 2014 Retirement Confidence Survey. The percentage of American workers who say they are not too confident or not at all confident they will have enough money to live comfortably throughout their retirement years now stands at 43%, down from 49% a year ago. While this is trending in the right direction, it is still concerning that more than four out of every 10 American workers currently put their chances of a comfortable retirement at less than 50-50.

The survey does a good job of dissecting the results to explore correlations. For example, the retirement confidence levels are vastly different between workers who have a retirement plan—e.g., an IRA, a defined contribution (DC) plan, or a defined benefit (DB) plan—compared to those who do not. Of those who have a retirement plan, only 28% say they are not too confident or not at all confident about a comfortable retirement. Of those who do not have a retirement plan, 69% are not too confident or not at all confident. It’s likely that many of these workers have very little personal savings. Add to that everyone’s concern about the path that Social Security is currently on, and it’s no wonder that almost seven out of 10 American workers with no retirement plan take a dim view of their chances for a comfortable retirement.

There’s an obvious solution to increasing retirement confidence in America, which is to get more workers into retirement plans. It may well be that a good portion of that 69% has 401(k) or similar retirement savings vehicles available at their employers, but they are not utilizing them. To get more workers into these plans, employers need to be continuously encouraging their employees and educating them on the power of “starting early,” the benefits of tax-deferred growth, and how they are leaving money on the table if there’s a match. Plus, automatic enrollment is an excellent mechanism to get new employees contributing at the onset. Small employers who do not currently offer a retirement savings vehicle should consider that retirement plans can help attract and retain employees and instill the importance of saving for retirement.

One of the most common 401(k) designs is one in which the employer matches 50 cents of every dollar an employee contributes, up to 6% of pay. Translation: employee contributes 6% of his pay and employer kicks in another 3% of pay, for a total of 9%. A person age 35 making $50,000 doing this every year for 30 years would have about $500,000 at age 65 (assuming 3% pay increases and 6% return on investments). Do you think half a million dollars would boost someone’s retirement confidence level?

A stabilization reserve could ease possible declines in VAPP benefits

May 8th, 2014 No comments

Variable annuity pension plans (VAPPs) have a lot going for them. They stay fully funded and have contribution and accounting stability like 401(k) plans. However, benefits increase or decrease depending on whether a plan’s investments return more or less than the set “hurdle rate.” With a basic VAPP, retirees will experience decreases in their benefits some years, but there is a benefit stabilization strategy that maintains the funding stability and dramatically diminishes benefit declines. Milliman’s Grant Camp and Kelly Coffing provide some perspective on this strategy in their article “Making the case for variable annuity pension plans (VAPPs).”

Here is an excerpt:

A stabilization reserve is built to keep benefits level during down markets. We call it the cap and shore-up method:

Build a stabilization reserve (by capping benefit increases in high return years).

A stabilization reserve could be developed in several ways. Two possibilities are described below:

  • Limit VAPP benefit increases to a certain maximum increase per year, say 10%. When the plan’s investment return would result in benefit adjustments greater than 10%, benefits would only increase by 10% and the excess return would be used to build a reserve.
  • Build the reserve with a portion of the return directly above the hurdle rate. For example, if the hurdle rate is 4%, do not provide benefit increases on the portion of the return between 4% and 5%. Benefits would only increase when returns are greater than 5%.

Spend the reserve in down markets to prevent benefit decreases (shoring-up benefits).

When benefits would otherwise decrease, use a portion of the stabilization reserve to prevent benefit reductions. The intent is to protect each retiree’s high-water mark (i.e., the highest level of monthly benefit received in retirement) to the greatest extent possible.

For example, if a retiree’s underlying VAPP benefit decreases from $1,000 to $900 per month, the stabilization reserve would provide $100 a month to shore up the benefit, maintaining a total benefit of $1,000 per month. The retiree has not had his benefit payment decrease.

The next year, the underlying VAPP benefit of $900 per month will be adjusted based on the plan’s investment return. If the underlying benefit exceeds the prior high-water mark of $1,000 per month, the underlying benefit is paid (this becomes the new high-water mark) and no payment is made from the reserve. However, if the underlying benefit is still less than the prior high-water mark, a portion would again be paid from the reserve.

Figure 4 from the article illustrates how a retiree’s basic VAPP benefit would have performed compared to a stabilized VAPP benefit from 1984 to 2013.


What to look ahead for in pension risk management

May 1st, 2014 No comments

Defined benefit plan sponsors are concerned about contribution and funded status volatility. Some recent pension risk management strategies have focused on liability-driven investing (LDI) and lump-sum distributions. In this article, Milliman consultants Tim Connor, Scott Preppernau, and Zorast Wadia discuss in general terms methods that plan sponsors may implement to de-risk their pensions moving forward.

Here is an excerpt:

We suspect that 2014 will see a continued trend of sponsors looking to de-risk their plans through the various methods mentioned above. In addition, we believe sponsors will investigate the benefits of a hybrid plan design such as the variable annuity plan for the reasons mentioned above.

Another trend likely to continue is the implementation of lump-sum windows or permanently increased lump-sum thresholds. These strategies have found favor with many plan sponsors, particularly in response to recent increases in Pension Benefit Guaranty Corporation (PBGC) premiums. Because PBGC premiums include a per-participant charge, and because that charge has increased substantially in recent years, sponsors will no doubt continue to take a hard look at the idea of offering lump sums if it translates into fewer participants for whom they must pay those premiums. In addition, the rates utilized to pay out lump sums have been fully phased in for a few years now, from the previous basis of 30-year Treasury rates. That old basis resulted in a period of time where lump sums were seen as costly to sponsors. That is no longer the case. On a U.S. GAAP accounting basis, plans are valuing liability at rates that are close to the rates that are now utilized to pay lump sums. In other words, there is no longer much of an accounting gain or loss to a plan that pays out a lump sum. Yet, it does accomplish de-risking by transferring management of the pension to the participant.

On the investment side, we also expect sponsors to explore some nontraditional de-risking solutions. Not all sponsors share the belief that leaving the space of equity investments makes sense in the long term. Some feel they can’t afford not to be seeking returns in the market. For them, a tail risk hedging investment strategy can be an attractive de-risking solution. A typical strategy allows for upside through equity investments, while at the same time mitigating downside losses that occur in volatile, declining markets. The concept of hedging tail risk is quite familiar to the insurance industry, which utilizes such strategies to manage its own risk in guaranteeing certain products, such as variable annuities. It makes natural sense for defined benefit plan sponsors to incorporate the approach to de-risk their own pension promises.

Read Grant Camp and Kelly Coffing’s article Making the case for variable annuity pension plans (VAPPs) to learn more about the variable annuity pension plan design. Also, for more Milliman perspective on lump-sum distributions, click here.

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.