For 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.
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.
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.
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.
The funded status deficit of the 100 largest corporate defined benefit pension plans increased by $10 billion during May as measured by the Milliman 100 Pension Funding Index (PFI). The $268 billion deficit at the end of May is primarily due to a drop in the benchmark corporate bond interest rates used to value pension liabilities. Investment gains helped to partially offset the full extent of liability increases in May. During May, the funded ratio fell from 84.7% down to 84.3%.
PFI co-author Zorast Wadia discusses the index’s latest results on this Milliman Google+ Hangout.
The Governmental Accounting Standards Board (GASB) in 2012 released new accounting standards for public pension plans and participating employers. These standards, GASB Statements No. 67 and 68, have substantially revised the accounting requirements previously mandated under GASB Statements No. 25 and 27. Required implementation is imminent, with GASB 67 effective for plan fiscal years beginning after June 15, 2013, and GASB 68 effective for employer fiscal years beginning after June 15, 2014.
In this article, Milliman’s Ryan Lane discusses the development of the long-term expected rate of return assumption and the selection of the municipal bond rate (both of which are used to determine the single equivalent discount rate), covers the technical details of calculating the money-weighted rate of return, and summarizes of the discount rate and other asset-related disclosures required by GASB 67/68.
To read Milliman’s PERiScope series on technical and implementation issues surrounding GASB 67 and 68, click here.
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 May, these plans experienced a $29 billion increase in pension liabilities and a $19 billion increase in asset value, resulting in a $10 billion increase in the pension funded status deficit.
In every month of 2014 so far we have seen a decline in interest rates. These pensions have experienced a $43 billion increase in assets, but the market gains have been dwarfed by a $125 billion increase in liabilities.
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 4.06% were maintained, funded status would improve, with the funded status deficit shrinking to $241 billion (86.0% funded ratio) by the end of 2014 and to $187 billion (89.2% funded ratio) by the end of 2015.
PlanSponsor has published a four-part series of articles authored by Milliman’s Zorast Wadia and John Ehrhardt. The series focuses on pension risk as well as measures that employers should consider in de-risking their corporate defined benefit (DB) plans.
• De-risking corporate defined benefit pension plans
The first article provides an overview of the corporate DB landscape since Milliman’s inaugural Pension Funding Study in 2000. The article also highlights a three-step process for plan sponsors pondering a de-risking strategy.
• Major risks facing DB plans today
Employers should understand their current pension risks before implementing a de-risking strategy. This article details several risks sponsors must deal with.
• Managing and mitigating DB plan risk
The final two articles address a de-risking framework referred to as “the three Ms”: managing, mitigating, and moving risk. This article offers perspective on the first two.
• Moving DB risk, and the risks of de-risking
Zorast and John discuss the last of the three Ms, moving risk, in this article. They also pose questions that can help sponsors understand the risks associated with pension de-risking.
Corporate pension plans had a good year in 2013. The Milliman 2014 Pension Funding Study reported a $198.3 billion improvement in the funded status deficit during 2013. This improvement was due to a win-win situation where there was a 7.5% decrease in plan liabilities from higher discount rates and a 9.9% average return on plan assets.
There are a few interesting pieces of information that can be gleaned from the Pension Funding Study about plan sponsors that have made moves to de-risk their pension plans.
• In general, the asset allocations of the plans in the study have shifted toward a higher allocation of fixed income investments. However, some plan sponsors have retained a more traditional asset mix.
• In 2013, plan sponsors with higher allocations to equities experienced greater improvement in pension funded status than those with lower exposures to equities.
• Some plan sponsors who undertook de-risking activities such as lump sum payouts or annuity purchases may need to increase cash contributions to maintain funded status.
- For example, Ford was one of the companies that undertook de-risking activities in 2012. Its 2013 contribution increased by more than $1.6 billion.
• There are 22 pension plans in the Milliman 100 index that had asset allocations to fixed income investments over 40% in 2009. Since 2009:
- These 22 plans experienced significantly lower funded ratio volatility than the other 78 plans.
- From 2010 through 2012, these plans earned higher average annualized returns.
- Until 2013, this strategy paid off for these plans in terms of reducing funded status volatility.
• For the plans that did not increase asset allocations to fixed income investments, the combination of higher interest rates to discount liabilities with favorable returns on assets led to a significant improvement in their funded ratios.
What are the morals of the story? De-risking pension plans may provide advantages to plan sponsors in reductions in funded status volatility. But these advantages may come at the price of higher cash contributions and missing out on favorable moves in the market.
The funded status deficit of the 100 largest corporate defined benefit pension plans increased by $15 billion during April as measured by the Milliman 100 Pension Funding Index (PFI). The $258 billion deficit at the end of April is primarily due to a drop in the benchmark corporate bond interest rates used to value pension liabilities. Asset improvements helped to partially offset the full extent of liability increases in April. From the end of March through April 30, the funded ratio fell from 85.3% to 84.7%.
PFI co-author Zorast Wadia offers some perspective on the latest results in this Milliman Google+ Hangout.
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 April, these plans experienced a $21 billion increase in pension liabilities and a $6 billion increase in asset value, resulting in a $15 billion increase in the pension funded status deficit.
We keep slipping further and further away from full funding. The historic improvement of 2013 has been countered by a $72 billion decrease in funded status so far in 2014, with falling interest rates driving much of the change.
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 4.20% were maintained, funded status would improve, with the funded status deficit shrinking to $228 billion (86.5% funded ratio) by the end of 2014 and to $175 billion (89.7% funded ratio) by the end of 2015.