It’s been a tough year for corporate pension plans. Weak stock markets and falling interest rates have left a $440 billion hole in the nation’s 100 largest plans, with the shortfall more than doubling in the third quarter.
The shock came just as pension funds appeared to be recovering from the financial crisis of three years ago. And it left many companies scrambling to narrow the widening gap between the value of their pension-fund assets—typically stocks and bonds—and the fund’s liabilities—or, how much the company will owe retirees.
Though many U.S. companies are sitting on large piles of cash, their past few years of struggle to shore up pension funds could lead to a shift in the way the funds invest their money.
“The third quarter of 2011 was the second-worst in history for pension liabilities,” said John Ehrhardt, a principal at actuarial firm Milliman Inc. The firm’s data show that the deficit at the top 100 defined-benefit plans—the kind of company-sponsored funds that guarantee payouts of a specified amount—widened sharply as of Sept. 30 from $186 billion at the end of June.
Only the fourth quarter of 2008, which followed the collapse of investment bank Lehman Brothers Holdings Inc., showed a greater percentage increase. Pension-fund deficits widened to $269 billion at the end of 2008 from just $6.7 billion at the end of the third quarter, a nearly 40-fold climb.
The number of Americans covered by defined-benefit pension plans has dropped sharply in past decades as companies have shifted to 401(k)s and other plans that don’t guarantee payouts. But 14% of the country’s private-sector work force still participates in some sort of defined-benefit plan, according to the Washington-based Employee Benefit Research Institute.
To see the latest Milliman Pension Funding Index, go here.
A new article in LifeHealthPro looks at the hybridization trend as it applies to retirement. Here’s an excerpt:
It’s crept onto your restaurant menu, into your pocket and your retirement portfolio, too. It’s called hybridization—taking distinct elements of one item and combining them with distinct elements of another to yield another distinct multifaceted product. Use that recipe in the culinary world and you get fusion food. Use it in the high-tech arena and the result is an all-in-one device called a smartphone. Apply it to financial and insurance instruments, and to annuities in particular, and the possibilities are seemingly endless.
The drive to innovate and deliver versatile solutions that address multiple client needs has put annuity providers in full hybridization mode. From the structure of the contract chassis itself, on down to other, more granular aspects of their products, insurers are borrowing and blending elements of various insurance and financial instruments to put a unique spin on their annuity offerings.
“Really what they’re doing,” explains Tim Hill, FSA, MAAA, principal and consulting actuary in the Chicago offices of Milliman, an actuarial consulting firm that provides insurance companies with product development guidance, “is mining these features from other things and using them with annuities. That approach seems to rule the annuity marketplace today.”
The result is an influx of specialized, sometimes complex products with hybrid structures, hybrid compensation models, hybrid benefits, even hybrid hedging strategies.
For advisors, this proliferation of hybrid annuity products and features means having a wider range of potential solutions to offer clients. But it also means more product education, observes Hill’s colleague Carl Friedrich, FSA, MAAA, also a principal and consulting actuary at Milliman. “There’s a real learning curve [annuity producers] need to climb when they’re working with some of these [hybrid] products.”
Defined benefit (DB) plans are subject to annual premiums that must be paid to the Pension Benefit Guaranty Corporation (PBGC). When a DB plan becomes underfunded, sponsors have no choice but to pay an increased premium. Or do they?
The PBGC is the federal insurance agency meant to protect the pensions of DB plan participants in the event of the employer-sponsor’s bankruptcy. They assess a flat dollar annual premium for each plan participant, as well as a “variable” premium based on the plan’s funding deficit, known as the PBGC variable rate premium (VRP). Given current market conditions, there may be a palatable way to reduce the VRP, or in the best case, eliminate it.
With interest rates at historic lows, you may have given thought to the idea that now might be a good time to borrow. After all, money is cheap right now. But if you haven’t considered borrowing to fund your pension plan, maybe you should. And here’s why.
The interest rate you get on borrowed funds can be thought of as being even lower than what you get it at. And that’s because if you contribute the cash from the loan into the pension trust, you reduce the underfunding in your DB plan, which in turn reduces the required premium owed to the PBGC. The variable rate premium requires DB plan sponsors to pay 0.9% of the underfunding. That’s essentially a 1% tax. To the extent you can reduce the underfunding in your DB plan, you can think of your borrowed rate as being 1% lower than what it truly is, because you won’t be subject to the VRP anymore, at least on the dollars contributed.
This strategy works even if you can’t fully fund your plan on a PBGC basis. Every dollar you contribute saves the 0.9% tax. Not all plan sponsors have the ability to borrow, and many surely need to put funds to work elsewhere, but you’d be remiss not to at least consider this potential savings strategy.
Last week we asked you what you’re doing to encourage employees to enroll in your company’s 401(k) plan. The majority of those who voted in the poll reported using auto-enrollment and/or auto-escalation to encourage participants to participate in their 401(k) plans. We think auto-enrollment is an effective tactic too. Of course, even 100% participation in a 401(k) plan might not be considered a success if plan participants aren’t contributing enough. So this week we’re wondering…
By year-end 2011, sponsors of calendar-year single-employer retirement plans must act on necessary and discretionary amendments and perform a range of administrative procedures to ensure compliance with statutory and regulatory requirements. In addition, there are year-end issues that employers sponsoring nonqualified deferred compensation plans (NDCPs) should consider. This Client Action Bulletin looks at key areas such employers and sponsors of defined benefit (DB) or defined contribution (DC) plans should address by December 31, 2011.
An article at Workforce.com looks at the growing popularity of target-date funds. These funds have proven to be useful retirement vehicles for many plan participants, but they are not without certain risks. Here is an excerpt from the article:
For plan sponsors considering a target-date fund, knowing whether the fund goes to or through retirement is critical, experts say. Funds that go to retirement hit their most conservative asset allocation near the retirement date, while through funds don’t hit their most conservative point until after the fund date name.
“Plan sponsors really need to have a good understanding of what they have so they can clearly communicate and monitor” their target-date funds, says Jeff Marzinsky, principal and investment consultant for Milliman in the consulting firm’s Albany, New York, office. “If participants aren’t aware [of the type of plan they are in], they may be taking more risk than they thought.”