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.
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.
Some multiemployer pension plans have had their funded status deteriorate because of the difficult and volatile investment markets of recent years, leading to either increased contributions or reduced benefits—or in some cases both. For some multiemployer plans, this has made collective bargaining more difficult, reduced participant pay increases, and caused some employers to struggle to stay competitive. Multiemployer plan trustees may be looking for alternative, sustainable ways to provide participants with lifelong benefits that allow for more predictable contributions.
One alternative for multiemployer trustees to consider is changing the pension plan so that future accruals are paid through a variable annuity plan (sometimes referred to as adjustable pension plans). Much like changing to a defined contribution (DC) plan, changing to a variable annuity plan shifts the plan’s investment risk for future benefit accruals to the participants. A new Milliman white paper, “Variable annuities: A retirement plan design with less contribution volatility,” describes variable annuity plans and some advantages they may have over DC plans.
To download the entire paper, click here.
Here’s some good news about defined benefit (DB) plans: Public employees, in overwhelming numbers, are showing that they understand and appreciate the value of their defined benefit pension plans.
We know this is true because we studied the data from seven statewide retirement systems that offer employees the choice between a DB and a defined contribution (DC) plan such as a 401(k). The systems included in the study were Colorado Public Employees’ Retirement Association, Florida Retirement System, Montana Public Employees Retirement Association, North Dakota Public Employees Retirement System, Ohio Public Employees Retirement System, State Teachers Retirement System of Ohio, and South Carolina Retirement Systems.
Pensions & Investments picks up on the release of the new report on public retirement plan preferences, “Decisions, Decisions.” Here is an excerpt from P&I:
Public-sector employees overwhelmingly choose defined benefit plans over defined contribution plans when given a choice, according to a report by the National Institute on Retirement Security and Milliman.
In six states that offer new employees a choice between DB and DC plans, the report found that DB was chosen by most employees, ranging from 75% to 98% among the state plans.
“If you had an election with 75% of the vote (for a candidate), it would be well past a landslide,” Mark Olleman, a consulting actuary and principal at Milliman, said in a telephone interview. Mr. Olleman is co-author of the report, which was issued Thursday, with Ilana Boivie, an NIRS economist.
Statewide DC plans have lower investment returns than DB plans because DB assets are pooled and professionally managed, according to the report.
“Some states have considered moving from a DB-only to a DC-only structure in an attempt to address an unfunded liability,” the report said. “Making this shift, however, does nothing to close any funding shortfalls and can actually increase retirement costs.”
Reuters casts the findings in an even broader context, comparing public and private employer approaches to retirement:
To fix their persistent pension problems, some U.S. states are looking to reshape their retirement plans to resemble those in the private sector, but they may find may employees resistant and the savings elusive.
For more perspective, check out coverage from Plan Sponsor, AdvisorOne, Institutional Investor, and BenefitsPro. And you might also might appreciate the article from Investment News with our favorite headline so far: “This just in–DB plans rock.”
A new study of the retirement plan choice in the public sector finds that defined benefit (DB) pensions are strongly preferred over 401(k)-type defined contribution (DC) individual accounts. The study analyzes seven state retirement systems that offer a choice between DB and DC plans to find that the DB uptake rate ranges from 98% to 75%. The rate for new employees choosing DC plans ranges from 2% to 25% for the plans studied.
In recent years, a few states have offered public employees a choice between primary DB and DC plans. The new study, Decisions, Decisions: Retirement Plan Choices for Public Employees and Employers, analyzes the choices made by employees and finds that:
- When given the choice between a primary DB or DC plan, public employees overwhelmingly choose the DB pension plan.
- DB pensions are more cost-efficient than DC accounts because of higher investment returns and longevity risk pooling.
- DC accounts lack supplemental benefits such as death and disability protection. These can still be provided, but require extra contributions outside the DC plan, which are therefore not deposited to the members’ accounts.
- When states look at shifting from a DB pension to DC accounts, such a shift does not close funding shortfalls and can increase retirement costs.
- A “hybrid” plan for new employees in Utah provides a unique case study in that it has capped the pension funding risk to the employer and shifted risk to employees.
An article by Steve White and Mark Olleman in Benefits Magazines, “Rethinking the Pension Freeze,” examines a benefits strategy that combines elements of both defined benefit (DB) and defined contribution (DC) while taking advantage of an existing pension plan.
As California goes, so goes the nation?
According to the AP, the board of the California State Teachers’ Retirement System (CalSTRS) has delayed a decision about whether it should decrease the rate of return it expects to receive on its investments.
“The investment assumption is the single most important assumption we work with,” said Mark Olleman, a consulting actuary at Milliman Inc. “The primary risk is that over the long term, what happens if we don’t achieve investment return assumptions?”
The dilemma: if the returns shrink, local school districts and the state would be asked to pay more to ensure the fund has enough money to pay pension benefits to retired teachers. Unfunded pension obligations for government employees could cost states tens of billions of dollars in coming years.
As the AP story points out, CalSTRS has grown an average of 8.6% per year over the past 30 years, including when it lost one-quarter of its value between 2008 and 2009.
The expected annual rate of return for CalSTRS has been set at 8% since 1995 but consultants and investment staff have advised the board that the fund should decrease its expected rate of return to 7.5% annually.
Because of the complexity of the issue, the board decided that it will revisit the matter in November.