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Posts Tagged ‘Tim Connor’

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.

What to look for in 2012: Defined contribution plans

April 23rd, 2012 No comments

Defined contribution (DC) plans
July 1, 2012, is a significant date for defined contribution (DC) plan sponsors, including persons who have legal responsibility for managing someone else’s money, trustees, and investment committee members. By that date, plan sponsors should have received information from all plan service providers disclosing their status as it relates to the plan, such as an ERISA fiduciary and/or registered investment advisor, their estimated fees, how they are compensated, and the services they provide. The new U.S. Department of Labor (DOL) regulations are intended to improve fee disclosure to regulators, plan sponsors, and plan participants. Plan sponsors have a fiduciary responsibility to review, for reasonableness, the compensation of their service providers that is paid from plan assets both directly and indirectly. However, in our experience, some plan sponsors are not aware of the total amount of fees paid from the plan or how they are calculated.

Many plan fiduciaries may not be aware that it is both a fiduciary breach and prohibited transaction to allow the plan to pay more than what is considered reasonable expenses. In practice, how does a fiduciary determine if plan fees are reasonable? If you’ve taken your plan out to bid within the last three years, you should have current market information and documentation for your due diligence files to support the fees you are paying, or have taken action by going back to your service provider(s) to negotiate lower fees on behalf of plan participants. In lieu of going out to bid, there are other options available: for example, you can benchmark your plan. The DOL has developed fee disclosure worksheets that can be found on their website at: DOL Publications “Understanding Retirement Plan Fees and Expenses “ and “Cost Disclosure Sheet.”

There is nothing in the regulations to imply a plan must have the lowest fees, just that the plan’s fees be reasonable and commensurate with the services provided. Qualitative differences in services may impact fees. For example, quality of service varies with respect to the range of planning and guidance tools available to participants, which may drive up fees. We strongly encourage plan sponsors to develop a diligent process to evaluate fees on an ongoing basis and to document their processes. Costly litigation can be avoided by implementing a sound process, which shows that you have taken reasonable steps to fulfill your plan fiduciary responsibilities.

What to look for in 2012: Lump-sums

April 18th, 2012 No comments

Defined benefit plans: Lump sums
Speaking of de-risking strategies, another idea that may gain more traction in 2012 is payment of lump sums from defined benefit (DB) plans. This year, 2012, marks the first year that the 417(e) interest rate required to calculate the minimum present value of a DB pension is equal to the interest rate used to calculate its liability for Pension Protection Act (PPA) minimum funding purposes (ignoring the 24-month averaging). In the past, the lump sum was based in part on 30-year Treasury rates, which often resulted in the payout of lump-sum amounts greater than the corresponding liability funded for in the plan’s funding target. With this no longer the case, the settlement of lump sums might be an attractive way to eliminate longevity risk from DB plans. Alas, the buyer must beware. The introduction of lump sums into a plan that otherwise had no accelerated forms of payment could lead to some unwelcome news should the plan ever fall below certain funding thresholds that introduce the sponsor to the world of benefit restrictions. Additionally, the other subtle point to consider is that just because the PPA requires the valuing of liabilities using corporate bond rates doesn’t mean a sponsor has to equate that to their idea of the true liability on the books. To the extent a sponsor is confident the plan’s asset mix will generate long-term returns on average in excess of corporate bond rates, lump-sum settlements are arguably still expensive and represent a lost opportunity cost. As is the case with almost any financial strategy, it’s all about the risk appetite.

To end this series, we’ll look at defined contribution (DC) plans.

What to look for in 2012: De-risking

March 27th, 2012 No comments

Defined benefit plans: De-risking
Given the highlighted areas of concern already discussed, it’s likely that plan sponsors will look ever harder at the idea of de-risking their plans in 2012 and onward. The volatility of worldwide markets has been dubbed the “new normal” by many economic minds. Smoothing mechanisms are losing favor in the financial world, and the International Accounting Standards Board (IASB) has already moved toward a more mark-to-market structure, with the Financial Accounting Standards Board (FASB) likely not far behind. Sponsors have already been “encouraged” by the Pension Protection Act of 2006 (PPA) to take on less risk in their pension portfolios, and now the accounting world is joining in on the push. When you further consider the world of pain that comes with benefit restrictions under the PPA and the ramifications of being at-risk, not to mention higher Pension Benefit Guaranty Corporation (PBGC) premiums the more underfunded a plan is, it stands to reason that employers should be very attracted to pension risk management more so than ever.

Liability-driven investment (LDI) strategies have been one popular approach to mitigate risk by reducing the exposure to the most volatile assets in a portfolio, instead concentrating investments in assets that act more like liabilities, namely long bonds. However, the cost of implementing an LDI strategy is high right now because current yields on bonds are so low. Also, there is still a lost opportunity cost with regard to the impact on financial statements, at least with U.S. GAAP anyway.

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What to look for in 2012: Financial statements

March 12th, 2012 No comments

The impact of low interest rates on defined benefit (DB) pension plans not only leads to higher contribution requirements but also to an increased squeeze on corporate earnings. Under current U.S. GAAP guidelines, large losses in the funded status of a pension plan (whether because of asset returns less than expected or liability increases that are due to lower interest rates) accumulate on the balance sheets through other comprehensive income (OCI). In most cases, these losses are slowly realized through earnings over time. Absent significant increases in asset returns or interest rates over the next few years, corporate earnings for DB plan sponsors will continue to drag from the gradual recognition of the losses that led to the current, historically high underfunded statuses.

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What to look for in 2012: Discount rates

March 12th, 2012 No comments

As we are now under way with the 2012 calendar year, it’s time to look at the issues we expect to generate heavy interest during the year. For one thing, the federal deficit has attracted a lot of attention lately and will likely continue to do so. The upcoming presidential election is likely to feature plans on reducing deficits, and these plans will undoubtedly reach the world of employee benefits in some fashion. In addition, the economic environment of recent times, both globally and locally, has been unstable to put it kindly. Pressure on employee benefit plan sponsors is coming from a lot of different directions. In this series, we look at a few of the potential headliners that may affect defined benefit and defined contribution plans in 2012.

The year that just passed saw some extraordinary events take place. Those that are unforeseen are what make predictions impossible, complicating matters and leaving their mark on the global economy and political landscape. The European debt crisis, political revolutions, an earthquake and tsunami in Japan, and the downgrade of U.S. debt, to name just a few, were major events that dictated the direction of economic and regulatory policies. What will 2012 hold? First, we’ll look at defined benefit (DB) plans.

Defined benefit plans: Discount rates
First and foremost on the minds of defined benefit sponsors are interest rates. How low can they go? It seems like DB plans have already circled around the limbo stick of interest rates several times and are now faced with rates so low that not even the retirement plan of double-jointed contortionists could slide under without buckling. Bend don’t break has been the unfortunate reality for DB sponsor’s balance sheets and funding requirements. The rate on the Citigroup Pension Liability Index, a common benchmark used to discount pension liabilities, hit a record low in December of 4.40%. That was the lowest rate reported by the index in its history.

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Retirement plans: What to look for in 2012

March 1st, 2012 No comments

We take a look at the year ahead for retirement plans, as Tim Connor and Genny Sedgwick offer their perspective on what to look for in 2012. Some of the challenges facing these plans—such as asset volatility and the effect low interest rates are having on pension liabilities—have become all too familiar to plan sponsors. But there are also new concerns, such as the phase-in of a fee disclosure rule for defined contribution plans and the march toward common worldwide accounting standards for defined benefit plans.

The full article, “Retirement plans: What to look for in 2012,” is available here.

The most important retirement stories of 2011

January 19th, 2012 No comments

If you’re like a lot of people, you’re probably anxious to put 2011 in the rearview mirror. Yet the biggest stories of 2011 could play out for years to come. So let’s take a look in that rearview mirror and see if there’s anything we can learn from some of the key stories we tracked on Retirement Town Hall in 2011.

A record nobody wants to break
In the third quarter of 2011 the Milliman Pension Funding Index had its second-worst quarter in the history of the study (read the full story). Like a consecutive losses streak, nobody wants to break any records for worst quarter in the study.

How will underfunded pensions start to dig out in 2012? “With interest rates remaining at historic lows and low expectations for investment gains, plan sponsors will be facing record levels of contribution requirements in 2012 and 2013,” says John Ehrhardt.

Risky business
The Department of Labor (DoL) gathered experts to discuss the trend towards using investments with higher rewards but higher risks in pension plans (read the full story). Investing is all about risk and reward but pension plan managers face unique circumstances when investing people’s retirement money. That’s why many are exploring new approaches to managing this risk.

“The risk management techniques used by variable annuity providers saved insurance companies $40 billion during the financial crisis,” says Tamara Burden. “Pension plans can benefit from similar techniques, especially in this time of record-low interest rates.”

No more Social Security blanket
Changes are afoot at the Social Security Administration (SSA). In 2011 the SSA announced its plan to stop issuing paper checks (read the full story) and statements (read the full story). These moves are certainly eco-friendly, but they are really intended to help the SSA’s bottom line.

What effect will these changes have going forward? “As the world becomes more reliant on technology, electronic deliverables like these make more sense from both a practicality and cost standpoint,” says Tim Connor. “Get used to it, embrace it, and take part in it.”

Downgrades, they’re not just for hurricanes
The day some thought would never come came in 2011. The S&P’s downgrade of the United States was a dramatic event within the investing world that affected nearly everyone (read the full story). The downgrade led to immediate volatility, at the time.

What will be the lasting effects of the downgrade on those who manage retirement plans? “As humans we tend to forget, most of the initial effects of the downgrade have subsided, investors are still buying U.S. debt,” says Jeff Marzinsky. “However this should not lead investors to a false sense of security. The U.S. economy is improving, but still fragile, markets are volatile, and interest rates continue to remain low.  Investment policy and diversification are key areas to keep a close eye on, more than ever.”

As exciting as watching paint dry
It’s more of a non-story than a story, but 2011 was something of a regulatory vacuum in which employers operating both defined contribution (DC) and defined benefit (DB) plans waited and waited and waited for regulatory guidance on key issues…and are still waiting.

“There are numerous examples where some regulatory guidance would be quite welcome for plan sponsors,” says Charles Clark. “There are holes in the DB funding rules, many questions still swirling around disclosure rules, and new uncertainty around cash balance plan regulations, just to name a few.”

Why pay PBGC premiums?

November 21st, 2011 No comments

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.

Categories: Defined benefit Tags: ,

Should target normal cost include investment expenses?

September 14th, 2011 No comments

The American Academy of Actuaries thinks No, and I’m inclined to agree.

The Pension Protection Act generally requires defined benefit (DB) plans to pay a minimum contribution each year that is comprised of two parts, namely (1) the target normal cost and (2) a shortfall amortization. In simple terms, the first component covers the cost of additional benefit accruals and plan expenses for the upcoming year, and the second represents a seven-year mortgage of any debt (i.e., underfunding) that the plan has. A question currently being wrestled with by the IRS as they formalize guidance is whether or not plan expenses in the target normal cost should include “investment related expenses” or just “administrative expenses.”

Administrative expenses ordinarily include things like legal, accounting, and actuarial fees, termination insurance (PBGC premiums), and perhaps some administrative costs of the trustee, such as those involved with cutting checks to retirees or processing contributions. Investment-related expenses in this debate refer to the costs associated with professional management of the plan’s portfolio of assets. Broken down to one of its most basic decision levels, the choice facing a plan sponsor with regard to investments is whether to pursue “active” or “passive” asset management. Passive management usually entails investing in index funds, which are designed to have little maintenance and low cost. Active management involves professional advisors seeking out opportunities in their niche markets in search of superior returns with various risk and reward characteristics. With passive management, the goal is to track the market. With active management, the goal is to beat the market.

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Categories: Defined benefit Tags: