Variable annuity plans may benefit employers and employees

The Variable Annuity Pension Plan (VAPP) is now the Milliman Sustainable Income PlanTM (SIP).

The Milliman Pension Funding Index (PFI) published this month demonstrated that while the top 100 pension plans in the United States saw an optimistic $106 billion cumulative increase in funding in the first quarter of 2013, these pension plans have seen a $37 billion decrease in funded status for April 2013. Simply put, pension benefit obligations are increasing, while growth in assets, either by employer contributions or investment return, has failed to keep pace. This market volatility in the investment return experienced over the past five years is driving some plan sponsors to review plan design with an eye towards increasing stability. Many are considering a move to fixed cost defined contribution (DC) plans, while some are also considering variable annuity plans (VAP) (sometimes referred to as adjustable pension plans). Although still not common, variable annuity pension plans have been in existence since 1953.

Milliman recently published a white paper by Mark Olleman, Kelly Coffing, and Ladd Preppernau, “Variable annuities: A retirement plan design with less contribution volatility,” which demonstrates how, with a variable annuity structure, both single and multiemployers as well as their employees share many of the advantages of both traditional defined benefit (DB) and defined contribution plans. The following chart highlights both important advantages and disadvantages of defined contribution and traditional defined benefit plans, as well as the advantages shared by variable annuity plans.

Defined Contribution Plan

Traditional Defined
Benefit Plan

Variable Annuity Plan

For   Employees
  • Employees have complete freedom over their   retirement planning.
  • Employees often outlive their benefit.
  • Investment risk in a market downturn is borne 100% by employees.
  • Employees are guaranteed lifelong income.
  • Income is static for the duration of the benefit, so   inflation reduces purchasing power over time.
  • Employees are guaranteed lifelong income that may   increase to offset inflation.
  • Investment risk is borne by the employee, as income   adjusts to the asset performance of the plan. Income increases when assets   perform well. Income decreases when assets don’t perform as expected.
For   Employers
  • Stable plan costs assure the sustainability of   offering retirement benefits to employees.
  • The same benefit tends to cost more than if provided   through a defined benefit plan.
  • Investment risk is borne by the employer, leading to   large swings in plan costs.
  • Volatile markets increase the difficulty in funding   a defined benefit plan, and may stretch the limits of offering retirement benefits   to employees.
  • Stable plan costs assure the sustainability of offering retirement benefits to   employees.
  • The same benefit tends to cost less than if provided through a DC plan,   which is due to longevity pooling and higher investment returns.

Many of us have focused on the “guaranteed benefits” of traditional defined benefit plans for a long time. It may be time to change our focus to “lifelong” benefits, where the exact dollar amount is not guaranteed, but participants are assured that they will not outlive their benefits and some inflation protection may be provided instead.

Note that although similar in name, these variable annuity plans are not your typical annuity product offered by an insurance company, although companies or individuals seeking to transfer investment risk may wish to purchase them.