Can variable annuity pensions offer more retirement security?

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

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.

Figure 1 - VAPP benefit accrued example

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.

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