Experts from actuarial, legal, and policy fields came together to discuss the critical challenges of unfunded and withdrawal liabilities in pension plan management.
Highlights of what was discussed include:
- Important funding obligation distinctions between single employer and multi-employer pension plans
- How economic factors and assumption changes impact liabilities
- Key strategies and proactive approaches to manage challenges
- The importance of long-term views and maintaining adequate reserves
- Recommendations to transfer risk and the critical need for service providers
Webinar speakers included:
- Ellen Kleinstuber – Founder, Infinity Actuarial Consulting
- Michael Kreps – Principal, Groom Law Group
- Dan Doonan – Executive Director, National Institute on Retirement Security
- Jeff Anderson – New Business Development Manager, Berwyn
- Jack Hartwig – Marketing Manager, Berwyn
Webinar Transcript
Jack
Thank you all so much for joining us here today and taking time out of your busy schedules. We’re really excited to bring you the next episode from The Berwyn University on the topic of unfunded and withdrawal liabilities – what every pension leader needs to know. We have some great panelists here today that will lend their expertise from the various areas of our industry. We’re joined by Michael Kreps, Principal and Retirement Services Chair at Groom Law Group. We have Ellen Kleinstuber who is the Founder of Infinity Actuarial Consulting, a boutique consulting firm whose mission is to empower retirement plan stakeholders to manage risk effectively, understand cost drivers and simplify the complexity associated with plan funding, accounting, administration and participant communication. We also have Dan Doonan, who is the Executive Director of the National Institute on Retirement Security or NIRS. If you’re not familiar with NIRS, they are a membership supported think tank focused on retirement, security and pensions. If you’re interested in any of these organizations or learning more about them, we will have the contact information for each of our panelists at the end. So, without further ado, I’ll pass it over to our moderator, who is Jeff Anderson, our New Business Development Manager at The Berwyn Group to kick things off here. So, Jeff, it is my honor to pass things over to the panel.
Jeff
Thank you, Jack. I appreciate that and good afternoon everyone. First, let me start by saying I really appreciate the time and knowing each of the people on this panel – what a great group of people that we are fortunate to have participated in this. With today’s topic around unfunded liabilities and withdrawal liabilities, what I’d like to do is start the conversation off by having each of you speak to how these unfunded liabilities withdrawal liabilities intersect, how they’re distinct and give us some understanding how both are crucial for effective pension plan management. Michael, maybe you want to start us off from a legal standpoint and discussing the various implications across the different types of retirement plans.
Michael
Sure, happy to and thanks for having me today. Let me do a quick overview of the funding regime from a legal perspective and I’ll defer to the people who are better at math on the actual numbers. But from a lawyer perspective, I think it’s helpful to get a little bit of a lay of the land you. Know we’ve got this defined benefit plan system that’s all centered around the idea that these benefits are guaranteed, that someone who says we are promising to pay you X dollars in the future and that can’t change. Congress fixed that obligation with the passage of regulation in 1974 and it created two different regimes for funding that. There’s a corporate single employer context and there’s a multi-employer collectively bargained context in the single employer world, which are most of your corporate plans. You know it’s the ones for just a sole employer that starts a plan for their own employees that guarantee is enforced that benefit guarantee is enforced by a statutory funding regime. That sets very specific rules for how much you have to contribute based on calculations of anticipated liabilities and current assets, those are mechanical. Actuaries may take a little issue with this because it is an oversimplification, but those are mechanical calculations to determine an amount to contribute to a plan based on an attempt to quantify the cost today of providing a benefit tomorrow and that obligation is carried on the employer’s balance sheet. It is stuck on their balance sheet for publicly traded companies at least and for some others it’s something that goes right to the employer’s bottom line and can vacillate as interest rates change. You can see your liabilities grow or shrink depending on the movement of interest rates just because that grows and shrinks the liabilities. Now that’s the side of a single employer. Quickly on the multi-employer side, they were designed a little bit differently. Multi-employer plans are sometimes referred to as Taft Hartley plans. These are plans established to cover one or more than one. They’re established through collective bargaining. So, a union and employer will agree to that the employer will participate in a pension plan on behalf of its employees. That pension plan is managed by a joint board of labor and management and the funding rules. There are much different as they were designed to reflect the reality of the bargaining relationship. And so, the funding rules themselves are much looser. They’ve got more strenuous overtime, but they’re loose or more flexible set of standards that are intended to force the bargaining parties to reckon with future obligations and fund the plan. And if you don’t, there’s some sticks in there, some penalties effectively, that force the bargaining power parties to pay more. That obligation on the multi-employer side is not a direct obligation. The benefit obligation of the employer, but instead the employer owes their pro-rated share of the underfunding of a multi-employer fund and we refer to that as withdrawal liability. And I’ll let Ellen get into a little more details on any that she wants. But at a high level, that’s the basics. Single employer, it’s the employers obligation and they are responsible for meeting pretty stringent funding rules to fund that obligation, whereas in the multi-employer world, the rules are a little more flexible and really to designed to incent the bargaining parties to come up with agreements that will fully fund the plan to make good on the benefit obligations.
Ellen
Michael that was actually a great setup in handoff. So, when you think about the single employer space, right there really is there’s no concept of a withdrawal liability directly indirectly the cost or the liability for a single employer plan sponsor in the private sector to withdraw from sponsorship is planned termination. They have to settle all their obligations, whether that’s through paying off some or going out and purchasing. Duties and the multi-employer space, I think Michael could explain well why there is this flexibility on funding and why funding is really viewed and liabilities are measured on a long-term approach. But when you have multiple employers to get together, they each have to still be responsible for their portion of the plan, and then when one of them decides to exit again, understand like they want to say, OK, I want to pay. I’m leaving for the night. I want to pay my tab. I don’t want to get a bill in the mail tomorrow or later. How much do I owe you? I don’t want to be surprised. So, when that’s happening, measuring withdrawal liability in either multi-employer or a multiple-employer plan, the difference between the two multi-employer, the sponsor is usually a union or collective bargaining group whereas in a multiple employer typically not bargained at some other entity that is sponsoring a plan for these unrelated employers. So, when one of those unrelated employers wants to pull out, they’re leaving a risk behind for the other employers that any amount that they pay might not be enough. As experienced the merges after they’re gone and likewise if you go too conservative on how you value and determine withdrawal liability, then that withdrawn employers overpaid for the risk that they left with the plan. Really, with no way of getting that additional money back. So, a key decision that planned sponsors with support from their actuaries have to make is how do we value employer withdrawal liability and how do you balance these two competing concerns, right? If you do it. So, if you look at things and say I’m going to value withdraw liability solely on the plans long term valuation assumptions. Right, because this plan is, we’re expecting it the rest of the plan is going to go on, you know, sort of in perpetuity. And so we can weather the ups and downs that come from any one individual years experience, often that means that if that long term experience deviates adversely from what was assumed in that original upfront calculation, there’s really little or no margin to absorb that the plan ends up taking on more of the risk in most cases. Then the withdrawal employer, if you swing to the other end, you say fine, we do everything on a current market basis and I’m going to, you know, get more money in that will because that opens up to me some different types of investment and funding strategies, which I think we’ll talk about later in our program that reduces some of the long term risk. But then you have to worry about are you going to be able to get employers into this hold plan at all? Because who wants to have that risk of that big check waiting for them at the end of the night if they decide that they want to withdraw? So, it’s finding that right balance point. Determining where on the spectrum you want to fall, how are you allocating these different risks to each individual employer really has to pay for their fair share, and how do you determine that versus you can’t make this so unappealing that they’re not going to run into these arrangements?
Jeff
Very good. So, I think what I’m hearing the two of you say is this is challenging stuff and the people that are listening in here are having to deal with the, you know, there’s some real challenges here. So, Dan, from your standpoint, can you outline all these liabilities matters at a policy level and what trends are driving increased attention to the issues.
Dan
Yeah, and thanks for having me on. Obviously, no one wants more debt or liabilities on their books, but what type of plan does impact how unfunded liabilities impact you? So, for public plans, this might mean higher contribution rates, possibly budget pressures and if costs go up for employers and private plans, including multi-employer plans, it can impact their ability to borrow if their balance sheet looks better or worse. The financials that Wall Street might see, and even the value of the firm as well as sort of contribution rates and costs. I think in addition multi-employer plans need to keep their employers in their system, right? Keep a healthy demographic balance. So, the perception that a plan might be falling behind can cause employers to leave and impact on the ratio of retirees, people receiving and people participating as workers. I think as far as the trends go The Great Recession hurt all investors, including pension systems. If you remember, we had some of the largest financial institutions in the world failing all at once, and that event put pensions and especially public pensions on the front page for years. I think there was a CBS segment right after the Super Bowl about public pensions. You don’t think that it occurred before and it led to a lot of changes in benefits, funding strategies and more. I will say we have looked at some sample plans and sort of gone through the old game loss and said you know what is today’s? Where did it come from? And I think most people, including policymakers and maybe corporate decision makers, probably assume well, the returns haven’t been good enough. But the vast majority of the plans we looked at, the markets have recovered. Over time, a lot of those investment losses were made-up for with a good year since then. But we moved the gold line a lot on assumptions. The discount rates came down – that creates a higher funding target and means more money has to go in to reach that higher funding target. And that’s a kind of analysis you can do for your own plan. So, your stakeholders understand where we are and how we got here.
Jeff
So, from as far as the economic and regulatory drivers and the stakes that we’re talking about here, Dan, maybe we’ll start off with you this time. How are the current economic challenges, high interest rates, inflationary pressures, market volatility, the shaping or reshaping of the unfunded liability landscape…how should plans adapt?
Dan
Yeah, I think you know interest rates are up historically, it’s not very high. I think we got used to that post Great Recession when the Fed growth rates were down. You know that decision was good for the economy is definitely good for borrowers who had houses that were hard to afford. But for pension plans and asset owners, low bond yields and then maybe look somewhere else for investments. But you know when you think back at that period, treasury bonds at one point we were paying less than 1%. A lot of our plans, we’re assuming above 7, sometimes 8, that was a big spread to cover. When you think of interest rates, bond yields, it’s a double-edged sword for funds. Higher yields mean future bonds will pay you more. But the face value of the bonds you have falls, right. So that’s sort of offsetting, but it certainly could impact future asset allocation, because I think we’ve seen plans move to more complicated asset mixes, partially because fixed income was really unattractive. I think on inflation, the main thing we’re seeing, higher wages increases, you know, for a long time, wage increases were lagging, the economy was struggling. Now we’re seeing higher inflation. Employers feel like they need to give higher raises. That certainly impacts final pay plans. Like any plan where your benefit is based on pay, that means. Higher benefit accruals, not just for this year but for all past service as well. And I would say, I would love two things together. You know, markets have always been volatile, but pension plans are getting more mature over time and that means more challenging in my mind. You know higher ratio of plan liability to payroll. If you think about assets missing by 10%. How many years of payroll does that mean? I think that’s something you can look at. And we’ve been having fewer kids since the Great Recession. So, I think this move towards more mature plans will continue. Simply because we’re living longer, having fewer kids. There’s going to be more retirees in the general popular. But I think, given that we balance these financial risks largely over the payroll of the firm offering the plan or the firms, I think that points are made to manage risk in the future to continue to improve. And I will say, we have improved in a lot of ways and we should aim to continue that.
Jeff
And, Michael. Secure 2.0 and recent PBGC developments have significantly altered liability considerations. What are the essential legal insights that fiduciaries should be grasping to maintain compliance and mitigate their risks?
Michael
Yeah, it’s a really good question and it would take just a quick tour down memory lane real quick just to give you some perspective, so the current funding regime we’re operating under for pension plans was largely not entirely, but you know was it most recently revamped in 2006 with the Pension Protection Act and the government there was really worry that the pension system was failing, that a bunch of large plans would go insolvent and that the pension insurer PBGC would have effectively itself become insolvent, and that have been kind of a simmering issue for a while, and Congress passed a big piece of sweeping legislation. I believe it was 98 to 0 in the Senate. It was a bipartisan, bicameral. Everyone was happy except the pension plan sponsors, Bill’s pension plan sponsors hated it because it cranked up the funding obligation for plans. And then Congress spent the next 10 years loosening those restrictions in response to the Great Recession. And so, I think the big lesson from the past decade of congressional tinkering with the funding rules is that Congress is responding to real or perceived crises and what they do when they pass legislation to address those real or perceived crises is they take a whack with a pretty big hammer, right. They put pretty stringent rules in place so they change them in some way, but they paint with a really broad brush and the most important thing fiduciaries can do for this is to understand the kind of changing landscape there. But you can funding proof your plan. Without regard to the kind of funding rules you can contribute more to your plan to get to a place where there’s a more static contribution base or a more static contribution level. You can mitigate a lot of these risks and you can come up with a more consistent funding stream or funding schedule for your plan, provided you’re willing to depart a little bit from the statutory structure that the Congress attended as a bare minimum.
Jeff
Ellen, I hope Michael and Dan didn’t steal all your thunder here, but if you could share with us your thoughts on recent economic turbulence and how that’s tested, traditional actuarial assumptions and what kind of recalibrations do you think are necessary for long term plans?
Ellen
Yeah. So, the example that that Dan gave about discount rates, long term investment assumptions coming down over time. So, if you had an employer that withdrew a decade ago, and maybe you’re assuming 8% long term return to the time and now you’re looking at it. Saying OK, maybe I really can only support 7. The half or 7 going forward at the point you make that change, there is an immediate bump in your unfunded liability that emerges with respect to that block of participants. From that withdrawn employer and without anything to go back to that withdrawn employer and pick up more money from them, right? Because they don’t want that supplemental bill that ends up spreading the cost across the remaining employers through increases in contributions reduction, funded status. All of the things that Dan and Michael talked about that challenge, trustees and fiduciaries and how they manage their plan going forward. Maybe you had some gains against that 8% assumption that you could book that will help offset that. Maybe you didn’t. So, whether you know whether it’s your economic assumptions or the demographic assumptions that go into the valuation, typically when we’re doing an annual valuation and determining the unfunded liability or calculating what withdrawal liabilities would be for the year, we’re making assumptions that are forward-looking. And this actually is one of the things that we love is that we get to tweak this a little bit every year as new experience emerges, we get to say, OK, yes, that assumption is still good or we would recommend making a refinement to it. But we get that a new bite at the apple every year. Right. So, what we’re doing now, the first point is being really cognizant thinking about how you’re seeing data trending maybe being more responsive or little quicker to make some tweaks and adjustments. And maybe we have been in the past as we’re seeing these table stakes of unfunded liabilities becoming more of a concern for people. The second is there’s a lesson I think comes out of the single employee. In our market, you know where we talked about withdrawal liability really being planned termination? Ask yourself, are these assumptions I would be comfortable with if this was my one and only bite at the apple. Because really, when you’re talking about withdrawal liability for that withdrawing employer, it kind of is your one and only bite. And if you go over to the insurance side and insurers that are in the pension risk transfer space, doing group annuity buyouts and buy INS, that’s how they price because they don’t get to come back to one of their customers years down the road and say, hey, I didn’t really price your product, right? I need more money. From you and most of the time, they’re not giving divide back. So, it’s not to say that we are entirely revamping the way we think about actuarial assumptions, but if you have a plan, particularly one that’s paying you with that assesses withdrawal liability, maybe the stakes on how we think about those assumptions and how quickly. We want to start to respond if we’re starting to see some emerging experience, you don’t want to overreact and have cost ping ponging up and down all over the place. But maybe we want to be a little quicker to act than we might have been in the future. And I think the other big one out there is longevity life expectancy. You know, people are living longer and we really want to think carefully about how that might change in the future, how longevity is going to increase. And again, we don’t want to overshoot the market. We also don’t want to undershoot it. I think the good thing is that we’ve moved into a phase of actual practice, where most plans or many plans are using what we call generational mortality tables. So, they’re not just saying here’s where we are at a point in time, but we’re going to continue to project that. There will be these continued improvements in life expectancy. Thinking a little more particularly for plants that are in like the mid-sized range where you don’t have enough of your own experience to go out and do an experience study and say here is what the mortality experience for my participants have looked like, consider how some of the other models that are emerging these zip code or lifestyle based mortality models. Might be helpful in your assumption setting process whether you use them directly as your assumption or you use them. As a way of calibrating a standard mortality table that you’re going to use to really make sure you’re getting that best and most refined estimate of what that unfunded liability is at the point that you’re assessing it.
Jeff
Good. Thank you. Yeah, you hit on some concepts there of being reactive and being proactive, and many of the challenges that with anyone in this space you controlling what you have the opportunity to control is certainly very important and there are certain things that you have to react to and certain things that you can be more proactive with. So, with that, Michael, can you share with us or highlight some common misconceptions that plan sponsors hold regarding withdrawal liabilities and proactive? Legal strategies that can help address these misunderstand.
Michael
Sure, sure. I think the biggest misconception is just that when you trigger withdrawal liability that you that you owe the full amount immediately, that there’s some kind of requirement that you withdraw from a plan all of a sudden you a billion dollars. The truth is withdrawal liability is just a number. It’s a calculated prorated share of the plans under funding based on the plans rules and status rules and that is actually not paid in one big lump sum. It can be if you choose to. You can wipe your hands at the plan and cut a check to the plan, but in reality in most cases it’s there’s a statutory payment scheme that’s based on periodic payments over usually up to 20 years can be longer depending that gives you time to pay off that liability. And a lot of times the ultimate amount you pay is dependent on a negotiation with the fund about not only the underlying number, but also how quickly you pay that off. Some funds will provide discounts if you pay off faster. Some will use different rates. If you pay faster, some will let you take more time or have creative payment schemes. There’s lots of ways to work around it with the fund, or, you know, adversely with the fund. Either way, to come to a payment schedule, that’s something other than just you owe the exact number that’s on the page when it’s assessed.
Jeff
Thank you. Ellen, which actuarial assumptions most critically influenced withdrawal liability calculations and what kind of advanced modeling techniques can actuaries deploy to forecast those potential scenarios?
Ellen
So, the big tier that always comes to mind immediately when you’re measuring any sort of pension obligation liability is your investment rate of return and or your discount rate. So, for multi-employer and public sector plans, those usually are synonymous in a single employer space. You have a disconnect between what you expect the assets are going to return in the future and how you may discount liabilities. For different purposes and that of course, mortality or life expectancy. But I would also add to that a third category of most critical assumptions, and that is any assumptions, that relate to any subsidized benefits that are payable in the plan. So, you go back years ago in actuarial practice and it was common that we would say more time in age of 65. We’re just getting make a simple model and everyone retires at 65 and you know when we’re remeasuring. Every year and we’re kind of chewing up for experience if people retire early, we’ll happen to work later. And that was that was reasonable. Now the way pension plans are managed on both the liability side and on the investment side, we care. More than we used to about predicted future benefit payment, cash flows and when are they going to hit as opposed to is just the total pot in the right ballpark. So, I think if you have plans that offer subsidized retirement benefits, you want to look very carefully that what retirement behavior has been. And are participants taking advantage of those benefits? I’ve worked with some multi-employer plans and some single employer plans where they had some very significantly subsidized benefits that hit at a particular point in time and I could tell you every participant in that plan knew exactly what that was, and that was the date that they were working towards is when they could get that. Unreduced early retirement benefit at age 60 or when they hit 25 years of service? Whatever the provision. So, you don’t think very carefully about what that kind of experience is going to look like because theirs are where you can get big pops in the liability that occur when behavior deviates from what you assume and that’s what can kind of throw your withdrawal liability calculations into disarray. Also think about forms of payment that might be subsidized and/or that have very different timings of future cash flow. So lump sum distribution options or plans that pay out life insurance benefits where you can have some bigger cash draws that come in as compared to traditional annuity benefits? And then I think the other thing I would say is just remember that your actual evaluation liabilities, these are estimates. And an estimate of what a future obligation is going to be. So, it’s the estimate that you come up with is only as good as the data and assumptions that go into your actuarial model. The old garbage in, garbage out. So, think about, the evaluation they’ll use one static set of assumptions. And we’re selecting them at a point in time to reflect what we think. Will happen in the future, but we’re selecting them today. Some of the more recent changes in actuarial practice, where actuaries are now required by our standards of practice to include a risk assessment in the valuation report, I think those have been very helpful in educating plan sponsors and fiduciaries about what some of the risks are that they face and I see, particularly in the public sector, I’ve seen something really good. Risk assessments and evaluation reports are some of the things that we do when we’re doing a risk assessment is we look at assumption sensitivity, what happens if our actual experience deviates from what we’re assuming we might stress test the plan, what happens if there’s multiple concurrent adverse events, we do stochastic forecasting what’s the range of possible future outcomes or what is the probability of achieving a certain outcome like reaching 100% funded over our target time frame or increasing our unfunded liabilities because of adverse experience? So, I think looking at some of those maybe having your actuary go beyond doing a basic risk assessment for you can help inform which of these assumptions for your plan are going to be the most sensitive. And those are the ones that you really want them focusing your attention on and, I would also say just the last piece on this is the data quality. You know, again garbage and garbage out. So, if you have plans that have gaps in the data where you have to make assumptions, you know we’re missing data, we’re missing date of birth for 200 people out of 2000, we can make an assumption that those people are of the of the same average age as the other 1900 that are in the plan and from a valuation standpoint. That’s perfectly fine, because you’re going to chew it up every year. And eventually you’ll find out when that person was going through and do some conscious data mining to fill in those gaps and assumptions so that there’s you’re taking some of the guesswork out of it and you’re tightening up that a little bit. And then of course obviously look for when sponsoring this, looking for dead people, both the new intents and their beneficiaries to make sure that you’re measuring your liability more accurately, so someone retired with 100% joint and survivor annuity. It’s common that will track the retiree or the primary annuitant to check that they’re still living or not. Less common that to go and do that same kind of search on the contingent beneficiary. But if you find that that contingent beneficiary is already deceased, now you know fixed dollar benefit and you’re paying it over one lifetime instead of two. That’s going to reduce your liability, reduce your unfunded liability and help you get more accurate.
Jeff
Yeah, that’s a great point. Controlling the unfunded liability picture as much as you can on the front end with clean data is extremely critical. Dan, if you could discuss with us the broader economic implications that happen when large employers withdraw from unfunded or underfunded plans and does this influence national dialogue on future pension reform sustainability?
Dan
Yeah. So, I’ll start from the worker perspective, you know, providing a pension to a worker is an incredible service, right? You’re pulling all these risks in retirement. The person has this experience that is smooth, predictable. You know, you’re buying wholesale. I don’t know of any retirement systems I would not prefer to manage money over my parents. Right. You have professionals doing this? You know what they’re doing? That is a really nice service that you’re doing for people and when it comes to accruing benefits for retirement, I think it’s important to understand if you can have half your career in a 401K and half in a pension, you want the first half in that 401K those early dollars can be powerful by the time you’re older that it’s really expensive to buy income replacement. Right. It’s simply too late. The accrual patterns, if you look at just percent of pay replaced in retirement, kind of looks like an ex, right, the early pension dollars on as powerful as delayed and vice versa in the 401K. So, what we’ve seen employers offering a pension pulling away. I think we’ve seen a lot of workers say, well, I don’t need to save that much. And now in the back half of the working career, it’s really hard to get caught up. So, I think from a human perspective, it’s really clear that that’s not an ideal situation. And I think you know from the employers perspective, it’s certainly going to impact turnover. There’s a really strong understanding there, but I’ll give you an example. Half of U.S. workers have less than five years of service and their current job amongst teachers, it’s almost half that have more than 10 years, right. So, you have these jobs where not just pensions that shouldn’t, I’m not attributing. Owe that to pensions, but good benefits and you have this career model of employment. So, what kind of work are you doing? Do you need experienced workers? I think there’s some consideration there and I think you know there’s been a lot of conversation about how many people are falling short of reaching a secure retirement. The national dialogue, I feel like turned the corner a little bit a year or two ago. We’ve had more interest more conversations about if we return to pensions, maybe it doesn’t look exactly the same way. But what? What would be a happy middle ground where employers wouldn’t be fearful of offering it, but workers still getting most of the experience that is so valuable in terms of predictable income, having so much of this really complicated project retirement. Done for them by professionals. Sort of consolidated at a retirement plan. So, I think it’s really positive that we are having that dialogue and I think really there’s been kind of a convergence in terms of 401K’s and pensions because I think we all know what works and what we need.
Jeff
Good. Thank you. OK, so let’s talk for a moment about innovative approaches to mitigate and prevent liabilities. I think Ellen touched on this as well in the last segment. But Ellen, why don’t we pick up with you here? What are some funding and investment strategies that effectively reduce unfunded liabilities and what are the potential consequences if liabilities remain unaddressed?
Ellen
So, these two concepts, your funding strategy and your investment strategy, they have to go together and they have to work together. When you look at any retirement plan there are only two sources of money to pay for benefits to and the expenses of the plan. There’s the money coming in, that’s contributions, and there’s the earnings on those on those benefits, the more earnings you have, the lower your contributions needed to fund those benefits or vice versa, right? But then when you think about this in a risk standpoint, the more investment risk you take on, you may have lower contributions, but they also be maybe more volatile. So, if you don’t like that volatility, you can commit to making a little bit higher contributions. They’ll be a little stable. That’s the price of taking on that less investment risk. You cannot manage one of these without the other. You can in practice, but I don’t advise it and I think we’ve really seen a progression in retirement plan management on the defined benefit side over the last couple decades. They’re being much more of this holistic view of how you put these together, but you had asked about the two different categories. So, on the investment side, one of the things that you know, you can look at is the role of purchased insurance. Whether this isn’t an annuity buyout arrangement, where the plan sponsor effectively transfers the obligation to pay future benefits for some or all participants to an insurance company, right? You see this, we see this most common in the single employer space. Whether it is just a lift out transaction for a partial portion of the planned population or it is part of the exit strategy of a termination. This can also be utilized by multi-employer and public sector plans. It hasn’t been as frequently and there’s some good reasons for that. You look in the public sector, there’s always this question about intergenerational equity, right? And so, if you have a plan that’s has some unfunded liabilities and you take some of the risk off the table. By going out and settling benefits for some of those now you’ve taken a group of participants and you’ve given them 100% benefit guarantee while everyone left in the plan still takes on some risk and you know how will that, how will that sit? How will that go from a public perception standpoint, but also from a participant reaction standpoint. You create these different classes of the housing guarantee and the house of an insurance guarantee versus the house a backing of the government guarantee same thing in the multi-employer space. You know there’s questions about elevating the security or replacing at a risk of security. The non arises of state guarantee security. For different class of participants and if you have plans that have received special financial assistance, you have to be mindful of those restrictions because you can’t use the SFA funds to go out and purchase an annuity contract. You’d have to use other funds. And so, you’ve already got some restrictions on the SFA funds having to be, largely not exclusively, but largely in fixed income. So, do you want it to have another big fixed income component? There’s another flavor of those that are the annuity buy in arrangements where the plan makes us buy upfront, they spend a pot of money in exchange for a guaranteed stream of income coming back into the plan from the insurer overtime. So again, there are places for that where you look at it and say, hey, if I purchase this investment, I’m holding it within the plan. Now I can be more strategic in my risk-taking and other aspects of the portfolio because I know I’ve got a certain measure of liquidity cover and it’s going to be a cost effective, relatively cost-effective liquidity for. There are more traditional immunization or cash flow matching strategies that can be employed through a fixed income portfolio. Where you look at the coupon and principal return income payments that are going to come in and use those to cover cash flows. And again, now that gives you some liquidity with some return, especially when you’re in an environment where we’ve been in recently. Where I’m seeing some of the folks out there that specialize in this area structuring portfolios and they’re locking in 5 to 6% returns on fixed income. Through this cash flow matching and that makes it easier to go into maybe some lower. Risk return seeking investments in the other parts of the portfolio. And then on the funding side, this is not going to work for everyone, but where you can pay more than the minimum that’s determined. You know, if you see the contribution goes down because you’ve had a year to a good experience, you know, pay what you paid a few years ago. Keep that level. Don’t take that dip. Don’t ever take contribution. Holidays don’t. Never let it go to zero because there’s just a psychology that of having to find the money again. If you’re in a cyclical industry, work with your consultants to develop a contribution strategy that works with the employers business. Michael, that might mean contributing more than the minimum in for the good years and then use some of the funding credits you build up to. You know, cover any shortfalls in the lean years, but only do that if needed. Like always try to make the minimum in cash. If you’re trying to dig yourself out of this hole, then I come out of single employer space as my legacy in consulting and, think carefully about how you want to handle credit balances and some of the optics that come from maintaining that rainy day fund. And actual unfunded liability, but when you have these credit balances, it can on paper through the funding rules, force you to report and manage around an unfunded liability, and so you want to think about what are the optics of that to participants of saying, well, you know, there’s enough assets in the plan to cover 95% of the liabilities. We got this big rainy day fund. So, it really looks like we’re only 80% funded. Make sure you know which measure you’re funding to and you don’t overvalue that rainy day fund. If it’s causing you some other optical or financial issues.
Jeff
- Seeing lots of head nods there from Michael on that subject. So, Michael, to you from a compliance and fiduciary duty standpoint, what plan design elements in government governance practices offer the most robust protection against escalating unfunded liabilities?
Michael
They’re obvious and Ellen did a great job talking about this stuff on the on the investment side, they’re obviously strategies to better match your liabilities and your asset performance to reduce some risk, they’re also on the planned design side. There are lots of ways to design your plan where the benefits are set in a way that provides more long-term certainty for the employers that are less dependent or more responsive to the market. Let’s say there are, you know, cash balance and other types of structure plan structures that take some of the market risk off the table for employers. So, you can design a plan in a way that mitigates risk both from an investment and a design and a benefit design standpoint. Uh, you can get it to a place where you’re funding obligations are fairly consistent, regardless of the way the markets move. I think the key is good governance and a good long-term view and Ellen was making this point. These are long-term obligations. They’re 30 plus years. You know, people could start at your company when they’re 20. Should be in the plan until they’re 65. I mean that could and you’re paying for another 30 years. That is a long-term obligation and there will over the course of that whatever 95 years I just mention. And there will be ups and downs in the stock market. Interest rates will go all over the place. That’s just how the world works. But if you have in your governance practices, you’re meeting periodically with the folks who have authority over the plan with your actuaries. You’re taking a longer-term view of the liabilities and figuring out and proactively manage them both through benefit changes. Or just funding contribution increases that will keep you out of trouble for the most part, I will say that’s for both ways, not just underfunding, but also overfunding. We haven’t mentioned it much on this call, but I have lots of clients who have over funding issues at the moment where they have too much money locked up in their pension plan and that is causing them distress. So, it goes both ways, but all of those risks can be mitigated by taking a long-term view and having kind of smart conversations. And addressing issues when they when they start and not waiting, waiting to the end. Now congress kind of forced this on multi-employer plans in in 2006 with the Pension Protection Act forced them to look forward and if the plan is in distress put plans in place to fix it. But all plans can do this and it does work. The clients I have that have been proactive generally have fewer funding problems.
Jeff
Very good. Dan, what have you seen happening in the pension industry that might help prevent future underfunding challenges? And if you have any thoughts on how these efforts might evolve or how to plan administrators balance between the competing priorities?
Dan
Yeah. I mentioned there’s been a lot of assumption changes. I think you know we’re in a safer place today with a couple of percentage points between what we’re assuming and the 30-year Treasury as opposed to the gap that was wider 10 to 15 years ago. I would say when I think about the changes in the industry, I mentioned that we see a convergence here. If you look at 401K’s, their selling point is costs are predictable, right? The reforms of 401K’s have been auto enrollment right, so you go to work, you’re in the plan. Auto investment, right? Life cycle funds. You don’t have to monkey around with it. That’s going to be done for you. That’s starting to look a little bit more like a pension. You’ve got to work. This thing happens, you have resources building for retirement now we’re hearing more and more about keeping people in the 401K post-retirement and provide them with life income, right. They’re preserving their strength, which is costs stability or predictability on the DC side and really moving towards the product that looks a little bit more like pension. On the flip side, pensions are really user friendly for workers obviously, but cost stability has been the challenge. I think we’re seeing more reforms that have occurred in the last 15 years really have been moving us towards variable benefits. Ellen talked about funding strategies that sort of lean towards safety. We’ve seen more reserve funds in the public sector, things that really aim to get you through that period where the markets are down, right markets eventually rebound, but there are those periods where when you take a snapshot with the valuation that maybe Ellen does things look bad at that point in time, so I think some of the things that we’re talking about, like funding strategies, benefit designs, stabilization funds, that helps. Sort of put a buffer there because it, like Michael said, it is really a long-term project and there will be bad days over that 95-year period.
Jeff
We had several questions from our participants on this webinar that were sent in to us and one of those questions was around the pros and cons of using group annuity contracts to mitigate risk. Feels like this might be an appropriate place to talk about that if any of you have any commentary around that and maybe speaking to single versus multi-employer? Thoughts on using group annuity contracts to mitigate risk?
Michael
And that’s a long-standing practice. In fact, group annuity contract purchasing, annuities for participants is the only way to terminate a plan. The only real way to terminate a plan outside of bankruptcy or a distressed termination. So, it’s kind of baked into the statute, this idea that you can go and satisfy your pension obligations by purchasing annuities, for employees – and that can be done. Either by the plant purchasing the annuities and then distributing them, usually in the in the context of a planter. Insurers have and continue to have in the past and continue to offer annuities at the planned purchases that that aren’t allocated to any individual, but rather used as a funding mechanism for the plan. It could be a good way to mitigate risk the insurer takes on a lot of that risk now. They’re fiduciary obligations for selecting the insurer. Congress and the Department of Labor have weighed in heavily on those, and there’s some litigation around that. But this is kind of a tactic that can in some cases be a little more expensive. In the short term, for funding the liabilities, but can also provide a lot of certainty.
Ellen
Yeah. And I think Michael kind of hit all and I’ll just follow up on that, that last point about you know, thinking about the cost of purchasing an annuity compared to maintaining that liability and the risk. And I think that the single employer plan market has really focused a lot on this over the recent years, just because of the significantly escalating PBGC premiums, it’s driving a lot of plan sponsors out of the market. They’re saying why, why? Why do I take on this? Or why do I have to pay for risk that they don’t believe is commensurate with the premium being charged in the multi-employer space? I think and I’ve seen some of my prior employers, clients can go through this conversation about do we want to go out and purchase annuities for a portion of our retirees and the difference in the price to purchase the annuity compared to the long-term funding liability brought a little bit of sticker shock to it. Maybe lessons learned coming on the single employer space is, you know, look holistically at the risk that you’re taking on and this is sort of speaking in the multi-employer and public sector space. Multi-employer, you do still have PBGC premiums, they still have gone up quite significantly and you’re not getting a very big guarantee for some of the premium that’s being. So, think about what the cost and value of that guarantee is compared to what the cost and guarantee is. If you move that benefit to an insurance company and then you think about, you know, the other administrative costs that that go with it and you got some fixed costs that are going to change, but you have the cost of missing participant searches and annual funding notice mailings and keeping track of people and all these other communications. And that has a cost, and often the service providers understandably will. Their fees will scale with the number of bodies in the plan. So, you’re saving on PBGC premiums, you’re saving on some administrative costs. And if you think about what the present value of those cost savings are over the remaining time that those participants would have stayed in the plan, you also want to factor that in when you’re doing this. This cost benefit analysis.
Jeff
Very good. So, we are bumping up against the clock. I do have one final question for each of you. I do want to mention that there were several questions submitted, some of those I believe were answered through this discussion. So very appreciative of that. If they were not, we will certainly be reaching out to you by e-mail. To connect you with the right person to get those questions answered, but final thought here from each of you very quickly. Any critical strategic recommendation that you have for fiduciaries and administrators as administrators aiming to proactively manage their liabilities that you didn’t cover or that you want to highlight again?
Michael
Real quick. Lawyers like to joke about actuaries being the nerds and the risk of party. But you should make best friends with your actuary. Don’t you know they’ll give you reports that are what they’re required to give you to show the funding obligations, but they know a lot more and they know how to help you understand risk. So, work really closely with your actuaries. Have them work with you to take a long-term view and honestly, you’ll be OK. Pensions aren’t as complicated as people sometimes think they are. They just require a little bit of patience and perseverance.
Jeff
Very good. Dan or Ellen, anything more to add to that?
Dan
Real quickly, you know, I mentioned markets tend to recover what happens when markets are down matters a lot. If you’re cash flow positive, you’re buying stocks every year. In the long run, that’s probably an opportunity to buy stocks at a discount. If you have a high negative cash flow, you’re paying out a lot of benefits. Contributions are lower. You know how much are you selling up while markets are down? So that’s something I think you know where you stand versus other plans. Know your cash flow and plan for those moments when the markets are down.
Jeff
Very good. Ellen, any final thought?
Ellen
I’m going to jump off again from Michael’s comments there. Appreciate the attorney putting the pitch in for the actuaries and the value we can bring. Thank you on behalf of my profession I would say you want your entire team of service providers and advisors all working together. Breakdown the silos and bring them all into the conversation. I’ve seen a lot times where the investment people come in and do their presentation and then they leave and then the actuaries come in and give their presentation, then they leave or the vice versa or the actual investment persons in the room the whole time. But the actuary comes in and then it’s just…and think all of these pieces together. How you manage the investments, how you manage the liabilities, how you manage the legal risk, how you administer the plan and what benefits are being paid and what the trends are and where the pain points are. All of that go together to creating the total picture. For the plan fiduciaries, so you need to hear from all of your advisors and I think you can get some magic happening and some really good outside the box thinking when you let those providers in the room together. You break down those silos. The other thing is, and this is just, you know, this is the reality of where your service providers, they’re in business, right. They have a business to run. And so there’s always a little bit measure of competition. Make sure that it’s friendly competition. With each other, and if you have surfers that are not kind of playing nice with each other. You know, think about how you get that dynamic to change because these two pieces, the assets, investments and then the liability side of it, they go together. They are inextricably linked. When you’re talking about unfunded liabilities, you cannot have one without the other. And so, it’s foolish to try and manage one without the other. Do them both together. Have everyone on the same team rowing in the same direction for you.
Jeff
Very good. Well, thank you all very much. I really appreciate your time and all of the wonderful insights today. Jack, I’m going to flip it over to you and close this out here.
Jack
Yeah, thanks to all for hanging on for a couple extra minutes here and a huge thank you to our panel. Michael, Ellen, Dan, thank you guys so much for lending your expertise to the discussion here and Jeff, thank you for keeping the conversation flowing. If any questions do arise here, at the last minute, feel free to e-mail them over. Thanks again to our panelists and thanks again to all of you who took time out of your day to join us. We really appreciate you all and hope you all have a wonderful second half of your week.
