The triumphant return of the DB plan?

Rising interest rates and high bond yields could bring pension plans back as a preferred retirement strategy. Maybe.

Image credit: Stuart Miles Image credit: Stuart Miles

With all of the prevailing data as proof, it might seem slightly insane to suggest that defined benefit pension plans could make a gigantic comeback - and emerge again as America's predominant retirement strategy.

After all, we continue to see major companies scurry to drop their DB obligations and each day brings news of flatter returns and deeper funding deficits for the once-powerful pensions, both public and private.

But if you extrapolate some emerging financial trends and think about the long-term effect of the inevitable rise in interest rates - and consider the everpresent reality that DC benefits aren't going to be a complete solution for the bulk of the American retirement savings public - there could be a big future for DB plans.

That's the contention of Pentegra Retirement Services and a new whitepaper which, on the surface, seems to paint a slightly too-good-to-be-true picture of the possibility of resurgence for DB plans.

According to Rich Rausser, VP of client services for the White Plains, N.Y.-based firm, it's not quite as far-fetched as it seems, especially with the Fed's eventual push to finally raise interest rates.

It may just take a little extra time, as last month's announcement by the Federal Reserve created a third round of quantitative easing - designed to further shore up the economy - and word that rates will likely be kept at rock-bottom levels through 2015. Rausser is undeterred, however.

"The bottom line is that when interest rates go up, pension plans become more affordable," Rausser says. "The Fed has to change course at some point with all these easy money policies. And once the economy is back in place, it would be shortsighted for plan sponsors to think that the current environment will last forever."

Pentegra's assertion, which no one in the industry is likely to disagree with (if they're really being truthful), is that DC plans simply cannot provide the retirement savings options workers are going to need, especially a regular and reliable income flow. DB plans are also better tool to attract and retain employees, versus the complicated, market averse and ultimately user-dependent DC benefit system.

"Much of it is a question of balancing needs," Rausser adds. "What's the most efficient way of providing a steady source of income? The downside to the DC plan is volatility."

Rausser said a combination of factors is emerging to help bring DB plans back to the forefront. First, Congress's recently passed MAP-21 (Moving Ahead for Progress in the 21st Century) law will increase liability interest rates and PBGC premiums.

As a method of counteracting the ways that low interest rates have increased pension plan liabilities, Pentegra's analysis suggests the law - whose rates are optional in 2012 but mandated for 2013 and beyond - could see effective interest rates increasing by 140 to 170 basis points. This would cause the value of plan liabilities dropping by 15 percent to 20 percent and funded ratios to drastically increase.

A 200 basis point change could bring a pension fund with an 80 percent funded ratio to 100 percent in a short time. And a fully funded pension fund - as was the norm before the financial meltdown - drastically reduces employer out-of-pocket expenditures, drastically freeing up resources. 

Despite all the bad recent news on pensions, some companies and communities still live with a better-than-fully-funded system. As Bloomberg noted this week, Bristol, Conn. - home to sports broadcaster ESPN and other significant employers - holds a pension fund that's 200 percent funded, so much so that the community hasn't had to contribute to its $556 million system since 2007. 

Strong financial management back in the booming 1980s and '90s helped foster a system that's admittedly unique across the U.S. "We're very fortunate because we had forefathers who exercised restraint and had the ability to understand the marketplace," Bristol Mayor Arthur Ward told Bloomberg. "They set the standard for the rest of us."

Bristol's ahead-of-the-curve situation is reminiscent of the fat-and-happy days of the DB world, Rausser says, though that situation could gradually return.

"The period from 1987 to 2000 was something of a funding holiday for the pension business, as there were no required contributions during that time. Folks need to get over the short-term pain if they want to start returning to that level."

What else might foretell the return of the DB world? Rausser says a 30-year bull market in bonds and the decade-long stagnation in equity markets have also created an environment which could be more beneficial for DB plan sponsors. Pentegra's analysis is that these secular trends are likely coming to an end and, as a result, funding costs for DB plans will plummet in the near future.

Taking those factors into consideration, the argument becomes one that DB plans would actually be more cost-effective than DC plans, not to mention much more secure and attractive to employees.

"Rising rates mean deficits turn into surpluses for DB plans, surpluses that employers will economically own," the report surmises.

It also means some more efficient account and investment management across the board, Rausser adds, advice that could be beneficial for any plan.

For more information, please read:

10 states where the pension fight is fierce

California goes into the private retirement business

Public pension plan assets fell in second quarter



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