A new type of defined benefit pension plan is gaining some traction in both the public and private sectors that could reverse the trend of companies and governments dumping their defined benefit plans in favor of defined contribution plans.
The adjustable pension plan is the brain child of executives at Cheiron Inc., an actuarial and financial consultancy with offices across the country. The idea is to merge some of the best features of a traditional defined benefit plan with features from the defined contribution plan market to get a hybrid that provides employees with a lifetime income stream. The big upside is that the employer and the employees split the investment risk between them so neither side shoulders all of it.
Bill O’Meara, president of the Newspaper Guild of New York, a union for news professionals, including those who work at The New York Times and Consumer Reports magazine, said that both publications moved to an adjustable pension plan within the past year. Both are still waiting for the Internal Revenue Service to make a determination about the adjustable pension plan and whether it meets all of the necessary criteria to be considered a defined benefit plan, but verbal responses from the U.S. Treasury and IRS have been positive, he said.
The plan developed for The New York Times provides a flat dollar or career average pay formula for the participants. The benefit is developed after determining what level of contributions are available to fund the plan, said Richard Hudson, principal consulting actuary at Cheiron.
The information is used to determine the cost of the plan and develop the ultimate benefit level that can be sustained by the employer’s contributions.
The costs are developed using conservative assumptions to make sure the benefits can be delivered as promised. There is a minimum benefit employees will receive. Employees get the greater of the floor benefit or the adjustable benefit so they are guaranteed a paycheck every month for life.
The adjustable pension plan looks at investment risk, maturity risk, mortality risk and inflation risk when determining the costs.
To offset the investment risk, it is shared between the employers and employees. The adjustable component is tied to the overall performance of the pension plan, Hudson said.
From that, the actuaries figure out what the formula will be for the coming year. Once it is set, it is set. Employers and employees know exactly how much they will have to put in for the upcoming year.
“From the employer’s point of view, it looks like a defined contribution plan,” O’Meara said. Each year they know what they need to pay into the plan. If it is $7 million one year, it won’t jump to $10 million because the stock market tanked or interest rates dropped.
“Employers like it because their expenses are predictable and they are still providing retirement benefits for their employees,” O’Meara said.
Traditional pension plans are subject to the risk and volatility associated with the stock market, but with the adjustable pension plan, a lot of the risk is turned over to employees.
“It is not perfect, but why we thought it was acceptable is we still get payment for life. Every month an employee gets payment,” he said.
He likened the system to a plate of pancakes. One year the pancake could be bigger and the next year, smaller, but at the end of a person’s career they can add the pancakes up and eat them all.
“The pancakes added to the plate are locked in at that rate. You can’t go back and say, ‘that pancake we gave you two years ago will be cut in half,’” O’Meara said.
Investments in the plan are very conservative and stable. Cheiron, which developed the plan, tested the investment policy over the last 100 years. They looked at the stock and bond markets and they factored in repeated crashes of the stock market. The plan still withstood the ups and downs and was able to provide benefits for employees.
The New York Times plan was priced when interest rates were the lowest they had been in years. The “expectation is that if interest rates return to normal, employees will get an increase in their retirement benefits. Because the multiplier for the plan was 1.2 to start off with, that was above what the average employee at the New York Times was getting under the old plan anyway. If rates go up, the multiplier will go up. It will automatically go up. There is no manipulation by the employer or the union,” he said.
The New York Times plan covers about 1,000 workers. If the IRS doesn’t give its seal of approval by July 31 when the company’s Form 5500 is due, the New York Times plan will convert to a defined contribution trust instead. The IRS must make its decision by then for those employees to be able to keep this benefit.
The New York Times plan went into effect Jan. 1, 2013 and the Consumer Reports plan began June 1, 2013.
“One thing we’re dealing with is the inertia at the IRS. The IRS and Treasury say they like the plan but they are so slow these days on determination letters,” said Gene Kalwarski, CEO of Cheiron. “They are clogged up on Affordable Care Act issues. Everything else is on the back burner. We are trying to turn up the heat on them.”
In the meantime, other private and public sector entities are showing interest in the adjustable pension plan model. The Maine Public Employees Retirement System was the first government entity to consider the adjustable pension plan.
Sandy Matheson, executive director of Maine PERS, said that the state legislature put together a taskforce a couple of years ago asking for new options to the current traditional pension plan, which is currently about 78 percent funded, that would complement Social Security.
The taskforce was made up of employees, employer representatives and employee representatives. They decided what the plan should accomplish and “then started to look at how to meet those principles within the cost parameters and risk and volatility parameters we were looking at,” she said.
Cheiron is the actuary for Maine PERS. “We knew about their work in this area and had them assist us in this,” she said.
The taskforce submitted its recommendation to move the retirement system to an adjustable pension plan to the state legislature early in 2012, but the legislature has not held a hearing or acted upon it yet.
“It’s just part of the process. We’re kind of in the queue,” Matheson said. The taskforce had hoped to implement the adjustable plan for new state employees and teachers beginning in June 2015, but that date could be adjusted depending on when the legislature gives its approval.
“We really like that design because it really meets the principles of a sound and secure retirement income,” she said. “That’s really what we were looking to achieve. An income stream.”