Perspectives February 14, 2014

The Next Great DB Risk: Complacency

What a difference a year makes—strong investment performance and a modest rise in interest rates during 2013 caused a steep increase in the funded status of the typical defined benefit (DB) plan, reversing a multi-year downward trend.
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The improvements moved most frozen plans closer to being ready for termination and gave active plans a welcome reprieve from the pains of the last several years.  

But the drastic improvements could lull plan sponsors into a false sense of security that could result in complacency at a time when they should be evaluating what actions to take.  DB plan risks didn’t go away just because plans are on the good side of risk now.  Even if a plan is 100% funded, it still may not have the appropriate risk controls in place.

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Whether the DB is active or frozen, now is a critical and opportune time to help plan sponsors evaluate the status of their plans and proactively develop strategies to manage the ongoing risks of a DB plan.

What goes up can come down

The increased funded status can easily be threatened if equity performance slides or interest rates decrease.  Additionally, currently scheduled increases in Pension Benefit Guaranty Corporation (PBGC) premiums—double to triple the level from a few years ago—will make it more costly to operate a plan. The premium will be even higher for underfunded plans.  And there is the potential for significant premium increases down the road.     

It was difficult in a low interest rate environment, and especially if a plan was underfunded, to realistically consider some de-risking options, but improved conditions make de-risking a much more viable option.

Here are four steps to help DB sponsors analyze and manage their risks:

1.       Revisit asset allocation decisions – Plan sponsors have discussed liability-driven investing (LDI)   for years, but have used it sparingly. A carefully constructed long-bond strategy on a portion of the allocation as part of a portfolio can help “immunize” or more closely match liability movements.  As funded status increases, moving to this type of strategy under a “glide-path” approach has virtually become a standard method for managing frozen plans.  Make sure there is good coordination between the investment adviser and actuary to assure that DB plan risks are appropriately analyzed and monitored.

 

2.       Consider de-risking transactions – The goal of nearly all frozen plans is to eliminate all risks. These plans typically achieve that by paying out lump sums, purchasing annuities, or a combination of the two strategies.  Any plan, frozen or not, can use these approaches to reduce the size of the liability and the per-head portion of PBGC premiums. Reducing plan risk can also help eliminate the risks of losing benefits for some participants. Plan sponsors who want to de-risk could consider buying annuities for retirees, adding a permanent lump-sum provision, or offering the temporary availability of lump sums for terminated participants.  It is important to help the sponsor carefully analyze the short- and long-term financial implications of these transactions before taking action.  It is also critical to not overlook the quality of data management and administration which are needed to make sure these transactions are analyzed accurately and implemented efficiently.  The impact of data quality is often overlooked and underestimated.

 

3.       Evaluate plan design – A number of sponsors made DB plan design changes during the past several years in reaction to the pressure on company finances.  It will be much easier to conduct a strategic analysis of how well the overall retirement program is meeting the sponsor’s goals when not forced to make decisions based primarily on the bottom line.  Now is an opportune time to demonstrate value by helping the sponsor reassess the overall goals for offering a retirement program and the acceptable level of risk the company wants to take.  Then the sponsor can evaluate plan design options that can help achieve company goals.

 

4.       Inject efficiencies – Make sure your clients understand the total expenses required to operate the DB plan and help them evaluate where they might be able to save money.  This is a good time to look for efficiencies in providing this very valuable benefit to employees.  One way to streamline cost for sponsors with multiple retirement plans is to streamline administration costs by finding providers who can service more than one plan type. Not only are there efficiencies for the sponsor in outsourcing plan administration, there are also financial benefits when the actuarial service is integrated with investment management. This move also gives employees a more holistic picture of their retirement readiness by providing a consolidated view of retirement benefits all in one statement.    

 

When things are not painful, it is easy to ignore them, but with a DB plan, that could be a costly mistake.  Analyzing and implementing the proper changes now could help reduce the pain in the future and could save DB sponsors millions in running their retirement program.  You can demonstrate your value by helping to lead this effort as their valued partner. Now is the time for action.

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Mike Dulaney is a senior consulting actuary at the Principal Financial Group.  Mike consults with defined benefit plan sponsors on the design, financing, and risks associated with their retirement programs.

NOTE: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.

Compliance February 14, 2014

Non-ERISA 403(b)s an Endangered Species

Aside from government and non-electing church plans, is there really such thing as a non-ERISA 403(b), given the rules plan sponsors must follow now?
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“Yes, non-ERISA still exists, the safe harbor is still available, but organizations will have to work at it,” Robert J. Toth Jr., from the Law Office of Robert J. Toth Jr. in Fort Wayne, Indiana, tells PLANADVISER. However, Toth contends the Department of Labor (DOL) really doesn’t like non-Employee Retirement Income Security Act (ERISA) plans because in its view, they lessen participant protections.

The DOL issued a “safe harbor” regulation in 1974 under which it granted 403(b) “elective-deferral only” plans an exemption from ERISA as long as certain conditions were met. These conditions were based on the principal of limited-involvement by the plan sponsor in the arrangement.

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The DOL has made its view of what it means by non-involvement clearer via a couple of actions in the past two years. In Advisory Opinion 2012-02A (see “b(lines) Ask the Experts: No Safe harbor if 401(a) Match Tied to 403(b)”), the DOL is quite clear that matching contributions to a 401(a) plan that are based on 403(b) elective deferrals violate the "limited involvement" of an employer required to maintain the exemption from ERISA.

In addition, the DOL in November 2013 filed a lawsuit against a provider of mental health and drug treatment services seeking to restore employee retirement plan contributions that were not remitted to the plan’s trust or not remitted in a timely manner (see “Restoration of Funds Sought for Health Clinic Employees”). “What makes the case so striking (besides the fact that it is an enforcement effort by the DOL against a 403(b) plan, of which we have seen few) is that the DOL appears to condition the plan’s ERISA status on the ‘discretion’ exercised by the plan administrator in failing to make timely deposits,” Toth wrote in a blog post.

The Internal Revenue Service (IRS) regulations passed in 2007 made it even harder for 403(b) plan sponsors to maintain limited involvement, requiring much more oversight of plan limits, transactions and design. “Monitoring isn’t a problem, the DOL says monitoring [plan limits] will not trigger ERISA status,” Toth says. “It’s other things that are tricky.”

For example, he tells PLANADVISER, if a divorced participant’s spouse presents a domestic relations order (DRO) to a non-ERISA 403(b) plan, the plan sponsor cannot make the determination that the DRO is a qualified domestic relations order (QDRO), or it will trigger ERISA status. He adds that plan vendors were previously agreeable to making that determination, but not so now, because the new regulations say the sponsor is responsible for making sure plans maintain their tax qualified status, and vendors do not want liability for something that is the responsibility of plan sponsors. 

In addition, Toth says non-ERISA plans cannot offer loans and hardship withdrawals now because the regulations require them to sign off on loan and hardship requests. This reduces the value of offering a non-ERISA plan to employees.

“It’s not a bad thing to be covered by ERISA,” Toth states. He believes all non-ERISA plans should consider migrating to ERISA coverage. He points out that ERISA will preempt the application of state laws—contract, tort and negligence, for example—to which non-ERISA plans are subject. 

“If you have a non-ERISA 403(b) plan, instead of having the DOL challenge you on it, take a look to see if it is worth it to maintain that status,” he concludes.

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