Last month's inversion of the U.S. yield curve roiled equity markets throughout the world as investors worried about the imminence of recession signaled by long-term rates falling below short-term rates. This reversal of the normal relationship, in which investors demand and receive a greater return on Treasury securities in exchange for effectively lending the government money for a longer period, represents a flight to safety and investor doubts about future economic growth.
For defined-benefit (DB) retirement plan sponsors and retirement plan participants, however, perhaps less important than the inversion is the historically low level of return those longer-term Treasury securities now provide.
No. 1 challenge
“The low level of interest rates, now and for the foreseeable future, is the biggest challenge for defined-benefit plans,” said Kevin Mahoney, senior vice president at The Mahoney Group of Raymond James in West Nyack, N.Y.
Interest rates approaching zero on long-term, safe securities, of course, makes funding long-term pension obligations more expensive and more capital-consuming for plan sponsors. Yet, looming on the horizon, there is the possibility of an even more challenging investment environment, a world of negative long-term interest rates, which was once inconceivable but now prevails over German and Japanese 10-year securities.
“As interest rates kept declining in recent years, many plan sponsors just kept hoping that interest rates would rise and that they wouldn't have to do anything,” Mr. Mahoney said. “But that's not a strategy. Plans have to strategically chip away at risk and liabilities, which requires looking at those liabilities more than once a year in an actuary's report. With pensions, the biggest mistake is managing to the market, not to liabilities.”
He says that despite the continued downward path of rates, it's not too late for plans to act. David Hinderstein, president of Strategic Retirement Group in White Plains, N.Y., agrees. “The first step is to stop the bleeding and get the funded status up,” Mr. Hinderstein said.
The “bleeding” Mr. Hinderstein explained, comes in part from demographic factors that are steadily increasing funding pressures. These include the aging of most workforces and the growing longevity of retirees, all of which are making funding requirements increase at a pace faster than returns. In addition, he said that the administrative costs of running a DB plan are rising, as are the premiums that must be paid to the government's Pension Benefit Guaranty Corporation.
This year, the per-participant flat PBGC premium rate is $80 for single-employer plans, up from $74 in 2018, and the variable-rate premium is $43 per $1,000 of unfunded vested benefits, up from $38, with a cap of $541 times the number of participants, up from a 2018 cap of $523.
“We saw a plan with 1,100 participants that was paying out about $1,000 a year per retiree yet had costs of about $200 per retiree,” he said. “Even plans that were frozen to new participants five years ago are still underfunded because of the rising expenses. It's really Accounting 101 — plans are paying out more than they are putting in.”
To raise the funding status of client plans, Mr. Hinderstein sometimes suggests borrowing to fill the gap.
“With interest rates so low, companies can borrow and then get rid of their liability at a lower cost than making up the shortfall themselves,” he said.
Michael O'Connor, head of MassMutual's institutional solutions defined-benefit business, also believes in approaching a DB plan's problems strategically.
“In working with chief financial officers, who now are typically the corporate officials responsible for DB plans, we view our job as helping them develop a strategic plan that centers on de-risking and managing assets so that they are aligned with long-term liabilities,” he said.
De-risking, in Mr. O'Connor's view, has several components. One involves reducing complexity and cost, and he said MassMutual's integrated administrative model, which offers investment, actuarial and record-keeping services under one roof, does that.
“If companies use different providers, they may find that their solutions are not connected strategically,” he said. “Advisers continue to recommend and select the funds the plan uses, but we help plans with creating an investment policy and are present at the table when decisions are made about funded status. Then we follow up with quarterly asset modeling, which leads to portfolio solutions that promote alignment of assets and long-term liabilities. That's an area where we have considerable experience, since as an insurer we've been doing liability matching for 170 years.”
Given rising expenses and the ongoing and unknown balance-sheet risks associated with sponsoring a DB retirement plan, plan sponsors, perhaps now more than ever, are looking to end their plans.
Terminating a plan
While most still intend to help provide a secure retirement for their employees — both out of a sincere sense of ethical obligation and because attractive retirements help attract and retain qualified employees — terminating a DB plan by offering participants a lump sum, or by having an insurance company take over the liability and provide participants with an annuity, or some combination of the two is the goal. And plans are looking to their advisers to help them reach that goal.
“Actuaries, consultants and asset managers have a vested interest in keeping DB plans going forever,” said one adviser who wished to remain anonymous. “And with many plan sponsors only looking at the asset side of the plan, not the overall effect on a company's liabilities, the only ones that can provide unconflicted advice about how to bring the plan up to funded status and then how to end the plan, are advisers.”
As Kevin Mahoney put it, only somewhat in jest, “If you do your job right and get the plan fully funded, the sponsor terminates the plan and puts you out of business. The bright side is that you wind up with a 401(k) client you'll never lose.”
Despite the irony inherent in the business, Mr. Mahoney observed that the many DB plans still in operation continue to represent a good market for retirement plan advisers. What's more, since plan advisers frequently work with sponsors' defined-contribution plans as well, a loss in the DB area is likely to be counterbalanced by a gain on the DC side.
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