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From the Negotiating Committee: Variable Benefit Plan Risks - 4/16/18
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From the Negotiating Committee: Variable Benefit Plan Risks - 4/16/18

 

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APRIL 16, 2018
A
s you may be aware, we have previously attempted to negotiate improvements to the current A-Plan and have been unable to make any permanent changes. FedEx has been reluctant to make plan modifications due to the increased cost and risk associated with traditional pension plans under the regulations found in the 2006 Pension Protection Act.
The variable plan concept addresses the pilot’s desire to improve the current benefit while offering an alternative to the current pension funding and accounting regulations for our current A-Plan. The tradeoff involves a risk shift to the employees that must be understood and quantified. The primary risk shift occurs on the investment side, but can be effectively managed through a combination of stabilization features in the plan design as well as a more conservative investment philosophy. 
The following is a summary of the risks associated with Variable Benefit Plans such as the one under consideration by the MEC as well as variable plans that contain no stabilization features.
 
Downsides/Risks associated with Variable Defined Benefit Plans
  • In a variable plan design, the investment risk for future benefit accruals is moved from the plan sponsor to the participants by changing benefits to match the actual investment returns of the trust.
    • In down markets, participants share directly in lower returns and pension benefits decrease to match investment returns. In up markets the benefits would be increased to match investment returns.
    • Similar to the risks associated with a Defined Contribution Plan or ‘B Plan’  
  • While the aim of variable benefit plans is to provide inflation protection over time, like our Defined Contribution Plan, the reality is that in some periods negative returns may cause benefits to fall short of this goal (to maintain purchasing power).
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Chart 1. Compares a Fixed $130,000 Benefit, a pure Inflation Adjusted Benefit, and a Variable Benefit with a 5% Hurdle Rate. These benefits are placed against the historical backdrop of returns (50% Fixed Income/50% Equity) from 1968 through 2017.
  • Significant investment losses coupled with a protracted recovery can result in a substantial reduction in benefit accruals.
041018_nccomm_2(1).png
Chart 2. Compares a Fixed $130,000 Benefit, a pure Inflation Adjusted Benefit, a Variable Benefit with a 5% Hurdle Rate, and a Stabilized Retirement Benefit. These benefits are placed against the historical backdrop of returns (50% Fixed Income/50% Equity) from 1968 through 2017.
  • Variable defined benefit plan volatility has caused plan sponsors to look for ways to stabilize benefits.
    • Floor benefit - With larger floor benefits, it is possible for the plan to experience funding issues if assets fall dramatically, leaving the floor benefit underfunded.
    • Stabilization reserve – With positive investment returns, benefits will increase less than fully variable defined benefit plans due to the diversion of contributions and investment return to shore up the stabilization reserve. Benefits will be stabilized only if the reserve account can afford the increased benefit.
    • Fixed retiree benefits – Including the ability to fix retiree benefits does not provide inflation protection for participants.
      • Lower returns in a bond portfolio provide lower expected benefits for the same contribution and participants who retire right after a market downturn lock in losses for life.
    • Without a stabilizing feature such as floor benefit accrual or a stabilization reserve, these plans are less appealing because they do not guarantee that participants’ monthly pension benefits will not decrease. (It is important to note that we are not considering any plan that does not have a stabilizing feature.)
      • Retired participants are subject to the same adjustments and some retirees could see benefits decrease below their initial retirement benefit in periods of poor investment return should the participant choose a non-fixed benefit at retirement.
  • Variable defined benefit plans shift the focus from a specific benefit guaranteed for life to lifelong income.
    • Unlike traditional defined benefit plans, variable defined benefit plans change benefits to match investment experience.
  • A lower hurdle rate will provide a smaller initial benefit with more potential inflation protection, while a higher hurdle rate will provide a larger initial benefit with less potential inflation protection.
  • Changing from a traditional defined benefit plan to a variable defined benefit plan does nothing to reduce existing unfunded liability on benefits earned under the old plan’s formula.
    • No changes are made to the old plan’s benefits and you will still receive the fixed annuity you have earned from the old plan upon retirement.
  • In a variable defined benefit plan there will still be risk for mortality, retirement, termination, and disability experience, but these are not as significant as investment risk.
  • Portfolio Management Fees (also known as Advisory Fees) and Administrative & Operating Expenses are borne by the trust and will impact the effective rate of return continuously.
  • As of October 2016, there were fewer than 100 of these plan types in the United States.
 
References

Barney, L., Actuary Makes the Case for Variable Benefit Plans, Plan Advisor, 2016.  https://www.planadviser.com/actuary-makes-the-case-for-variable-benefit-plans/

Collins, S., The Expenses of Defined Benefit Plans and Mutual Funds, Investment Company Institute, Vol. 9, No. 6, 2003. https://www.ici.org/pdf/per09-06.pdf

Hudson, R., The Adjustable Pension Plan; A Balanced Approach, Cheiron, 2012. https://cheiron.us/articles/Hudson%20Nov%202012.pdf

Olleman, M., Coffing, K., Variable Annuity Pension Plans: An Emerging Retirement Plan Design, Milliman, Inc., 2014. http://us.milliman.com/uploadedFiles/insight/2014/variable-annuity-pension-plans.pdf

Olleman, M., Preppernau, L., Coffing, K., Variable annuities: A retirement plan design will less contribution volatility – White Paper, Milliman, Inc., 2012. http://www.milliman.com/uploadedFiles/insight/eb-published/pdfs/variable-annuity-plans.pdf

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