Sheet Metal Workers pension fund latest to go to variable benefits

The $3.7 billion Sheet Metal Workers' National Pension Fund last month became the latest defined benefit plan to shift some investment risk to employees.

The Fairfax, Va.-based union pension fund's move to a variable benefit approach is one of the most dramatic examples of tying pension benefits to the pension fund's returns.

Interest in the variable benefit plan, also known as an adjustable pension plan, is growing as defined benefit plans struggle to recover from market downturns. Some plan sponsors include benefit floors or ceilings, but the basic idea is that investment risk is shared by employee and employer, so when investment returns drop, benefit accrual targets can be adjusted downward the next year.

Another variation calls for traditional accrual and benefit formulas, but with part or all of the benefit fluctuating according to investment returns.

“Employers are looking for something that gives them a solution that's an alternative to 401(k) plans. Everybody knows that 401(k) isn't going to be enough. And if you put all the (defined benefit plan) risk on the sponsor, it will just collapse,” said Gene Kalwarski, founder, CEO and principal consulting actuary at Cheiron Inc., in McLean, Va.

Ron Palmerick, a management trustee for the Sheet Metal Workers pension fund, credits the plan's actuarial consulting firm, The Segal Co., and Segal actuary Lall Bachan for bringing the variable benefit idea to trustees.

“It's one of the few things that you can still use to try to stabilize the fund. You're trying to protect yourself from going backward. We try to take whatever opportunities present themselves,” said Mr. Palmerick.

It also helped that participants eventually understood the switch to a variable benefit was necessary for the fund, which as of March 31, had $6.4 billion in liabilities, making it 58% funded.

“We're very fortunate that the union understands that they've got to help us get rid of this liability and that the membership needs a pension,” said Mr. Palmerick.

To set each year's benefit accrual rate, staff and actuaries of the Sheet Metal Workers plan will use the average investment return of the preceding three years, once the actuarial valuation is made. If the three-year return average is 8.5% or better, most accruals don't change. Returns between 6.5% and 8.4% would trigger an accrual rate of 0.75% of contributions, anything below that would be 0.5%, and three years of zero or negative returns would mean no accruals. For 2014, based on preliminary investment returns, fund officials are predicting a return of 8.22%, which would mean an accrual rate of 0.75%.

Newspaper Guild of New York President Bill O'Meara noted that new collective bargaining agreements with the New York Times and Consumers Union, Yonkers, N.Y., call for an adjustable pension plan with some other features. For example, they have a floor benefit and they spell out specific dollar amounts the employer will contribute to ensure adequate funding.

The change “took some selling” to employees and though not perfect, “it's as close as we can get to a defined benefit plan that mitigates risk,” said Mr. O'Meara.

“We view it as a plate of pancakes. Some years you get a bigger one; some years you get a smaller one. But in the end you get a plate of pancakes that you can keep eating for the rest of your life.”

With the multiemployer plan sector facing some of the most acute funding problems, “I think you will see a lot more (variable benefit plans) because they (multiemployer plan trustees) know they need to change” benefit levels, said Tom Cliffel, consulting actuary in the Cleveland office of Horizon Actuarial Services LLC, which has some clients using variable benefit plans.

Mr. Cliffel is an advocate of a variable benefit approach that combines traditional accrual formulas with a defined benefit that fluctuates according to investment returns. “It is the most efficient way to provide benefits for everybody,” said Mr. Cliffel, who is the consulting actuary for the Major League Baseball Players' Plan in Cleveland, which has more than $2 billion in assets.

The player pension fund set the assumed rate of return, called the hurdle rate, at 4.5%. Investment returns above the hurdle rate increase the unit value of the benefit.

“It's gone up and down over its lifetime,” said Mr. Cliffel. While 2009 “was certainly the biggest down, the trustees never wavered,” he said.

“The potential decline in benefits (when implementing a variable benefit) is something that you need to be aware of, but it's not a big negative. Most diversified portfolios come back in a few years.” said Donald Fuerst, senior pension fellow at the American Academy of Actuaries, a former Mercer consulting actuary and a big proponent of the variable benefit approach.

“For participants, it gives you the potential for an increasing benefit that will keep up with inflation.”

He points to some longtime believers in the approach, including The Aerospace Corp., El Segundo, Calif., a California non-profit sponsored and funded by the U.S. government with some $2 billion in pension assets, and many smaller professional associations, where participants are more likely to take lump sums at retirement.

Multiemployer plans are considered the likeliest adopters of variable benefit plans because of the lifetime benefit it can offer union members, a key part of collective bargaining on heir behalf.

A new survey of large multiemployer plan executives by Pyramis Global Advisors found that 80% of respondents are expecting to see major changes in multiemployer plan design, and roughly 28% of them are expecting to see some type of variable benefit plan within 10 years.

“Their biggest concern with the current system was companies withdrawing from the system, and the only way to get new (companies) is to hit the reset button,” said Steve Benjamin, Pyramis vice president for market and business intelligence in Smithfield, R.I. “There's going to be a lower benefit, with the potential for more upside, but it's still going to be a guaranteed benefit.”

Some actuarial and benefits consultants note that tying benefits to investment performance in defined benefit plans already has happened on an informal basis, particularly in recent years.

“In its truest sense, it's been around since the 1950s,” said Pete Sturdivan, a consulting actuary with Milliman in Portland, Ore. He cites variable benefit plans that adjust costs after retirement, but keep the longevity risk on the sponsor, and is now seeing a renewed interest among clients.

“We are definitely having (variable benefits) discussed at the board level” at union plans, said Mr. Sturdivan.

While he concedes that “the unknown is very unsettling to people,” careful funding and benefit policies, an all-important benefit floor, and an asset allocation carefully constructed to at least meet the hurdle rate can help allay fears. “If this is structured appropriately, (participants) should feel comfortable that the accrual they earn every year is guaranteed.”

Lee Gold, a principal in Mercer's Denver office, said he has helped three private companies put in variable benefit plans in the last three years, and has had “quite a few” discussions with others. He wouldn't name the companies that adopted variable benefit plans.

One client even started preparing to unfreeze a defined benefit plan to adopt the variable benefit approach, but had a change of heart because “it was just too much change,” said Mr. Gold. “These kinds of plans can be better for the employee and the employer. People just don't know these options are out there.”