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%.