Shared-risk plan concept is gaining momentum

Officials in nearly every state are considering implementing shared-risk public pension plan designs that help mitigate funded status volatility and investment and longevity risks.

Such a move is seen as an alternative to drastic benefit freezes or cuts legislatures have imposed on struggling public plans since the financial crisis, and as a way to defuse criticism of public defined benefit plans in general.

While public plan participants have long been required to contribute to their defined benefit plans, in most cases, employers have assumed all or most of the investment risk.

Sharing that risk “was sort of an abstract concept until the recession,” said David Kausch, chief actuary with actuarial firm Gabriel, Roeder, Smith & Co. in Southfield, Mich., which specializes in state and local government plans. Now, he says, “there's definitely a big movement to share more risk. Employers are not able or willing to pick up all the costs anymore.”

Shared-risk plan design allows sponsors to change employee contributions, benefits, or some combination of the two, when the plan's financial condition is affected by market downturns, longevity changes or inflation.

In the private sector, particularly with multiple employers, interest in the variable benefit, or adjustable pension plan, idea is growing among sponsors like Consumers Union and the $3.7 billion Sheet Metal Workers' National Pension Fund, Fairfax, Va., which in 2013 adopted an approach that ties benefits to the pension fund's returns. Other variations promoted by actuarial firms, particularly for struggling multiemployer plans, call for different accrual and benefit formulas, but in general allow for sharing of investment risk through benefit adjustments.

In the public arena, “sponsors are moving away from pure defined benefit to more employee risk for contributions or benefits,” said Keith Brainard, Georgetown, Texas-based research director for the National Association of State Retirement Administrators.

“It's being done or looked at in virtually every state,” said Dana Bilyeu, NASRA's Portland, Ore. -based executive director.

The poster child in the U.S. for a shared-risk approach is the $95.4 billion Wisconsin Retirement System, Madison, which was designed from the start in 1982 to adjust employee contribution rates and reduce or eliminate retirees' annuity increases as needed. The system, one of the best-funded in the country, is 99.9% funded as of Dec. 31, 2013, according to spokesman Mark Lamkins at a time when most large public plans are below the generally accepted level of 80%. The first annuity increases in five years came this spring, following $4 billion in cuts since 2008.

Moving to a shared-risk approach also takes politics out of the equation, with officials knowing beforehand what funding levels dictate which actions.

“You don't want to overreact in a politically sensitive environment,” said Mr. Kausch of Gabriel, Roeder. He said he thinks shared risk can go a long way to preserving DB plans, but he cautioned that such designs can't help plans with severe funding problems.

An upcoming issue brief from NASRA will examine both formal and de facto risk-sharing approaches taken by public pension systems.

The shared-risk idea has found footing in the Canadian province of New Brunswick, which is set to roll out a new plan design for public and private pension plans later this year that could be a catalyst for other governments throughout Canada.

That model splits benefits into two tiers, with base benefits that are constant and ancillary benefits that can be adjusted up or down, if funding levels or investment returns change. The model also dictates a strict risk management approach that requires annual stress testing and asset-liability modeling. The chief architect is Paul McCrossan, an actuary who had been president of the Canadian Institute of Actuaries and the International Actuarial Association and a former member of parliament who was tapped by the Canadian government in 2010 to serve on a three-member task force looking at ways to bolster private-sector pensions in the recession-battered province.

In May, Canadian government officials announced they would expand the New Brunswick model to federal crown corporations and private-sector pension plans that are federally regulated, such as defense, transportation and banking, which Mr. McCrossan estimates will cover about 8% of the country's population.

Each province will have to decide whether to implement the New Brunswick model for other workers.

So far, officials in eight of Canada's 10 provinces have announced that they are studying the concept, according to Mr. McCrossan. “We've had so much interest that I think it's going to cover a very large percentage of the population.”

Ron Olsen, senior vice president and actuary for The Segal Group in Toronto, particularly likes that it required asset-liability modeling, but he sees a potential “Achilles heel” in the ability of plan sponsors to unilaterally convert accrued benefits into target benefits, which could invite legal challenges. So far, said Mr. McCrossan, unions are on board. “Employee representatives are saying that you have to take a risk of some benefit reduction, because in all likelihood you are going to have better security.”

Mr. Olsen said his firm has “been explaining it to legislators and (private-sector) clients. The basic concept of decoupling guarantees from risk pooling is a crucial development in pensions. It really does change the game.”

The New Brunswick experience is being watched closely, particularly as a model for U.S. public sector plans, where it has the potential to relieve some stress on employers. Several plans in the U.S. have already seen relief from plan design changes that shifts more risk to participants.

For the $24.4 billion Nevada Public Employees' Retirement System, Carson City; the $26.9 billion Iowa Public Employees' Retirement System, Des Moines; and the $31.5 billion Arizona State Retirement System, Phoenix, risk sharing means employee contribution rates can be adjusted up or down, depending on the plan's funded status and actuarial condition, which includes both market and demographic risk.

In Iowa, all participants share the funding risk since legislators raised contribution rates to the current fiscal year's 14.88%, split 60/40 between employer and employee. The rate was 9.45% for nearly 30 years, but beginning in 2008, it increased gradually over four years, then took a bigger jump with 2010 reforms that allowed the rate going forward to be adjusted up or down each year by as much as one percentage point.

Active members, now with a longer vesting period and higher retirement factors, also share the additional risk of having future benefits reduced if the legislature determines a decline in the actuarial condition.

Both rate and benefit changes that started in 2012 were needed after the recession to avoid a further funding slide, said IPERS CEO Donna Mueller. “At that point it needed a double shot in the arm. We evolved into more of a shared risk hybrid model.”

The contribution rate changes, which cannot be undone unless funding hits 95%, will better prepare the system for future shocks by building up reserves. “I think we really brought some stability to the underlying benefit and provided some security to our members,” said Ms. Mueller, who credits participants' support for the change. For the first time since 2001, IPERS will pay its full annual required contribution.

In Pennsylvania, people hired after June 2011 have a sliding scale of contribution rates that depend on investment performance. In 2015, when three years of investment results are measured, participants in the $50.5 billion Pennsylvania Public School Employees' Retirement System and the $25.7 billion Pennsylvania State Employees' Retirement System, both of Harrisburg, could see their contribution rates drop or rise.