Market opening up for more variable plans

The aftereffects of the COVID-19 pandemic on retirement plans and Congress' recent failure to achieve multiemployer pension reform could mean a boost for variable pension plans, pension experts say.

The concept gained more visibility this year with a new variable annuity pension plan agreement between three major grocery companies and the United Food and Commercial Workers International Union, Washington.

And while congressional negotiations to reform multiemployer pension funds broke down in December, the incoming 117th Congress could revive the one area of bipartisan agreement allowing for composite plans that combine defined benefit and defined contribution features to share more investment risk with plan participants.

"After the dust settles on 2020, it will provide support for arguments we often make for defined benefit plans — the asset allocation and investment management advantages" that have historically averaged higher net returns than defined contribution plans, said Bruce Cadenhead, chairman of the American Academy of Actuaries' pension committee. He notes that some defined contribution plan participants were spooked enough by market volatility caused by the pandemic to withdraw some assets, missing out on gains realized by professionally managed defined benefit assets.

"I think we're seeing more variable plans than we ever have before, and more variations of them. ... They certainly come up in conversation," even among corporate plan sponsors, said Mr. Cadenhead, chief actuary for Mercer's global and U.S. wealth businesses in New York.

The basic premise of a variable defined benefit or variable annuity pension plan is that the plan adjusts benefits up or down based on investment returns. An assumed rate of return called the hurdle rate, typically between 4% and 6%, determines whether benefits for all participants, including retirees, go up or down on a plan year basis. Some variable plans have floors limiting how low benefits can dip if markets drop, and some build up reserves to augment benefit drops in those cases.

One approach is to add variable features to existing plans so that benefits change going forward, while in other cases, sponsors start a new variable plan and freeze the existing legacy defined benefit plan.

For employers with unionized employees whose international or even local unions are often the ones raising the variable plan idea or companies that want to get out of a multiemployer pension fund for a variety of reasons, "it seems that variable annuity plans have become a popular compromise," Mr. Cadenhead said.

While the concept is more prevalent among multiemployer pension funds, "we have seen some activity from the single-employer side in establishing variable plans," said Robert Kurak, vice president and consulting actuary with Segal Consulting in Minneapolis. Segal actuaries implemented several over the summer and fall and continue to see interest, he said.

"We also continue to see a mix of adding a variable feature for future service to an existing plan, and some clients are interested in starting a brand-new plan," Mr. Kurak said.

In the corporate world, it is harder to overcome the momentum toward defined contribution, and variable plans are more complicated to administer, "but the big advantage is that the overall financial risk is reduced," so it often becomes a matter of what employers want for their employees, Mr. Cadenhead said.

Variable plans are getting another look in the public sector, which might have the most potential application of either variable plans or some variable features to share risk, said Mr. Cadenhead, speaking for the actuaries' group. Many states are bracing for reduced tax revenues because of the pandemic shutdown, and some have already curtailed plans to shore up underfunded public pension funds.

Variable plans limit the risk to the plan sponsor, and they are intended to allow the plan to stay better funded, he said, which also can address concerns over what future taxpayers will have to pay. "It is also an area where defined benefit plans are still popular, and there are fewer constraints in terms of the rules to design these plans. You can do much more creative things," he said.

The $107.9 billion Wisconsin Retirement System, Madison, was built from the start in 1982 to adjust employee contribution rates and annuity increases as needed. Since then, more states, including Colorado, Iowa, South Dakota, Utah and Maine, have implemented variable arrangements, along with the Canadian province of New Brunswick.

The variable plan trend got more visibility in early December as three major grocery companies and the United Food and Commercial Workers International Union-Industry Pension Fund ratified an agreement for the companies – Kroger Co., Stop & Shop Supermarket Co. and Albertsons Cos. — to withdraw from the fund and set up a new variable annuity pension plan.

The three firms were the largest annual contributors to the $6.1 billion UFCW International Union-Industry Pension Fund, Mokena, Ill., which as of June 30, 2019, its most recent filing, was 53.5% funded.

The employers will now contribute to the UFCW and Employer's Variable Annuity Pension Plan for future benefits under a formula negotiated through June 2028 with the international union and 20 UFCW local unions. Retirement security for grocery workers on the front lines of the pandemic was critical, said UFCW International President Marc Perrone in an emailed statement on the deal.

Stalled negotiations between FedEx Corp. and its pilots' union to switch to a variable plan may also be revived, observers say.

"The more people see these plans happening, the more interest there is in them. They are going to keep getting talked about," said Gene Kalwarski, CEO of actuarial consulting firm Cheiron Inc. in McLean, Va.

Still, actuaries caution, they can take years of planning, and the costs of switching plans limits the concept to well-funded employers.

In Kroger's case, the switch involved the company paying a withdrawal liability of $962 million to the existing pension fund in several installments and contributing $27 million to a transition reserve in the new variable annuity pension plan. On an after-tax basis, the two steps amount to $760 million, Kroger estimated.

Gary Millerchip, Kroger senior vice president and chief financial officer in Cincinnati, said the company's strong financial position enabled it to modernize its retirement benefits offering and make future benefits more stable. Kroger has also spent more than $1 billion since March to reward associates and implement COVID-19 safety measures, Kroger officials said.

Multiemployer pension funds were poised to get some more risk-sharing options from Congress this year, until negotiations over dramatically different pension reform proposals in the Senate and House broke down in December.

A rare point of agreement between the measures was the concept of composite plans combining defined benefit and defined contribution features to share more investment risk with plan participants. That sliver of bipartisanship could be revived when the next Congress convenes.

"The merit of variable approaches is one of the few things that people on both sides of the aisle agree on right now," said Josh Shapiro, senior actuarial adviser with Groom Law Group in Washington.

"I believe that variable plans will lead to a resurgence of defined benefit pension programs. It makes sense, and sooner and later what makes sense will get done," Mr. Shapiro said.