Pandemic puts new focus on variable plans

Interest in variable plan designs appears to be growing, sparked in part by the increased market volatility and uncertainty of this unusual year.

The latest move to adopt them came in July, when the $6.1 billion United Food and Commercial Workers International Union-Industry Pension Fund, Mokena, Ill., reached agreements with Kroger Co., Stop and Shop Supermarket Co. and Albertsons Cos. to withdraw from the pension fund and contribute to a new variable annuity pension plan.

Once ratified by the membership, the new UFCW and Employer's Variable Annuity Pension Plan will keep monthly employer contributions at the same rate as the national fund, but accrued benefits will be subject to a variable annuity calculation and adjusted annually to reflect net investment returns above or below a hurdle rate of return of 5.5%. Kroger officials said the changes will allow the company to minimize future exposure to market risk.

"The pandemic has really spurred quite a bit of interest in setting up variable plans," said Greg Reardon, a principal consulting actuary with Cheiron Inc. in New York. "Plan sponsors are looking and saying, 'Our plan isn't really doing all that well.' We continue to see volatility in the markets, and now this pandemic throws in an additional layer. Whenever you see additional volatility, trustees will look, so I think interest will be spurred."

For clients that already have variable plans, the actuarial firm has been doing a lot of stress testing, and "it is showing that the plans — as expected — weathered the storm fairly well," he said.

Variable plans come with a variety of design features. As in traditional defined benefit plans, participants earn benefits each year, but the full benefit earned to date (excluding any pre-transition "legacy" benefit) is adjusted upward or downward, typically each year. That adjustment is based on asset returns relative to a targeted investment return called the hurdle rate, often set between 4% and 6%. Some variable plans have floors on how low benefits can dip if markets drop or caps on benefit hikes in good markets, and some build up reserves to augment benefit drops in those cases.

Approaches include adding variable features to existing plans or starting a new variable plan and freezing the existing legacy defined benefit plan. In the case of multiemployer pension funds, setting up a new plan diminishes the likelihood of having withdrawal liability for employers leaving the plan, which can help attract new employers that may be critical to ensuring steady contributions in the future.

Along with plan design, key ingredients needed to address volatility are a more conservative investment policy and a strong commitment to funding. For plan advisers including actuaries and investment consultants, "everyone needs to be on the same page," said Mr. Reardon, who noted that investment consultants skilled in liability-driven investment strategies "are really knowledgeable in this area."

Investment policy in variable plans tends to be more conservative and include more fixed income, particularly for corporate sponsors, which may use high-quality corporate bond rates to ensure that when interest rates move, liabilities and assets are well matched, sources said.

Actuaries are hearing from all kinds of plan sponsors — corporate, multiemployer and public — interested in exploring the possibility of implementing a variable plan.

"I think in every sector, there's going to be more and more interest," Mr. Reardon said.

Kelly Coffing, a principal and consulting actuary with Milliman Inc. in Seattle, said the firm is getting more inquiries, with much of the activity to date among multiemployer pension funds. "It's a good answer for plans that are large enough to bear the costs of transition. A good candidate is one (with) good workforce prospects" to ensure consistent funding, she said.

"In a traditional defined benefit plan, the three big risks are investment, inflation and longevity," Ms. Coffing said. With a variable plan, longevity risk is borne by the plan, and investment risk is borne by the participants, while inflation risk is addressed by the variable feature. "The pattern is, level benefits in down markets," said Ms. Coffing, who also expects renewed interest.

"The goal is managing risk within the plan," she said. "Variable plans have this great benefit of staying funded in all market conditions" and they also can be tailored to fit a board's risk tolerance, she said.

The $14.9 billion Maine Public Employees Retirement System, Augusta, initiated a variable plan that modifies the cost-of-living adjustment based on inflation and market returns. Executive Director Sandy Matheson wanted to manage risk and secure the sustainability of a voluntary plan for participating local districts with $3 billion in assets covering roughly 20% of the state's public employees. Now in its third year, it is working well, but "it was a lot of work to adopt this," said Ms. Matheson, who hit the road to make sure all stakeholders understood how it worked and how it protected them in the long run.

"We created equitable sharing of the market losses — and gains. We looked at everyone's role and modernized it. It's sort of a fluid risk-sharing that protects all of the parties," Ms. Matheson said.

Robert Kurak, vice president and consulting actuary with Segal Consulting in Minneapolis, continues to see increased interest, particularly with multiemployer pension funds.

He helped trustees for the United Food and Commercial Workers International Union's Local 663 in Minneapolis set up a variable plan that went into effect January 2019. That was a good year, market-wise, so benefits increased by the 3% cap. The union was previously in a traditional multiemployer DB plan.

"As people start to see some of these plans being implemented, I expect to see continued strong interest," he said.

"It adds complexity but it can be accomplished," said Mr. Kurak, who helps trustees determine what design features are best for their situation and what they are comfortable with. For multiemployer plans, "a lot comes down to the board and their willingness to make changes, and to have a membership that would accept it," he said.