DB Risk Transfer FAQs
Transferring Defined Benefit Plan Risk
In recent years, many employers have modified their DB plans to reduce costs. Some employers have excluded new hires from the plan, others have reduced benefits and/or provided lower benefits to new hires while some employers have elected to freeze their plan, electing to curtail all benefit accruals for both current and prospective employees. This latter approach is often referred to as a “hard freeze” which eliminates future benefit accruals for active participants and results in significantly lower plan contributions.
“Our organization had searched extensively for the right resource partner to assist us with our frozen defined benefit plan. We were very pleased to engage Institutional Advisors and have been even more pleased with their innovative approach to pension risk, cost-efficient deliverables, and attention to detail.” Doug Wareham, President & CEO of Kansas Bankers Association.
So, why have required plan contributions increased even though the plan is frozen? There are several causes for these increases, the two most influential factors are rising Pension Benefit Guaranty Corporation (PBGC) insurance premiums and lower interest rates. And what will happen when liability interest rates rise? Better funded ratios, lower contribution requirements and lower annuity purchase rates. The following list of answers to common questions is designed to help participating employers better understand what it means to maintain a frozen DB and the impact on Beneficiaries and the potential costs to the Employer.
What is a “Frozen Plan"?
A Frozen Plan has elected to cease benefit accruals for all beneficiaries. No new employees are enrolled in the plan. The plan has not been terminated and is still subject to annual actuarial valuations and any actuarial gains and losses.
What is the difference between a “hard freeze” and a “soft freeze”?
A plan under a hard freeze discontinues benefit accruals for all participants and the no longer enrolls new hires. Under a soft freeze, benefit accruals continue for current active participants, but no new hires are enrolled.
What is the impact on participant benefits?
Participant benefits are earned through the day before the plan is frozen. The accrued benefits are payable at some point in the future based on the plan’s early retirement, normal retirement, or deferred retirement provisions.
Do participants of a frozen plan receive benefit statements?
Yes, participants receive a benefit statement every 3 years. The benefits at Normal Retirement Age remain unchanged from the previous statement. Since participants continue to earn vesting service, they may become vested in the benefit (earn the right to the benefit). In addition, an active service death benefit is shown on the statement and this benefit amount may change depending on plan provisions. It should be noted that the active service death benefit is not the same as the lump sum value of the retirement benefit. Participants also receive a statement at the time the plan is initially frozen.
“The partnership with Institutional Advisors plays an important role in executing on our long-term strategy of pension risk management.” Rob Ness, Chief Financial Officer of First Dakota National Bank.
What is the impact on employer costs when a plan becomes frozen?
When a plan is frozen the Target Normal Cost (TNC) is reduced to plan expenses only. TNC represents a year’s worth of new benefits plus plan expenses. When the plan is frozen there are no new benefits accrued, therefore, that part of the TNC becomes zero. However, to the extent the plan is underfunded, the amortization payments required to eliminate this funding shortfall remains part of your minimum contribution requirement. Furthermore, the plan is still subject to ongoing actuarial valuations and actuarial gains and losses, which may further increase these payments over time.
What is included in plan expenses?
Plan expenses are made up of 4 components:
1) A per head administrative charge based on the number of participants.
2) An asset-based fee based on the employer’s total plan assets.
3) A flat rate PBGC premium based on the total number of plan participants.
4) A variable rate PBGC premium based on the unfunded liability of the plan determined under pre- MAP21 (MAP-21 is pension relief legislation effective in 2012) liability rates (this number is contained on page iii of your latest actuarial valuation report)
How do Pre-MAP21 liability rates compare to MAP21/HATFA (HATFA is further pension relief legislation effective in 2014) rates?
For purposes of determining ongoing funding ratios and contribution requirements, the law requires plan liabilities to be valued using MAP21/HATFA rates, currently over 6%. In calculating PBGC variable rate premiums, the PBGC ignores MAP21/HATFA rates and uses Pre-MAP21 liability interest rates which are considerably lower (currently in the low 4% range), resulting in higher plan liabilities, lower funding ratios and ultimately, higher variable rate PBGC premiums.
If my plan is frozen why do my costs fluctuate?
When an employer freezes its plan no further benefits accrue for participants and therefore there is no further benefit expense. However, since the plan has not been terminated it is still subject to:
1) Annual actuarial valuations and associated gains and losses (i.e., mortality and turnover assumptions, etc.)
2) Fluctuating liability interest rates, increasing and decreasing plan liabilities associated with the frozen plan each year- lower interest rates increase plan liabilities requiring more plan assets on hand to pay future benefits, thus increasing employer contributions
3) Ongoing compliance and governmental reporting
4) Ongoing administrative, recordkeeping and investment management expense
5) Annual PBGC premiums (which will continue to increase through at least 2019)
6) The potential impact of lump sum benefit payments as interest rates used to value lump sums are currently lower than the interest rates used to value plan liabilities, causing the lump sum liability to exceed the current liability on the books, requiring additional employer contributions
Institutional Advisors is a unit of Lifetime Income Store, Inc., Tulsa, Oklahoma.
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