## How DB pension plan sponsors can reduce variable-rate PBGC premiums

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In 2014, variable-rate Pension Benefit Guaranty Corporation (PBGC) premiums were 1.4% of the plan's unfunded vested benefits, but rates will increase to 2.4% this year and to 2.9% in 2016. Many plan sponsors of defined benefit (DB) pension plans may not be aware of these increases and may be caught off-guard come October, when the 2015 PBGC premiums are due. However, they can take action now to reduce or eliminate the variable-rate premium. Pacific Life's Russ Proctor and Marty Menin spoke to PLANSPONSOR about a possible solution for sponsors of DB pension plans—a solution that can help stabilize their funded status should they decide to make a larger pension contribution in 2015 and reduce their variable-rate PBGC premium.

**PS:** The increase in the variable-rate PBGC premiums has been large. How can a plan sponsor address this issue?

**Menin:** That increase is certainly significant. In fact, if you look back at 2013, the variable-rate premium was just 0.9% of the
unfunded vested benefit amount. This means that the variable rate PBGC premiums will have actually tripled in just three years, going from 0.9% in 2013 to what will be 2.9% next year. There is a relatively easy answer: Plan sponsors can increase their contributions to their pension plan and reduce that unfunded amount, but that's not necessarily an easy thing for all plan sponsors to do.

**PS:** So, what do DB plan sponsors do? How do they start to address this?

**Menin:** If plan sponsors do not have the cash available to fund the shortfall, they could consider borrowing the money. After all, the unfunded pension liability is effectively already just debt owed to the pension plan, so they would be replacing variable pension debt with fixed debt.

Let's say you could borrow money at 6% interest and contribute that to the pension plan to eliminate the PBGC variable premium. Although you are paying 6% interest on the loan, you are saving almost 3% in PBGC premiums. Thus, the net cost of borrowing is reduced by about half. For some plan sponsors, the cost of borrowing might even be lower in this low interest-rate environment.

**PS:** Isn't there still a lot of risk for the plan sponsor? How do they prevent the plan from becoming underfunded again due to interest-rate or investment volatility?

**Proctor:** That's a great point. The volatility risk may actually be greater now that the plan is fully funded. The plan sponsor is going to see more variance in that funded status now that there are more assets in the plan. And, after plan sponsors have funded up their plan and avoided those PBGC premiums, the last thing they want is to be underfunded again. Yet, that can easily happen if the assets remain allocated 60% equity and 40% fixed, where they're subject to all the fluctuations in the market.

**PS:** If there is volatility in equity markets and in interest rates, what can plan sponsors do to maintain their funded status?

**Menin:** That funded status volatility is exactly why Pacific Life created our Pacific Insured LDI pension risk management solution. Insured liability-driven investing (LDI) is a solution that more accurately matches assets and liabilities than was generally available for plans in the past. It guarantees that the plan asset is going to move in sync with the projected plan liabilities, regardless of the interest-rate changes or the performance of the underlying investment portfolio. Thus, the funded status can remain stable.

![](/images/blog/easing-the-pain-image-2.jpg)

_(1) Guarantees are backed by the financial strength and claims-paying ability of the issuing insurance company._

**PS:** Can you talk a little bit about how that actually works?

**Proctor:** The plan sponsor's pension liability for generally accepted accounting principles, or GAAP accounting purposes, is equal to the present value of the projected benefit payments that the plan sponsor has promised to its participants. This present value is determined using a discount rate based on the current interest yield curve for high quality corporate bonds such as the Citigroup Pension Discount Curve. The Insured LDI solution provides a contract value that is calculated using the same projected benefit payments provided by the plan sponsor and the same yield curve. Thus, the Insured LDI contract value will change in sync with the plan liability as interest rates change. If interest rates go down, the pension liability goes up and the Insured LDI contract value would go up by the same percentage—and vice versa. Thus, the plan's funded status ratio would stay the same.

Insured LDI also pays the scheduled benefit payments in a bulk payment to the plan every month, which provides the monthly liquidity that the plan needs to make those benefit payments.

**PS:** What has the Insured LDI solution's track record been?

**Proctor:** Our first Insured LDI client funded $50 million in December 2011 and elected to use the Pension Protection Act (PPA) full yield curve to determine the Insured LDI contract value. We now have more than a three-year track record of performance, and the plan sponsor has received a statement every month documenting that the Insured LDI contract value moved exactly with its pension liability.

Interest rates and investments in the market have been very volatile over the past three years, but this plan's funded ratio has remained the same every month. This has allowed the company's executives to really focus on running their organization, rather than worrying what the daily changes in the market would do to the pension plan.

In fact, the total annualized gross return for Insured LDI for this client was 7.94% per year during the period from December 31, 2011, through March 31, 2015. Although that is a good annual return, the real value of Insured LDI is that the plan's funded status remains stable no matter what happens to interest rates or equity markets. Thus, a plan sponsor can now fund up its plan to avoid PBGC variable-rate premiums, then use Insured LDI to make sure it doesn't drop back below the desired funding level.

Let us help you.

Easing the Pain of Increasing Variable PBGC Premiums

Given current events and the economic uncertainty facing retirees, it might be beneficial for those nearing retirement age to consider guaranteed lifetime income. The [Setting Every Community Up for Retirement Enhancement (SECURE) Act](https://www.congress.gov/bill/116th-congress/house-bill/1994) was recently signed into law. It modifies several areas of current retirement rules and includes changes affecting [defined contribution (DC)](/lifetime-income/) plans that will make it easier for plan sponsors to add a lifetime income option to their DC plans. Providing a lifetime income option through a 401(k) plan may be attractive to plan participants due to potentially lower expenses and lower commissions. In addition, institutional or group pricing combined with unisex rates may be a particularly good benefit for women who elect to annuitize all or part of their account balances through their employers' 401(k) plans.

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## More Lifetime Income

Typically, lifetime income strategies provided at work through a 401(k) plan must use unisex pricing. This requirement means that women gain a pricing edge when purchasing lifetime income at work versus the retail marketplace. For example, if a participant rolled his/her DC account balance to an IRA and purchased lifetime income in the retail market, a woman would receive a slightly lower monthly benefit than a man at the same age. This result is simply because women generally live longer than men, and insurance companies take that into account when determining the monthly payment. However, in an employer-sponsored retirement plan, the insurance company providing the lifetime income solution must use the same annuity rates for both men and women, resulting in a positive outcome for women. In other words, if annuitizing a portion of their 401(k) balance makes financial sense given their retirement needs, then women win at work. 

The illustration at the top shows the expected differences between a male and a female annuity result at age 65. Note that in this example, both the male and female receive higher monthly benefits from an annuity purchased from a 401(k) plan due to no commission assumed on the 401(k) annuity. In addition, the female receives significantly more in total expected payments by about $11,000 due in large part to unisex pricing and her longer life expectancy. This is a valuable benefit to consider making available to employees of your organization.

Prior to the SECURE Act, few plans offered a lifetime income option. The SECURE Act helps resolve several of the key elements that have prevented plan sponsors from adding a lifetime income option to their 401(k) plans. 

## Fiduciary Safe Harbor

Plan fiduciaries have been requesting additional safe harbor guidance on selecting a lifetime income provider for years. Defined contribution plan sponsors were concerned that they would be held liable if an insurance company looked solvent at the time of selection but later failed. The SECURE Act provides new guidance on key factors that must be considered by plan sponsors and plan fiduciaries at the time a provider is selected. If these guidelines are followed, the plan fiduciary will not be liable for failure of the insurance company in the future.

As defined benefit pension plans and their guaranteed lifetime income features continue to disappear in the private sector, the annuity safe harbor rules are the best effort yet to provide guaranteed lifetime income options for 401(k) participants. The SECURE Act now provides plan sponsors the fiduciary guidance they've been seeking.
  
## Portability

Another obstacle to adding a lifetime income benefit in a defined contribution plan was the fear that the lifetime income option might incur penalties if distributed or rolled out of the plan after the participant changed employment. The new rule will permit participants to preserve any elected lifetime income options and avoid surrender charges and fees upon distribution to the participant or another qualified plan. 

  
## Communication and Education

The SECURE Act also adds a new feature to defined contribution plan statements, which must now include a lifetime income disclosure at least annually. This disclosure will illustrate the monthly lifetime income stream equivalent to the participant's total plan balance, providing vital information for retirement planning. The Act also includes a level of assurance for plan fiduciaries and plan sponsors that there will be no liability under the Employee Retirement Income Security Act of 1974 (ERISA) for providing an estimate of monthly lifetime income.
  
## Plan Sponsors Should Feel More Secure

Overall, passage of the SECURE Act will be seen by many as one of the most significant changes to the retirement landscape in years. Plan sponsors now have the opportunity to enhance 401(k) plans to provide one or more lifetime income options, so participants can choose to create guaranteed lifetime income for themselves and their spouses.

Women Win At Work as a Result of the New SECURE Act

## Comparing Pension Buy-Outs and Pension Buy-Ins

### Both options for defined benefit plan sponsors require careful consideration 

Defined benefit (DB) plan sponsors interested in reducing plan risk and eventually removing the liability from their company's balance sheet now have more options than just a few years ago. The new possibilities are helpful but also complicate the process of selection. To explore today's solutions, and how to use them, Alison Cooke Mintzer, editor-in-chief of PLANSPONSOR, spoke with Russ Proctor and Marty Menin, both directors of institutional sales at Pacific Life. They explained the difference between the traditional buy-out solution and the newer buy-in solution.

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**PS:** A buy-out of pension liability has been around a long time, whereas, in the U.S., the buy-in concept is relatively new. How are these two similar?

**Proctor:** A buy-out is a purchase of annuities for all or some of the participants in a defined benefit [DB] plan that transfers all the risk and liability off the plan sponsor's balance sheet to an insurance company. Buy-ins have been used for many years in the U.K. A buy-in, such as our Pacific Secured Buy-In solution, resembles a buy-out in that it transfers the investment risk, interest rate risk, liquidity and longevity risk to the insurance company. And, by the way, we just completed the third buy-in contract ever placed here in the U.S.

**PS:** Congratulations! So, what makes a buy-in different from a buy-out?

**Menin:** Under a buy-out contract, the liabilities are transferred to an insurance company and completely removed from the pension plan and the company's balance sheet. The insurance company issues certificates to individual plan participants and directly assumes all future payment obligations.

The key difference with a buy-in contract is that the plan sponsor retains the payment obligation to plan participants and the liability remains on the company's balance sheet. The insurance contract becomes an asset of the plan under which the issuing insurance company is obligated to cover the financial risks and makes covered benefit payments in bulk to the plan sponsor. Individual certificates are not issued to the plan participants and the participants remain in the plan for purposes of actuarial valuations, calculation of PBGC [Pension Benefit Guaranty Corp.] premiums, etcetera.

**PS:** Why would a plan sponsor choose a buy-in or buy-out?

**Proctor:** A buy-out is used when the plan sponsor is either terminating the plan, and has to buy annuities to complete the plan termination, or wants to completely settle a portion of the liability. A buy-in is more of a steppingstone to get to a buy-out; the plan sponsor may want to transfer most of the risk now but can't fully settle the liability yet.

One scenario where a buy-in may be helpful is for a plan sponsor that has borrowed money to fully fund the plan. A buy-in lets the plan sponsor lock in the annuity cost now and worry about terminating the plan later when the IRS [Internal Revenue Service] and PBGC approvals are received. This eliminates the risk of having to contribute or borrow more money 12 to 18 months later when unfavorable investment performance may have eroded the funded status of the plan.

It's also fairly common that companies have a large pension loss on their balance sheet, and it may be that completely settling the liability now would require that they recognize the loss on their income statement. A buy-in lets them secure the liability and the risks, transferring those to the insurance company, but leaving the pension liability unsettled until a better time in the future.

**Menin:** A buy-in is also an opportunity to capitalize on interest rate spikes. The plan sponsor may like where current interest rates are and want to lock that in, then complete the buy-out process later. The buy-in contract gives the plan sponsor more flexibility and time—something we try to emphasize with all our pension risk transfer products.

In the old days, you terminated the plan or you kept the plan. Today, a plan sponsor may desire to dollar-cost average into the interest rates applicable to a buy-out annuity contract. In other words, a plan sponsor may say, &quot;I want to de-risk my pension plan, but I don't want to do it all at once—I'd like to do it over a longer time frame, perhaps in segments.&quot;

Another benefit of a buy-in can be removal of longevity risk from the plan. Longevity risk has been in the news a lot lately. A plan sponsor can use a buy-in to transfer the longevity risk to Pacific Life without having to worry about full plan termination. Thus, a buy-in can be used for a longer transfer of risk without necessarily serving as a short-term bridge to a buy-out.

**PS:** If the endgame for the plan sponsor is a buy-out—as you said, plan termination—how does a buy-in fit into that strategy?

**Menin:** A buy-in contract lets the plan sponsor decide when to settle the liability and notify participants. Because a buy-in remains a plan asset, the sponsor can put a buy-in contract in place, then complete the regulatory paperwork required in a plan termination. The more plan sponsors seek flexibility in the pension risk transfer market, the more they'll see a buy-in as a creative solution.

**PS:** Continuing with flexibility, if you decide to pursue a buy-out strategy, how do you exit a buy-in contract, and are there additional fees?

**Proctor:** For Pacific Secured Buy-In, all the plan sponsor needs to do is provide a letter requesting the conversion to a buy-out. There are no additional charges, administrative costs or any fees. At that point, the liability and assets are completely transferred to Pacific Life and removed from the plan and the company's balance sheet. This may trigger the settlement accounting, but the plan sponsor controls when a conversion and settlement occur.

It is this control and flexibility that makes a buy-in a valuable tool for U.S.-based plan sponsors as they develop their strategy to manage their pension plan risks.

In or Out?

## How longevity impacts DB plans and financial wellness

People are living longer than at any other time in history. But what does that mean for defined benefit (DB) plan sponsors? Are there ways to help bolster the financial wellness of employees who might spend decades in retirement? And are sponsors prepared for the impact of longevity: its effect on their plan's financial wellness? PLANSPONSOR discussed these questions with Russ Proctor and Marty Menin, both Directors of Institutional Sales at Pacific Life Insurance Company, to determine what plan sponsors should know about the impact of longevity.

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**PS:** How long are people living today?

**Proctor:** When the subject is retirement planning, the real question is how long do people think they're going to live? I hear
people approaching retirement who say they expect to live to age 76 because they remember hearing that's the age of life
expectancy. However, that number is a little out of date and—more importantly—that's from birth. Once you reach age 65, the
Society of Actuaries' mortality tables show that males are typically living to age 86 and females to age 89.

**Menin:** Especially for married couples; there's a 50/50 chance that one spouse will live to age 94, and a 20% chance one of
them will live to 100. Thirty to 35 years of retirement planning is a long time to plan for and to be certain that your money will last.

**PS:** Does longevity differ by demographics?

**Menin:** There are different ways to look at demographics, aside from the most obvious male versus female. The Society of
Actuaries' (SOA) mortality tables have begun to break out things like blue collar versus white collar. Where individuals live, their education, and their income are also factors that affect longevity. From a DB plan sponsor perspective, they may have different populations covered by the pension plan—such as manufacturing and research divisions in which workers have different educational or income backgrounds—and they need to consider those to determine what the true longevity risk is for their pension plan.

**Proctor:** From the plan sponsor's point of view, the difference between white collar and blue collar employees affects their
pension plan and how long benefit payments will be made. If you have a highly-educated, highly-paid white collar workforce, your risk may be much higher in terms of having to pay those benefits for a longer period of time and that will affect the plan's financial wellness going forward.

**PS:** How does this impact qualified pension plans?

**Proctor:** With the qualified defined benefit plan, employees have guaranteed payments for life. There is really no longevity risk for the employee. It's all on the employer. When you think of people living to age 86, 89 or even 100, the plan cost can increase significantly. It's all the more reason to transfer that risk to an insurance company, that's one of the reasons the buy-out strategy is so popular right now.

**Menin:** Most plan sponsors recently updated the mortality table they use to calculate the GAAP accounting pension liability. This increased the projected benefit obligations (pension liability) from 5% to 7%. Also, if these mortality rates continue to improve faster than projected, plan sponsors would need to update their liabilities again (Note: the SOA just updated their tables which reduced life expectancy by about 5 months).

**PS:** What's the impact on nonqualified defined benefit plans?

**Menin:** These plans are typically offered to the highly compensated senior executives in a company. The interesting thing is that many plan sponsors use the same mortality assumptions for their non-qualified plan liabilities that they use and apply to their qualified plans. Thus, the non-qualified plan liability could end up being higher than expected.

**PS:** How does this impact individual retirement planning?

**Proctor:** When a plan sponsor terminates their pension plan, leaving only a defined contribution plan, the longevity and investment risk that was once in the defined benefit plan is now shifted to the employees. The employees are then responsible for managing those assets for their lifetime and if the market performs below their expectations, the employees are the ones that suffer. Maybe they invest too conservatively, or the market crashes right before retirement, it can cause a pretty severe hardship for the employees. In contrast, the plan sponsor benefits from the law of large numbers. They're spreading these risks over a longer period of time, over several generations of employees in fact, whereas individual employees are subject to the investment performance of the assets they've accumulated.

**Menin:** Guaranteed lifetime income solutions have now become the next step in retirement plan offerings, and everybody is trying to figure out how to do it. It is difficult to protect oneself from longevity risk because you can build up a large account balance in a 401(k) plan, manage that money for 30 to 35 years and still have to think about watching the market and making sure you're properly allocated for that extended period of time. Slowly but surely, plan sponsors will start getting serious about adding some kind of lifetime income solution to their 401(k) plans.

**PS:** What solutions are available to address these issues?

**Proctor:** Once plan sponsors complete a DB buy-out, they ask: &quot;What do I do next?&quot; One strategy is adding a group annuity option to the 401(k) plan, such as a Pacific Lifetime Income® annuity. When employees retire, an annuity option gives them the opportunity to purchase a guaranteed lifetime annuity with a portion of their 401(k) assets. This provides additional guaranteed monthly income to supplement Social Security benefits.

By offering an annuity option, the plan sponsor also provides a great educational opportunity because some employees just don't understand what an annuity can provide in terms of guaranteed lifetime income. Employees often think, &quot;If I die too soon, I'll lose my money.&quot; But by offering a Pacific Lifetime Income® annuity, employees can learn about multiple forms of annuities. They can discover that with a joint life option, money isn't &quot;lost,&quot; it's paid to their spouse. Or if both spouses pass away earlier than expected, a 20-Year certain payout ensures their beneficiaries receive the money.

**Menin:** At Pacific Life, we provide an interactive website that lets employers or advisers run different scenarios for their participants. Providing these different scenarios to participants helps them understand and evaluate the lifetime income options available to them.

**Proctor:** We hear many plan sponsors say they're looking for more holistic ways to help employees with financial wellness. This means plan sponsors are thinking about whether employees understand their healthcare options, Social Security benefits, or investing basics. Educating employees about annuities can be an important part of that. After all, annuities are still one of the best ways to deal with longevity risk, which is an absolutely crucial factor in financial wellness for both companies and their employees.

Longer Lives, Larger Financial Needs

## Corporate Tax Cut? Profit Repatriation? Rising Interest Rates?

### Will President Trump's anticipated economic changes create opportunities for DB plans?
  
There is much debate in corporate boardrooms over the effect the current administration's economic policies will have on corporate tax rates, possible repatriation of foreign profits and interest rates. Considering all the talk about the changing economic environment, PLANSPONSOR sat down with Russ Proctor and Marty Menin of the Retirement Solutions Division at Pacific Life to ask them whether these developments will help defined benefit (DB) pension plans.

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**PLANSPONSOR:** If corporate tax rates are reduced significantly this year or next, how could this impact pension plan sponsors?

**Russ Proctor:** Under the assumption that corporate tax rates will get reduced, plan sponsors might consider accelerating the funding of their pension plans to take advantage of the larger tax deduction before the lower tax rates are fully effective. In some cases, the contribution could be made after the end of the plan year and still deducted for that year. For example, a company with a calendar year plan year may be able to make a contribution as late as September 15 of the following year and deduct it for the prior year's tax return. If a plan sponsor intends to make a contribution to the pension plan in one of the next few years, it may make sense to do that in a year when it can take a larger tax deduction.

**PS:** What if the new administration gives companies a tax break on their offshore profits? Could they use those repatriated profits to make pension contributions?

**Marty Menin:** There are many reasons a plan sponsor may want to contribute available cash to its underfunded defined benefit plan. These include the potentially larger tax deduction we just mentioned, as well as reducing PBGC [Pension Benefit Guarantee Corporation] variable rate premiums. This year, the PBGC premium is 3.4% of the unfunded pension liability. Assuming average wages increase 3% per year, it is projected to increase to 3.9% in 2018 and 4.4% in 2019 (1). If the plan sponsor can make a contribution to fully fund the plan, it can reduce the impact of those large and increasing variable rate premiums. Some companies are considering &quot;borrowing to fund.&quot; If you can borrow at an interest rate that is close to the PBGC variable premium rate, why not borrow the money and increase the funded status of the plan? So, whether a company has cash available, borrows the funds, or captures the funds thanks to a foreign profit repatriation program, it should review their options to deploy that cash, and that analysis may include the possibility of fully funding the pension plan.

**PS:** What would a plan sponsor do then? Terminate the pension plan? If suddenly you've made a huge contribution to your pension plan, what's next?

**Menin:** That's the key question: Once you've got a fully funded pension plan, what do you do then? Unfortunately, unless you've already filed for a plan termination, and filed all the necessary paperwork with the PBGC and the IRS [Internal Revenue Service], you can't immediately terminate the plan and get that liability off your balance sheet. A plan termination can take six to 18 months or longer. So, that's why we've built insurance options that offer flexibility for plan sponsors. There are tools that can help them lock in their funded status while they proceed with their plan termination.

**PS:** How would that work? How quickly can a plan sponsor act to ensure its funded status doesn't deteriorate after it has fully funded the plan?

**Proctor:** The quickest and probably easiest way to secure the plan's funded status would be to use our Insured LDI [Liability-Driven Investing] solution. Insured LDI is a guaranteed match to the plan's projected liability based on the Citi Pension Discount Curve. This provides an ideal asset/liability match for the plan sponsor. Thus, the funded status will remain stable as interest rates and equity markets remain volatile prior to full plan termination. In addition, Insured LDI is fully liquid, which allows the plan sponsor to withdraw the money without penalty at plan termination in order to pay lump sums or purchase annuities.

**PS:** What other options are available to plan sponsors to preserve their funded status?

**Menin:** There's another tool that's actually been a little bit more prominent in the United Kingdom. A buy-in annuity contract is an option for locking in costs and preserving funded status. Like Insured LDI, the buy-in will help stabilize the plan's funded status and doesn't require that the participants be notified of the annuity purchase, so the contract can be executed fairly quickly. The buy-in goes a step further than insured LDI by locking in all costs related to the annuity purchase including mortality, early retirement and other demographic changes. So, if a plan sponsor had just fully funded its plan and then wanted to quickly and completely lock in the annuity costs—say, interest rates had spiked at the same time—then a buy-in might provide a great solution.

**PS:** What other advantages does a buy-in provide for a defined benefit plan sponsor?

**Proctor:** The buy-in allows the plan sponsor to control when it completes the liability transfer regardless of what's going on in the market at that time. When a plan is terminating, there is usually a 120-day window for the plan to distribute assets after receiving IRS approval. If interest rates drop and the plan is not properly hedged against interest rate movements, then the plan might have too little money to purchase the annuities needed. The buy-in contract can be put in place, and then the plan sponsor can file the termination paperwork, prepare notices to plan participants and do all of those things it needs to do when terminating the plan. Once the plan sponsor is ready to fully terminate the plan, it would simply write us a letter to request that the buy-in be converted to a buy-out and issue annuity certificates to participants. As far as we know, Pacific Life was the first insurance company to successfully convert a buy-in contract to a buy-out contract.

It's important to mention that the plan sponsor is not required to terminate the plan or convert to a buy-out after purchasing the buy-in contract. In fact, the plan can keep the buy-in contract in place indefinitely or convert to a buy-out, whether they terminate the plan or not.

**PS:** So, to summarize, if the economic environment under the new administration encourages plan sponsors to fully fund their pension plans, it sounds like Pacific Life has some valuable tools for pension plan sponsors.

**Proctor:** The last thing those plan sponsors want is to fully fund their plan and then learn something's happened in the market that has caused them to be underfunded again. Once they're fully funded, they need to put a lid on that plan and secure that funded status. The tools we have available can help them do that.

New Economic Policies – Opportunities for Defined Benefit Plans?

## Maybe Annuities Aren't That Expensive After All

Defined benefit (DB) plan sponsors have been contemplating various pension de-risking solutions more seriously than ever. Some plan sponsors have the preconceived idea that annuities are &quot;too expensive.&quot; But many plan sponsors have not considered, and have not measured, the true economic cost of their defined benefit pension plans. To further investigate the concept of accounting cost vs. economic cost, Alison Cooke Mintzer, editor-in-chief of PLANSPONSOR, spoke with Russ Proctor and Marty Menin, both directors of institutional sales at Pacific Life. They explained the difference between these two types of costs.

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**PS:** What is a plan sponsor's accounting cost?

**Proctor:** Accounting cost refers to the amount of liability the plan sponsor has to report on its balance sheet for its defined benefit (DB) plan. This pension accounting liability is the present value of only the projected benefit payments that the plan sponsor promised to the pension plan participants. It does not include a variety of other direct or indirect expenses that the plan will pay in the future but that the plan sponsor is not required to recognize on the balance sheet now.

**PS:** What's the difference between that and the economic cost?

**Menin:** Economic cost refers to the all-in total present value of the costs that the plan sponsor will eventually pay for the maintenance of the pension plan. The direct expenses the plan sponsor pays includes for example: the annual administrative costs, actuarial costs, legal costs, asset management fees and Pension Benefit Guaranty Corp. (PBGC) premiums. Then there are indirect costs for which the plan sponsor may not receive an invoice that need to be recognized as part of the economic costs of the plan.

**PS:** Can you provide a little more detail about some of those indirect costs?

**Proctor:** An example of indirect cost is downgrades or defaults on bond investments. If the plan assets are invested in a bond that is downgraded or that defaults, then the plan assets will decrease. However, the plan sponsor does not receive a specific invoice identifying this cost. Another example is mortality improvement. The Society of Actuaries is releasing a new mortality table this year that indicates people are living longer. If participants live longer than expected, then the plan will have to pay benefits for a longer period of time, which will result in additional cost to the plan sponsor. This cost may not be realized in the accounting cost until the plan sponsor updates the mortality assumption. It is expected that the new mortality table could increase the liability 4% to 10%, depending on the age of the participants, compared with the table currently used in determining accounting costs.

Although some of these indirect costs such as default risk and mortality can be quantified and added to the economic costs, others are more difficult for plan sponsors to nail down. For example, there is a cost for the time spent by staff to research questions by participants, search for lost participants, conduct a search for a new asset manager, monitor and reconcile actual and expected investment results, etc. Indirect costs include the amount of time executives spend on all these things that take time away from managing the company's core business. Clearly their time is valuable but nobody is quantifying that expense.

There are many costs that plan sponsors just take for granted as part of operating the pension plan. Accounting rules don't require you to book those on your balance sheet, but you've got to take those into consideration when de-risking and comparing to the annuity costs.

**PS:** If a plan sponsor were to add in all of these additional costs you mention, how much higher is its economic cost relative to its accounting cost?

**Menin:** It will vary from plan to plan but could be about 16% higher than what the plan sponsor will show on their balance sheet. The chart we included here shows that, for an average plan, the present value of the future administrative costs, including PBGC premiums, is projected to add about 2% to the economic cost. Future investment management fees (based on a charge of 50 basis points [BPS] per year on assets under management [AUM]) would increase costs another 5%; mortality improvements are assumed to add another 6%; and finally the cost of default protection will add a few percent. Add these up and your true economic cost may be about 16% higher than the accounting cost disclosed on the balance sheet.

![](/images/blog/economic-cost-vs-accounting-cost.jpg)
  
The important part of this is that plan sponsors need to analyze these future costs of maintaining the plan and add them to the current accounting liability.

Whether a plan sponsor believes that its total economic costs are 116% of the accounting liability, as we described, or lower, or higher, it's vital to recognize that these costs are real. Plan sponsors need to be conscious of this when they compare their all-in plan costs with the costs of purchasing an annuity contract, to transfer the risk to an insurance company and de-risk their plan.

**PS:** How does that 116% compare with the cost of an annuity?

**Proctor:** It depends on several participant and economic factors. For example, for a group of retired plan participants, we often see annuity quotes that may range anywhere from 108% to 118% of their accounting liability. This cost is affected by the duration of the annuity contract. Are these people younger or older? How healthy is this group of participants? What industry are they in? The current interest rates at the time they actually purchase the annuity will affect the cost, as well. Costs are typically higher for active or terminated vested participants than for retired participants. This is due to longer duration of the liability, which includes reinvestment risk and more uncertainty of when the payments will commence.

**Menin:** For a long time, people just said, &quot;Annuities are too expensive,&quot; but often no one really sat down and crunched the numbers for comparison to the economic cost.

When the plan sponsor reviews the full calculations, they may find that it is often less expensive on a true economic basis to annuitize and transfer the risk to an insurance company.

**Proctor:** As we talk about comparing your economic cost with the annuity cost, it's also important to look at segments of the plan. Sometimes we see that the annuity cost is much lower than the economic cost might be for a group of retirees with very small benefits. The administrative costs for those small benefits may be 8% to 10% of their liability. So when you look at that small group, your economic costs may be 125% of the liability. If you can purchase annuities at 108%, you can have some significant savings on pockets of participants within your plan—you can pull out pieces of it, shrink the size of your plan and de-risk it in a very economical way.  

Economic Cost vs. Accounting Cost

Many defined benefit (DB) plans were closed to new entrants and/or frozen after the market crash in 2001 and the financial crisis in 2008. Due to many reports of the demise of DB plans, advisers might think all these plans would be terminated by now. However, many are still in existence and are—despite significant market returns during the past few years—still underfunded. As plan sponsors struggle with the volatility of their plan's funded status and the increasing expenses required to maintain them, they are looking for assistance. PLANADVISER spoke with Russ Proctor and Marty Menin, directors with Pacific Life in their Retirement Solutions Division, about the challenges defined benefit clients face, how some of them mirror challenges faced by defined contribution (DC) plans, and the solutions retirement plan advisers can consider to help resolve these issues.

---

**PLANADVISER:** First, why is funded status volatility a problem for frozen defined benefit [DB] plans?

**Marty Menin:** Volatility is somewhat accepted for an ongoing plan that is still accruing benefits for the company's employees. However, once the plan is frozen and employees are not earning any additional benefit, the volatility is just a financial irritation to the company. Add to that volatility the increasing administrative expenses, including Pension Benefit Guaranty Corporation [PBGC] premiums, and now it's more costly than ever to maintain these frozen DB plans.

**PA:** Many companies have not fully funded their plans hoping to earn their way out of this underfunding problem. Advisers know that doesn't work when saving in your 401(k) plan, but how has that worked on the DB side?

**Russ Proctor:** Yes, that's a good comparison. Just hoping your 401(k) plan earns its way into the retirement income that you need is not going to work, without putting some money in, and for the DB plan, this really has not worked out very
well either.

At the end of 2008, the average large plan was 78.3% funded. (1) The total funding shortfall for all of these plans was about $250 billion. At that time, the S&amp;P 500® index was at 826 and the 10-year Treasury was 2.25%.

Move forward to May 31, 2017, the 10-year Treasury is about the same at 2.21% and the S&amp;P 500® index has increased almost 200% to 2,412. On top of that, the Milliman 100 companies have contributed more than $385 billion to these pension plans during this time, more than the underfunding that was there back in 2008.

One would think the plans would be in a surplus position with that level of contributions and the approximate annual 12.8% market returns. Sadly, the funded status is still well short of 100% and stands at only 83.8%, an increase of only 5.5% during that time frame. (2)

**PA:** How is it possible that these plans are still that far underfunded given the increase in equities and that level of contributions?

**Marty:** Not all of those Milliman 100 plans are closed and frozen. Thus, some of those contributions are being used to fund the increases in the accrued benefits. Also, not all of the assets are invested in equities. Most sponsors would find it too risky to be 100% in equities in their pension plan similar to how an individual approaching retirement might not want to be 100% in equities. Therefore, not all of their assets are increasing at that historical rate of 12.8% per year. Other assets may be invested in a fixed income or traditional &quot;Best Efforts&quot; LDI [liability-driven investment] strategy designed to move in the direction of the liability when interest rates change but not close the funding shortfall.

**Russ:** Speaking of interest rates, even though the 10-year Treasury is a common interest-rate benchmark, the pension liabilities for GAAP accounting are based on corporate bond rates (e.g., Citigroup Pension Discount Curve). These bond rates have decreased about 2% from 5.87% at 12/31/08 to 3.77% at 5/31/17. This 2% reduction in the liability discount rate would result in an increase in pension liability of 20% to 30%. The fixed income or LDI assets should increase as interest rates decrease to offset this increase in liability. However, a best-efforts LDI strategy cannot guarantee that assets will increase the same as the liability when the discount rate changes.

Finally, the increasing ongoing administrative expense of maintaining the DB plan is eating away at the funded status.

**PA:** What are the risks for sponsors and advisers as they continue to try to earn their way out of an underfunding situation?

**Russ:** If what they have done for the last eight years isn't working, following the same strategy and hoping that something different will happen is sure to be a problem. They should be asking these questions:

- Do they expect the next eight years to provide the same or better equity returns of almost 13% per year? A market correction could have a huge negative impact on funded status.

- Will interest rates finally increase enough to lower the plans' liabilities? Many have been predicting an increase in rates for the last eight years, but we are still at a 10-year Treasury below 2.50%.

- Is it time to implement a strategy to get the plan fully funded in a timeframe that fits the organization they're working with to move the liability off the balance sheet?

**PA:** What are other ways advisers can help plan sponsors decide when or whether or not to fully fund their pension plans?

**Marty:** In 2019, PBGC variable premium levels are going to be about 4.4% of the unfunded liability. This is a cost that can be completely avoided simply by fully funding the plan. Even if the company needed to borrow the money to fund the plan, they may find the interest cost will be less than the PBGC variable premiums.

Another incentive to fund now is the potential reduction in corporate tax rates. Many plans are looking at accelerating contributions to take advantage of the tax deduction while the corporate tax rate is higher, versus what might be a 15% or 20% tax rate in the future.

**PA:** If a plan sponsor funds its plans to 100%, how can it make sure the plan does not end up at 80% again, like what happened in 2008?

**Russ:** It can take six to 18 months to completely terminate a plan and transfer that liability off the company's balance sheet. So, it's important for the company to remove as much risk from the plan as it can during that process so that funded status can be maintained.

Plans can consider an Insured LDI solution to guarantee the assets move with the liability and protect the funded status.

They can also consider purchasing a Buy-in annuity solution. That really locks in all the costs of those future annuities and transfers the risk to the insurance company without triggering settlement accounting.

Finally, they can purchase a Buy-out annuity for a subset of the participants, usually those with the smallest benefits. That will remove that liability, shrink the size of the plan, and eliminate all future administrative costs related to those transferred participants.

**PA:** For advisers without DB plan specialization, is there enough information and support for them to help their clients with DB plans?

**Russ:** Absolutely. Even though an adviser may not be a DB expert, think of the DB plan as an individual saving for retirement: &quot;I need to help them solve their retirement funding shortfall.&quot; Advisers can reach out to other pension consultants, insurance companies, and the plan's actuary to gather the necessary information to identify the funding shortfall and develop a plan to meet the company's funding goal.

**Marty:** Be the adviser who says, &quot;We are going to develop a plan to get you to 100% funded, and we're going to protect that funded status along the way.&quot; If you can solve these problems for your clients, you can become their trusted adviser. This could easily lead to a growth in other business opportunities—including additional defined contribution, nonqualified plan, or even personal wealth clients.

Invest or Contribute to Solve a Retirement Funding Shortfall?

## How DB pension plan sponsors can solve their &quot;orphaned&quot; DB SERP liabilities

With many corporate defined benefit (DB) plans now closed, frozen or terminated, many of those same plan sponsors may have leftover—i.e. &quot;orphaned&quot;—nonqualified defined benefit supplemental executive retirement plans (SERPs). These nonqualified DB SERPs, which were put in place for the company's executives and typically mirror the benefits of the qualified DB pension plan, are now also likely closed and/or frozen. However, nonqualified DB SERPs are not easily terminated. Pacific Life's Russ Proctor and Marty Menin spoke to PLANSPONSOR about a solution for sponsors of nonqualified DB SERPs—a solution that can help plan sponsors stabilize their balance sheets and solve the investment and mortality risk associated with these nonqualified plan liabilities.

---
  
**PS:** The trend for corporations who have qualified defined benefit pension plans is to de-risk those plans. How does this affect a plan sponsor that also has a related nonqualified DB plan for its executives?

**Menin:** Those plan sponsors that have closed or frozen their qualified DB plans likely took similar steps for their nonqualified plans. Many plan sponsors may not realize that they can't easily terminate those nonqualified defined benefit SERPs. If they were to terminate them, they have to be very careful to avoid triggering constructive receipt for the executives. This could create negative financial results for both the company and the executives under Internal Revenue Code (IRC) Section 409(A).

**PS:** So, if a plan sponsor has taken some action to de-risk its qualified DB plan, how does it also de-risk the nonqualified DB SERP?

**Proctor:** The good news is that one of the same solutions used to solve the qualified defined benefit risk can also be used for nonqualified DB SERPs. Our Pacific Secured Buy-In® solution is an asset that's designed to be owned by the corporation or a rabbi trust to de-risk the nonqualified DB SERP liability. With the Buy-In, Pacific Life makes a bulk payment each month to the company or rabbi trust in the exact amount that is needed for the company to make the individual payments directly to the executives.

**PS:** You're suggesting that a plan sponsor use a Buy-In annuity for its DB SERP liabilities. Could a sponsor use a Buy-Out and be done with it?

**Menin:** The problem with using a Buy-Out annuity contract is that once the insurance carrier issues an annuity certificate to the executive and starts paying the executive directly, then the executive is in constructive receipt of the full present value of the benefit stream.

**PS:** Clearly the Buy-In is a better solution. Are there other advantages to using a Buy-In contract as a solution for managing DB SERP risk?

**Proctor:** One of the main advantages of the Pacific Secured Buy-In annuity is that the plan sponsor would then have an asset to match the liability. The Buy-In asset value and the DB SERP liability on the plan sponsor's balance sheet will move in parallel for the retired participants in the DB SERP covered by the Buy-In annuity contract. This Buy-In solution has not been available to plan sponsors in the past; it's really only recently that it has begun being used for nonqualified plans.

**PS:** You emphasized that the Buy-In contract would cover all of the &quot;retired&quot; participants in the DB SERP, why is that so important?

**Menin:** As with most nonqualified plans, there are subtle tax issues that a plan sponsor needs to remember. The Buy-In contract is structured as a corporate-owned annuity that would be held as an asset of the corporation or as an asset of a grantor rabbi trust. That's the key, because under IRC Section 72(u), a corporate-owned annuity is potentially taxable on the &quot;income in the contract.&quot; The good news is that an immediate annuity is generally exempt from that same taxation. Retired DB SERP participants are receiving annuity payments now, so those would be considered immediate annuities, thus exempt from that Section 72(u) tax rule.
  
![](/images/blog/new-financing-solution-image.jpg)

**PS:** Is financing these DB SERPs really that important to executives? Can't they just keep on with the typical &quot;pay as you go&quot; method?

**Proctor:** Certainly they could continue with the pay as you go method, but these frozen plans are in a different stage of their life cycle than when they were first set up. When they were first set up, most of these participants were likely active employees, so the company was making very small or no monthly payments. These plans were probably frozen many years ago.

Those executives are now older and, in fact, most have likely retired. Therefore, the monthly benefit payments are now much larger, resulting in a greater liquidity demand on the company than in the past. Our Pacific Secured Buy-In solution provides the exact liquidity needed for the monthly benefit payments, and also transfers the investment, longevity and other risks to Pacific Life. It also minimizes the volatility in shareholder equity on the balance sheet that can occur with an unfunded SERP as interest rates change.

**PS:** Plan sponsors clearly need to ensure that they are aware of and paying close attention to the status of their DB SERP plans, correct?

**Menin:** Plan sponsors should evaluate what they've done with these defined benefit supplemental plans and make sure they are aware of all the applicable rules. A DB SERP usually mirrors the plan sponsor's qualified DB plan in that the benefits are paid as an annuity stream and are due for the life of the executive and likely for the life of the executive's spouse. As a result, these plans could be substantial liabilities for plan sponsors. Sometimes, too, SERP payments are much larger in terms of the monthly benefit than the qualified plan benefits for the company's executives; thus, the SERP benefits play a key role in the retirement planning for the company's senior management team.

New Financing Solution for Frozen Nonqualified Defined Benefit SERPs

Under GAAP accounting rules, plan sponsors of defined benefit (DB) pension plans must recognize the plan's funding deficit on the company's balance sheet. This wouldn't be so bad if it weren't so difficult to match plan assets to plan liabilities. Unfortunately, DB plans are consistently challenged by volatile interest rates and equity markets. While achieving a precise asset to liability match is difficult in the best of times, it is extremely challenging during periods of volatility.

Many plan sponsors use traditional liability-driven investing (LDI) strategies. However, because the pension payments are paid monthly over a very long period and the pension liability is measured annually based on specific corporate-bond rates, matching assets to liabilities is not an easy task. As those corporate-bond rates move, the liability moves as well. The plan assets not only need to deliver the monthly cash flows to pay benefits, they also have to match the movement in the value of the liability as closely as possible. Traditional best-efforts LDI strategies have had trouble with that precise matching, which results in tracking error.

Asset managers will say to a plan sponsor that they &quot;cannot buy the curve.&quot; They're referring to the Citi Pension Discount Curve (CPDC) that's used by many actuaries and plan sponsors to measure plan liabilities. It's a nearly impossible task for an asset manager to buy and hold the same bonds and allocation used to develop the monthly CPDC.

Even if an asset manager could hold all the bonds in the CPDC, it may not be a suitable investment for a pension plan because of the heavy concentration by industry and by issuer of the bonds used in the curve. This concentration increases the downgrade and default risk of the investment portfolio, and thus may not meet the diversification requirements of the plan's investment policy. If a bond is downgraded or defaults during a month, it is simply taken out of the CPDC in the following month. Thus, the CPDC never suffers losses from downgrades or defaults. However, a traditional LDI portfolio that actually purchased those bonds that were later downgraded or defaulted would suffer a loss.

An alternative to traditional best-efforts LDI could employ the services of an insurance company, because an insurance company can guarantee (1) the published rate curve precisely (i.e., mimic the CPDC) and promise to return the same benefit payments as the plan actuary measures when determining the GAAP liability. By employing this approach, an insurance company could &quot;mimic&quot; the curve and create an insured LDI strategy. This would result in no bond credit risk (no downgrades or defaults) and no interest-rate risk. As a result, there would be no tracking error. No matter how the yield curve changes from month to month, the guaranteed or insured LDI strategy will match the plan's projected liabilities; and thus, the plan's funded ratio will remain stable, and balance-sheet volatility would be reduced.

Financial executives and their Boards of Directors spend a significant amount of time trying to understand complex traditional LDI strategies, comparing actual results to expected results and reasons for the variances. By transferring this responsibility to an insurance company that offers an insured LDI strategy, those decision-makers can turn their attention back to the core business.

Of course, this insured strategy must provide flexibility so plan sponsors can adapt it to their needs. For example, this strategy could be implemented on a partial basis, such as stabilizing only the retiree liability. Also, the plan should not be locked in to the contract so that a plan sponsor can exit the contract completely with no penalties or surrender charges. In this way, transferring the liability to an insurance company could provide cash flow for retirees and remove the stress from the plan sponsor despite volatility in interest rates.

Reduce the Impact of Pension Volatility on the Balance Sheet

With the recent drops in the stock market and interest rates, the value and importance of including an insured de-risking strategy as part of your company's defined benefit (DB) pension plan investments are clearer than ever.

---

A de-risking strategy, such as insured liability-driven investing, ensures that your DB plan's assets move in sync with the liabilities as interest rates or equity markets change. Though you may see volatile equity and interest- rate changes in the market, your DB plan's funded status will remain stable. This is particularly important for frozen DB plans for which you intend to eventually fully fund the plan and remove the pension liability from the company balance sheet. There is nothing more frustrating than spending years funding your plan, getting it to the point where you are ready to terminate, and being forced to delay your plans after market volatility reduces your funded status.

You may remember back in 2008, when the S&amp;P 500® dropped 40% and 10-year Treasury interest rates dropped 200 basis points. (1) Companies without a solid de-risking strategy suffered significant reduction in their plan's funded status. For many plan sponsors, this resulted in diminished shareholder equity on the company's balance sheet. 

Although we recovered well in the years since 2008, the 2020 equity market correction reminds us that we need to be prepared for market volatility—and that there are tools that can help maintain a pension plan's funded status. Keep in mind that, for a near-fully funded plan, funded-status volatility in both the positive and negative can cause problems. For instance, if your plan is significantly overfunded, it could be difficult to recover those excess assets in the pension plan, and you may end up paying most of it to the IRS in excise and income taxes when the plan is finally terminated.

## Are you prepared for a sudden positive or negative shift in the market?

Consider the scenario illustrated below, which is a high-level example of what might happen to a plan sponsor under both pessimistic and optimistic economic scenarios. It assumes that equities change 20% and interest rates change by 100 basis points. We have compared the resulting impact on shareholder equity depending on the plan sponsor's efforts to de-risk the pension plan or to continue with the current investment strategy.

The de-risking strategy involves purchasing a guaranteed annuity contract designed to stabilize the plan's funded status. Note that a traditional liability-driven investing (LDI) approach is typically a best-efforts investment strategy that does not guarantee funded status will remain stable under changing market conditions. This example illustrates that not de-risking the plan exposes the plan sponsor to significant volatility in funded status, which results in a corresponding impact on shareholder equity.

It also shows that there is an asymmetric result without de-risking. The plan sponsor suffers 100% of the downside risk but can only gain a portion of the upside benefit due to the 50% reversion tax on excess assets.

Thus, a plan sponsor is not properly compensated for the risk being taken with the pension plan as it approaches full funding. The potential range of outcomes optimistically tops at a $130 million increase in shareholder equity and as low as $211 million decrease under the pessimistic scenario. The results are not symmetric because the plan sponsor ends up overfunded in the optimistic scenario and cannot receive excess assets back into the company as cash. (2)

Under the de-risking approach, the volatility is limited to a very narrow range, increasing or decreasing by only $6 million under the two scenarios. 

These results illustrate why a plan sponsor should consider de-risking now to reduce the impact of equity and interest rate volatility in the future.

Keep in mind that you need not put all your pension assets in the insured liability-driven investing strategy. You can choose a specific portion to dial in the amount of stability that is right for you.

![](/images/blog/prc1623-table-1.png)

![](/images/blog/prc1623-table-2.png)

![](/images/blog/prc1623-table-3.png)

Pension Stability in Volatile Markets

## Reconciling DB asset and pension liabilities

Defined benefit (DB) plans have endured much over the past few years, from new regulations to volatile interest rates and equity markets, all of which has led plan sponsors to find better ways to match their assets to the liabilities of the plan. Alison Cooke Mintzer, editor-in-chief of PLANSPONSOR, spoke with Pacific Life Insurance Company about their innovative Pacific Insured LDI® product. She sat down with Russ Proctor and Marty Menin, both directors of institutional sales at Pacific Life, to talk about liability-driven investing (LDI) and a new strategy for defined benefit plan sponsors.

---

**PS:** What are some challenges for the traditional LDI approach?

**Proctor:** Precise asset/liability matching is difficult for pension liabilities, particularly for traditional LDI strategies. The liabilities are paid monthly over a very long period of time, and the pension liability is measured annually based on corporate bond rates. As those corporate bond rates move, the liability moves as well. The asset not only has to deliver the monthly cash flows, it also has to match the movement in the value of the liability.

Traditional LDI strategies have had trouble with that precise matching, which results in tracking error.

A lot of asset managers talk about the fact that you cannot buy the curve, and they're referring to the Citigroup Pension Discount Curve (CPDC) that's used by many actuaries and plan sponsors to measure the plan liabilities. It would be a difficult task for an asset manager to try and buy all the bonds used to develop the monthly CPDC.

Also, the bonds in the CPDC may not be a prudent investment for a pension plan, due to the concentration by industry and issuer of the bonds used in the curve. This concentration increases the downgrade and default risk of the investments, and thus will not meet the diversification requirements of the plan's investment policy. If a bond is downgraded or defaults during a month, it is simply removed from the CPDC in the following month. Thus, the CPDC never suffers losses from downgrades or defaults. However, a traditional LDI investment portfolio that actually purchased those bonds that were later downgraded or defaulted will suffer a loss.

With Pacific Insured LDI, because it follows the curve precisely and uses the same benefit payment stream as the plan actuary to measure the liabilities, relatively speaking, there is no credit risk (no downgrades or defaults), no interest-rate risk and thus no tracking error.

**PS:** Can you tell me more about this Insured LDI product and how the contract works for plan sponsors?

**Menin:** Pacific Insured LDI was developed in response to plan sponsors' need of a better asset match for their pension liability. Insured LDI provides a guaranteed contract value compared to the traditional LDI strategies that use a &quot;best efforts&quot; approach. Insured LDI is the first solution to precisely match that movement in the pension liability: No matter how the yield curve changes from month to month, Insured LDI will match the plan's projected liabilities; and thus, the funded ratio will remain stable.

Finance executives and their Board of Directors can spend a significant amount of time trying to understand complex traditional LDI strategies, comparing actual results to expected results and reasons for the variances. With Insured LDI, the executives of the organization can now focus their energy on running their operations and not on worrying about the funded status volatility of the pension plan.

Insured LDI is also flexible, so plan sponsors can modify the product to meet their objectives. It does not need to be used for the entire plan. For example, some plan sponsors are looking to start using Insured LDI to just stabilize their retired liability, as illustrated in the pie chart below.

It also provides liquidity through the monthly benefit payments made by Pacific Life to the pension trust. The plan sponsor can also exit the contract completely with no penalties or surrender charges. Thus, they are not locked into the contract.

**PS:** You have a client who's been using this Insured LDI group annuity contract for a couple of years now. Has that product delivered what you—and your client—expected and promised? 

**Proctor:** We're very proud of the performance it's had over the last couple of years. The contract value moved exactly with their plan liability based on the projected benefits that the plan sponsor provided. So, as interest rates moved fairly violently over the last two years from month to month, Insured LDI performed exactly as advertised: It stabilized the funded ratio. Every month, no matter what happened to the yield curve or the equity markets, their funded ratio stayed the same—while providing monthly payments along the way to meet their cash-flow needs.

**PS:** How has the market changed and evolved in the last three years since the product was introduced?

**Menin:** We saw interest rates rise pretty significantly last year, and now they've actually backed off by some 40 to 50 basis points. For a plan sponsor interested in stabilizing their funded status earlier this year, our insured LDI product would have been a great solution for them. Could interest rates continue down another 100 basis points? Perhaps, but with Insured LDI, the plan sponsor does not have to worry if rates move up or down. The product is meant to protect the asset portfolio from those volatile interest-rate changes and to provide a superior asset/liability match.

As funded status improves, shifting into a risk-protected asset like Insured LDI can help lock in the big gains some DB plans made last year. Particularly as they get close to 100% funded, there's not as much upside for the plan. If equities run up another 30%, it doesn't help much to be 30% over-funded, but you certainly pay the penalty if there is a bad year and your funded status decreases. Now is a perfect time to lock in that funded status.

Insured LDI can work for ongoing plans, but it is particularly helpful for those closed and frozen plans that are approaching full funding, now is a great time to use this type of a product.

Asset/Liability Match, Set, Product

Implementing a pension risk-transfer strategy is an important part of a long financial journey. It's important for plan sponsors to work with an insurance company that has innovative solutions, financial stability, and great follow-up service.

These qualities are evident in Pacific Life's long and successful history serving the needs of pension plan sponsors. 

---

## A History of Innovation

In seeking ways to meet a broader spectrum of pension risk-transfer situations and needs, Pacific Life has introduced several firsts to the marketplace. We were the first in the United States to convert a Buy-In contract to a Buy-Out contract, and the first to sell a Buy-In contract for a nonqualified supplemental executive retirement plan (SERP). We were also the first to introduce a new concept in de-risking pension plans: Insured Liability Driven Investing (ILDI).

Wherever you are in the life cycle of your defined benefit plan, Pacific Life can help you achieve your short- and long-term goals, even if your plan is underfunded. For defined contribution plans, we offer [Pacific Lifetime Income®](/lifetime-income/), an open-ended contract allowing plan sponsors the ability to offer participants a guaranteed lifetime income solution for their retirement needs. Our full line of solutions means we can provide one solution or a strategically customized mix that takes into consideration your plan's funded status, employee population, financial obligations, long-term perspective, and more.


## Experience and Stability

Pacific Life counts more than half of the 100 largest U.S. companies as its clients. We sold our first group pension annuity contract in 1941.

Pacific Life's structure is relatively unique among insurance companies. We are organized under a mutual holding company with policyholders as members. We have no publicly traded stock; we are an independent company that remains focused on long-term strategies, our financial strength, and making decisions that benefit our policyholders and clients. This long-term commitment, combined with Pacific Life's disciplined investment philosophy, provide financial stability even during periods of economic uncertainty.

## Organizational Expertise and Commitment

Pacific Life prides itself on providing plan sponsors with outstanding support from beginning to end. We start with a consultative approach to understanding your specific circumstances and identifying an appropriate, customized set of solutions. We have also developed a reputation for exceptional installation and ongoing annuity servicing, so that the process runs smoothly both during and after your pension risk-transfer solution is implemented. Plus, we adhere to strict standards and documented procedures to maintain data integrity and privacy.


## Power of Pacific

The bedrock of any pension risk-transfer strategy is the selection of a strong and stable company with the ability to back its financial promises to you and your plan participants. For more than 150 years, individuals and businesses have relied on the strength of Pacific Life to protect their financial security, and today, we continue to maintain strong financial-strength ratings from major independent rating agencies. (1)  

Before moving forward with a pension risk-transfer provider, consider the following. Has the provider you're considering shown that they can offer solutions for a wide variety of plan sponsors? Have they brought a consultative and innovative approach to developing the right solutions for each plan sponsor? Have they shown a consistent commitment to the marketplace and demonstrated outstanding service to both plan sponsors and their plan participants? Experience and innovation does matter. Because what every plan sponsor needs is a provider that can be relied on for the long run. 

To speak with Pacific Life about a pension risk-transfer strategy, call us at (877) 536-4382 or email us at [GroupAnnuitiesBid@PacificLife.com](mailto:GroupAnnuitiesBid@PacificLife.com)

A History of Strength and Innovation

Many CFOs and treasurers have recently fully funded their defined benefit (DB) pension plan. Some took advantage of the larger tax deduction available for 2017 contributions. Others have benefited from rising interest rates and favorable investment returns. However you accomplished it, congratulations! But the real question is: What now? Should you maintain your current asset allocation and hope there won't be another major market downturn, or take action to lock in your fully funded status no matter how markets perform?

![A chart displaying recent market crashes.](/images/blog/db-plan-image-1.jpg)

## The Importance of Locking In Funded Status 

Most CFOs and treasurers would agree that maintaining their plan's funded status is an important goal. The last thing a financial officer wants is to explain to the board of directors why the funded status of the plan has decreased again due to an interest-rate decline or equity market correction. Remember, too, that your underfunded pension plan required you to make additional contributions and pay increasing variable Pension Benefit Guaranty Corporation (PBGC) premiums. Those premiums equal 3.8% of the plan's unfunded liability for 2018 and will rise to at least 4.2% in future years.

So, what kind of strategy can you use to avoid these potential problems? A pension buy-in may be the answer. A pension buy-in annuity contract is a well-tested idea that has been used for many years in the U.K., but has only become available in the U.S. in the last few years.

## Increasing Pension Benefit Guarantee Corporation Premiums

![A chart illustrating how PBGC premiums have increased from 0.9% in 2013 to 4.4% in 2019. That's a 390% increase overall.](/images/blog/db-plan-image-2.jpg)

The buy-in transfers all the pension risk associated with the DB plan liability for those participants covered under the buy-in contract. To complete the contract, the plan sponsor makes a one-time payment to the insurance company. Thereafter, the insurance company pays a monthly lump sum to the DB pension plan equal to the exact amount of benefits due to those plan participants who are still alive and receiving benefits. The pension plan uses this money to continue making individual payments to its participants.

The buy-in contract remains an asset of the plan, and the insurance company provides a monthly contract statement to the plan sponsor for accounting purposes. This means the liability and assets remain on the plan sponsor's balance sheet, but the funded status will remain stable regardless of how long participants live or what happens with the stock market or interest rates.
  
## Flexibility for Plan Sponsors
  
With [Pacific Secured Buy-In®](/secured-buy-in/), the plan sponsor can continue the contract for as long as needed and the plan sponsor remains in control. The contract also can be converted to a buy-out contract at any time for no additional fee. For example, let's say a plan sponsor has just started the plan termination process but will not be ready to complete that process for six to 18 months. With Pacific Secured Buy-In, the plan sponsor doesn't have to worry about what happens to the market or interest rates during this period.

Most plan sponsors will want to convert the buy-in to a buy-out within a few years. This is because, with a buy-in contract, the liability remains on the plan sponsor's balance sheet. Thus, the plan sponsor is still paying all administrative expenses for maintaining the plan. For example, even though Pacific Secured Buy-In can help keep the plan fully funded and help reduce or eliminate future variable PBGC premiums, the plan sponsor still has to pay the fixed per-participant PBGC premiums each year, which will be $80 per participant in 2019.

## No Settlement at Buy-In
  
An important feature of Pacific Secured Buy-In is that it does not trigger the pension settlement accounting transaction while the buy-in is active. Thus, at implementation of the buy-in contract, the company need not recognize in income the unrecognized pension loss it currently has on its balance sheet. With a buy-out, all or a portion of the loss would have to be recognized immediately. For U.S. companies, any pension loss would typically be recognized in income in the year the buy-in is converted to a buy-out. The plan can be terminated when it is most advantageous to the company.
  
## A Bonus for Multinational Companies
  
In addition to all the advantages discussed thus far, Pacific Secured Buy-In offers an additional advantage for multinational companies operating under International Financial Reporting Standards (IFRS) accounting. Under IFRS, not only is any pension loss not recognized in income at the time of the buy-in, but it also may not be recognized in income upon conversion to a buy-out. A company that did not use a buy-in first and, instead, started with a buy-out would have to recognize any pension loss in income in the year the buy-out contract was executed. However, if the company first uses a buy-in and later converts to a buy-out, the pension loss may never be reflected in income. The buy-in transition will simply be accounted for as a balance-sheet adjustment. This makes Pacific Secured Buy-In an important consideration for any multinational company considering a pension risk-transfer transaction for a U.S. pension plan.
  
## A Strategy to Help Secure Your Funding Level
  
How stable are your pension-plan investments? By transferring your plan assets to an insurance company through a product like Pacific Secured Buy-In, you will no longer have to manage the investment portfolio or worry about the fund balances. Instead, you can manage your business.

Your DB Plan Is Finally Fully Funded! Don't Let It Slip Away. 

What Is Your Pension Risk Strategy?

Recent market volatility has convinced many defined-benefit plan sponsors that they need to reduce the risks inherent in their plans, and do it soon. Yet, some strategies they might consider, such as terminating the plan, cannot be completed immediately.

If that's your situation, consider a buy-in annuity contract. A buy-in annuity is a versatile tool that can be used in a variety of situations, including:

**Removing risk prior to plan termination** – If you're not yet ready to terminate your plan, a buy-in annuity can lock down plan costs now, giving you time to file the necessary termination and regulatory paperwork with the IRS and Pension Benefit Guaranty Corporation (PBGC).

**Delaying recognition of settlement accounting** – With a buy-in annuity, you can de-risk your plan without the need to recognize the pension losses on your balance sheet until later when you terminate the plan.

**Facilitating a merger or acquisition** – Because a buy-in annuity locks down plan costs, companies negotiating a merger or acquisition can guarantee what those costs will be after the merger/acquisition is complete.

**Financially securing nonqualified SERP benefits** – A buy-in annuity can guarantee monthly payments under a Supplemental Executive Retirement Plan (SERP).

For more insight on how a buy-in annuity can help achieve goals like these, contact Pacific Life.

Plan Sponsors are De-Risking their Pension Plans... You Can, Too

The Right Path is a Flexible Path

Insured LDI Helps Keep Your Pension Plan On Course

The SECURE Act

How a CEO Got His CFO Back

Stabilizing Pensions During M&A

## Could an annuity buy-out be less expensive?

In 2013 and 2014, approximately $4 billion and $9 billion, respectively, of pension liabilities were transferred to insurance companies by sponsors of defined benefit (DB) pension plans. The first quarter of 2015 likewise saw more than $3 billion transacted in the first two months. To further discuss these ongoing trends in the pension risk transfer (PRT) market, Alison Cooke Mintzer, editor-in-chief of PLANSPONSOR, spoke with Russ Proctor and Marty Menin, both directors of institutional sales at Pacific Life. Here they continue their conversation, which started with last year's &quot;Economic Cost vs. Accounting Cost&quot; interview, now going into greater detail to explore the plan sponsor's economic cost for smaller pension benefits.

---

**PS:** What has changed in our pension de-risking market here in the U.S. since last year?

**Proctor:** There have been significant changes since we spoke to PLANSPONSOR last September. You mentioned the large increase in risk transfer annuity sales. In the fourth quarter of 2014, there were $7 billion in sales, and already in the first quarter of 2015 about $3 billion. Some of these transactions are focused on retirees with smaller benefits, indicating to us that plan sponsors understand the annuity cost may now be lower than the cost of maintaining these liabilities.

Also, the Society of Actuaries (SOA)'s new mortality table was released in October. Many plan sponsors adopted the new table for their 2014 year-end pension liability, increasing that liability by 4% to 10%, depending on the plan. The annuity pricing used by insurance companies already included the improving mortality, so it didn't affect the annuity pricing. Now the liability on plan sponsors' balance sheets is closer to the cost of an equivalent annuity provided by an insurance company.

**PS:** Tell me, how do you define &quot;smaller benefits&quot;?

**Menin:** Roughly around $200 to $300 per month, but the amount will be different for every company because each has a different expense structure. We often encourage plan sponsors to look at their population, evaluate their expenses and fees, and determine the right level for their plan. Our analysis found that for benefits less than $300 per month, expenses typically outweigh the price of an annuity.

**PS:** Plan sponsors have also been telling us how the increased expenses are negatively affecting their DB plans. Is it really that bad?

**Proctor:** It is, particularly for smaller benefits. For example, our chart shows an administrative expense of about 2% of the total retired liability for a typical plan. However, the &quot;per participant&quot; Pension Benefit Guarantee Corporation (PBGC) premiums have a larger percentage impact on the smaller pension benefits. PBGC premiums are now $57 per participant and will rise to $64 next year. For an average benefit, let's say a retiree paid $2,000 a month, the administrative cost for that total annual PBGC premium is about 0.27%. But for the smaller benefits—for example, a retiree paid $200 a month—that's an annual cost of 2.7%. Thus, the total administrative expense of 2% for the typical retiree liability would increase to 5% for retirees with small benefits. 

![](/images/blog/high-economic-cost-image.jpg)

When you add in the investment management fees and investment risks—defaults and downgrades, etc.—the total economic cost for smaller pension benefits can easily reach 113% of the accounting liability.

The annuity cost for these small benefits may be only 105% of the accounting liability. Thus, a plan sponsor may find that the price to buy annuities for these retirees is considerably less than the total economic cost of maintaining those liabilities in the plan, as estimated at 113% in the example above. 

**PS:** Is this a problem for all plan sponsors? Does industry make a difference?

**Menin:** This is true for many plan sponsors because not all of their employees participate in the pension plan for a full career. Even companies with highly paid salaried employees are likely to have a subset of retirees who are vested in a small pension benefit, having worked at the company only a few years before moving on to another company.

There are also industries, such as the retail industry, that typically have a lower-paid, higher-turnover work force. These plan sponsors will naturally accumulate even more small retirement benefit liabilities. Retailers with defined benefit plans typically have lower average benefits and thus a higher average expense ratio.

**PS:** So you're saying plan sponsors can segment out this set of smaller liabilities to an insurance company, and that buying an annuity can reduce expenses while still keeping the plan active?

**Menin:** Yes, absolutely. This is one of the most common forms of risk transfer we see today. A plan sponsor can demonstrate to its board of directors that the economic cost of these smaller pension benefits is more expensive than the annuity cost, even in this low-interest-rate environment.

**PS:** How do plan sponsors know whether this is the right option for them?

**Proctor:** We encourage plan sponsors to talk to their pension consultants and their advisers and ask for help analyzing the expense structure of their plan. In our example above, we show the impact of investment management fees, assuming 50 basis points (bps) per year, creating a 5% economic cost. This can vary widely, so each plan sponsor needs to determine what it actually pays, to pinpoint the true economic cost for the plan. We also show an increase, from 2% to 5%, for the economic cost of administrative and PBGC expenses for small benefits. Adding a default risk cost of approximately 3% gives us a total economic cost of 113%.

The point is plan sponsors can get an annuity quote and compare that against their economic cost to decide if the annuity purchase would make sense for them. They can then determine where their break-even point is for these small benefits, and decide which benefits they should buy out based on this detailed economic cost analysis.  

The High Economic Cost Of Small Pension Benefits

The Future of Sustainable Bonds

The Future of Sustainability 

Innovation in the Financial Industy

The Alternate Universe: Non-Qualified Plans versus Qualified Plans

Customer Experience and Lifetime Income

Effective Communication in a Hybrid Work Environment

Effective Communication in a Hybrid Work Environment — Webinar Series

A familiar saying tells us to “plan our work and work our plan.” That’s good advice for getting stuff done and something we can also apply to financial wellbeing in retirement. However, while experts may recommend different tactics and strategies, you’d be hard-pressed to find one who advises you just to wing it. 

With that in mind, Ruth Schau, FSA, EA, FCA, Institutional Division’s Sr. Director of Pension Solutions, explains that achieving financial wellbeing in retirement is planned, and shows how you can make it happen. 

 **KEY TAKEAWAYS**

- Getting help from a trusted source is a good start. 
- Employer-sponsored plans can be key; choose wisely. 
- Life expectancy should be part of the math. 
- Debt (like student loans) can derail even the best plan. 
- Retirees get sick, too; make sure healthcare is part of the plan. 
- A budget will keep your retirement finances on track. 

 

How to Achieve Financial Wellbeing in Retirement 

Looking to learn more about retirement payment options that might align better with employee and organizational goals?

Listen as Pacific Life’s Russ Proctor discusses the need for guaranteed lifetime income with Michael Finke, PhD, CFP, Professor of Wealth Management and Frank M. Engle Chair of Economic Security in this exciting new episode of the Wave Strength podcast. 

The session will cover:

- Do employees currently manage their retirement savings well throughout retirement?
- Do employees want access to guaranteed lifetime income options?

This episode will present information on options and the desire for guaranteed lifetime income. Professor Finke presents some survey results that may surprise you.

The Need for Lifetime Income

Looking to learn more about retirement payment options that might align better with employee and organizational goals?

Watch as Pacific Life’s defined contribution plan expert, Ruth Schau, FSA, EA, FCA discusses the need for guaranteed lifetime income with Michael Finke, PhD, CFP, Professor of Wealth Management and Frank M. Engle Chair of Economic Security in this exciting new episode of the Wave Strength Webinar series.

The session covers:

- Do employees currently manage their retirement savings well throughout retirement?
- Do employees want access to guaranteed lifetime income options?

This webinar presents information on options and the desire for guaranteed lifetime income. Professor Finke presents some survey results that may surprise you. Like and subscribe today!


Solutions for Lifetime Income

In this episode of The Wave Strength, documentary filmmaker Craig Leeson joins host Jim Breen from Glasgow where he’s putting the finishing touches on his latest film. Listen as Craig explains how corporate partnerships and finance make his current project to reduce climate change possible. Craig shares some amazing stories as he discusses the critical connection between film and finance.

---

**About Craig Leeson:**

With the noble goal to “make our world a better place to exist,” Craig Lesson is a journalist, activist, advocate, and adventurer who has dedicated his entire life and career to environmental concerns.

Documenting Sustainability: Filmmaking, Finance, and Fighting Climate Change

In this episode of The Wave Strength, Brian Woolfolk, head of the Institutional Division, joins host Jim Breen to discuss the Division’s first two years, noteworthy accomplishments, and his vision for the future. Listen as Brian shares the challenges of launching a division during a global pandemic, and the remarkable team that established its solid foundation. 

---

**About Brian Woolfolk:**

Brian joined Pacific Life in 2010, where he served as senior vice president of sales and chief marketing officer of the Retirement Solutions Division before his promotion to lead the Institutional Division. While Brian is a proud graduate of the University of Minnesota, he and his family live in Omaha, NE where they are loyal Nebraska Cornhuskers fans. 

Brian Woolfolk & the Institutional Division Celebrate Two Years of Growth and Innovation

**Article Highlights**
- Priorities are like alligators, deal with the closest one to the boat first. 
- Without goals, we might be flying...but it's unclear where we’re landing.  
- A good plan is like a map that takes us to our destination. 
- Finding allies and stepping outside of our comfort zone are keys to retirement success. 

In recognition of Women’s History Month, The Wave Strength proudly welcomed former Thunderbird, and U.S. Air Force Pilot Michelle “Mace” Curran to the Mission Critical webinar. Michelle and host Christine Tucker discussed many fascinating aspects of Michelle’s career, and Michelle shared several lessons, tactics, and strategies that can be applied to financial wellness and preparing for a successful retirement. Here are five key takeaways from the webinar which can help us become retirement ready. 

# 1) Establish Priorities 

One of the many highlights of the Mission Critical webinar was when Michelle shared her strategy for prioritizing: *Focus on the closest alligator to the boat, then deal with the next one.* Applying this strategy to retirement preparedness could mean reducing debt, creating a budget, or enrolling in an employer-sponsored retirement savings plan. 

# 2) Set Goals 

Without goals, we may be soaring, but we’re doing so without a destination, and that could lead to a bumpy landing. Goals serve as our destination and establishing goals will help set a course toward a successful retirement. 

# 3) Make a Plan 

Michelle repeatedly noted the importance of planning in achieving her personal and professional goals. Our plans are like a road map, it's how we navigate toward our goals. After we’ve established our goals, we can then begin planning to achieve those goals. Another important takeaway is realizing that it’s OK to change our goals and plans if our circumstances change. 

# 4) Find Allies 

Michelle emphasized the importance of trust among her fellow Thunderbird pilots. When we’re planning for retirement, it’s critical that we find trusted advisors, resources, and tools that we can depend on for accurate information and advice. 

# 5) Get out of the Zone 

Taking a calculated risk isn’t a bad thing, Michelle calls this “stepping outside of our comfort zone.” When applied to retirement planning, this can mean simply deciding to start the process of becoming retirement ready. Sometimes the first step is the most difficult. For Michelle, that first step was applying to be a Thunderbird, but by taking that risk she was able to soar to great heights. 

If we hope to soar toward retirement, it’s important to recognize that we are the pilots of our journey. And if we’re to make a safe landing, it’s mission critical to establish priorities, set goals, create a solid plan, find trusted allies, and step outside of our comfort zone. 

If you couldn’t attend the live webinar, click [here](https://youtu.be/ITuh82uXKHk) to watch Michelle and Christine discuss how planning and goal setting can help you soar toward your dreams. You can catch it now on The Wave Strength, located on Pacific Life’s YouTube channel. 

---

**About Michelle Curran:**

Michelle Curran has led an impressive career as a Fighter Pilot during her 13 years in the United States Air Force. From 2019-2021, she flew as the only female pilot for the Air Force Thunderbirds and performed for millions across the country and internationally. Michelle was also named the Distinguished Alumna of the Year by the University of St. Thomas in 2021, and has been featured on The Kelly Clarkson Show and CBS Evening News. 

Before joining the Thunderbirds, Michelle was a combat-proven fighter pilot completing missions around the world. Her passion for pushing limits, inspiring others, and changing lives led to the creation of her company, Upside Down Dreams. Through this platform, she is committed to empowering men and women of all ages to overcome obstacles, face the fear of failure, and excel at whatever they are passionate about. 


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