Study: There’s a Better Way to Withstand Downturns than Old DB Model

Under new set-up, a plan is over-funded, which serves as a cushion in a downturn.  Any benefit cuts are only as a last resort.

Pensions would have fared better during the financial crisis of 2008 and the COVID-19 pandemic market downturn if they had been allowed to use a proposed flexible system called a composite retirement plan, according to a study issued by several construction and contractors associations.

That’s as opposed to a traditional defined benefit multiemployer plan, where benefit levels are locked in. Many multiemployer plans today are underfunded. Under the composite variety, the plan first becomes overfunded early on. And if a recession or some other calamity hits, this cushion—20% over what’s needed—see it through and avoids brutal benefit reduction. As a last resort, if things get even worse, the plan has the ability to trim benefits.

Composite plans are a proposed new type of multiemployer retirement plan that has not yet been authorized for use in the US. They are “a voluntary approach with built-in guardrails to keep plans on track,” Josh Shapiro, the white paper’s author and a senior actuarial advisor with Washington, DC-based Groom Law Group, said in a release. The firm wrote a report based on the group’s findings.

The concept of the composite plans is relatively simple and has two main features that differ from defined benefit plans. The first is an asset cushion created when establishing benefit and contribution levels intended to protect against market downturns.

This would require plan contributions to be calibrated to reach a funding level of 120% instead of the 100% traditional plans aim for. And the second is to allow trustees to make benefits cuts before the situation gets out of control, but only as a last resort.

“While reducing past benefits is never easy,” said the report, “taking this step at the first sign of a long-term imbalance will prevent plans from ever facing the dire funding crisis that currently plagues the multiemployer pension system.”

As many as 117 multiemployer pension plans covering 1.4 million participants are underfunded by $56.5 billion, and could become insolvent within the next 20 years, according to actuarial consulting firm Cheiron.

The report includes a case study intended to evaluate how a composite plan would have performed during the financial crisis of 2008 compared with a traditional pension plan.

“Our case study illustrates how the key composite plan features can provide greater long-term benefit security than current pension plans,” said Shapiro.

The hypothetical case study focuses on a defined-benefit pension plan that was 75% funded immediately prior to the 2008 market crash. The plan assets are assumed to have declined by approximately 26% from the 2008 market crash, and the plan also experienced an immediate 10% reduction in its level of covered work.

The case study assumes that following the 2008 downturn, the trustees of the plan took several actions to improve funding levels, include cutting the rate of benefit accrual earned by active participants by 40%, and scaling back early retirement subsidies applicable to non-retired participants, which resulted in a 5% reduction in overall plan liabilities.

Additionally, a series of mandatory contribution rate increases were implemented that resulted in 4.5% annual increases in rates for 2009 through 2012, 3.5% annual increases for 2013 through 2016, and 2.5% annual increases after that.

Despite the steps taken, the study says the funding level of the plan would have continued to trend downward, and even the generally favorable investment returns that occurred between 2009 and 2020 would not have been sufficient to stabilize the plan, which would have entered critical and declining status due to its projected insolvency.

However, if the plan had been subject to the 20% funding cushion that applies to composite plans at the beginning of 2008, its assets would have been 15% higher than they were under the current funding rules. However, even with the additional 15% of assets held by the plan, these measures would have been insufficient to return the plan to financial health. The case study therefore also assumes that the trustees would have reduced accrued benefits by implementing an across-the-board benefit reduction of 5%. The benefits could be restored later if the plan recovers sufficiently.

According to the case study, the higher funding target and ability of the trustees to proactively reduce benefit levels would have produced a 2020 funded ratio of 84%, opposed to a 48% funded ratio in the baseline scenario. The baseline traditional pension plan was projected to fully exhaust its assets in less than 15 years following the 2020 plan year, while the composite plan was projected to be fully funded over a 10-year timeframe. 

Additionally, the baseline traditional pension plan would have needed to cut benefits by more than 40% in 2020 to be in approximately the same funded position as the composite plan.

“By providing employers with the cost predictability they need to be successful in their businesses,” said the study, “composite plans will achieve greater long-term employer participation than traditional pension plans.”

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