The Wrong Objective Gets One The Wrong Outcome!

The financial press continues to focus on the wrong benchmark for DB plans.  Here is an example of what gets reported all the time: “Utah Retirement Systems returned 7.52% in calendar year 2014, surpassing its benchmark return by 151 basis points and meeting its actuarial assumed rate of return.”

What’s the issue? DB plans only have one true benchmark – their liabilities! A DB plan only exists to meet a promised benefit. In addition, the plan’s liabilities don’t grow at the return on asset (ROA) assumption. The liabilities grow or diminish in value with changes in interest rates.

2014 was a bad year for DB plans, as liability growth far outpaced asset growth.  Utah’s 7.52% may look good relative to some hybrid asset benchmark, but I suspect that the funded ratio and funded status once again deteriorated.

Let’s stop focusing exclusively on assets. If plan sponsors and their consultants had focused more on their specific liabilities, I believe that DB plans wouldn’t have had to rethink their benefit formulas or worse frozen and terminated plans at the rate that they have been.  The US economy cannot afford to have everyone’s retirement be dependent on accumulated balances in defined contribution plans.

Double DB® – Answers To Your Questions

Earlier this week we shared with you the virtues of Double DB® and encouraged you to reach out with any questions.  I am very pleased with the response that we’ve gotten.

As a reminder, a group of us have confronted two important pension issues: pension cost volatility and resultant perilous pension indebtedness due to prior underfunding (see Illinois, NJ, and a host of other plans).

We have developed an over-arching, patent pending answer to all of it – Double DB®, which;
(1) Provides pensions, not “employee accessible” cash.
(2) Is “percentage of payroll” financed.
(3) Easily “manages” debt from past underfunding.

Here are some of your questions.

Q: How do you manage debt from past underfunding of a traditional DB plan?

Have the plan actuary determine the percentage of payroll expected to finance the plan debt in 30 years based on the actuary’s estimate of the rate of growth in the underlying payroll and the estimate of the rate of growth of the debt. Plan to allocate this percentage of payroll to debt financing every year. If it turns out that more or less than 30 years is required, simply accept the longer or shorter term or adjust the allocated percentage of payroll along the way.

Q: How do you fund and manage Double DB®?

Have the actuary determine the percentage of payroll needed to finance future service benefits of the plan. Plan to pay this percentage of payroll in every future year. In the first year, plan to place one half into a trust fund identified as DB1 and the other half into a trust fund identified as DB2. In the second and each future year, place the then actuarial cost of half of the future service benefit cost into DB1 and the remainder into DB2. Accordingly, one half of the future costs of the plan will always be financed on an actuarially sound basis within DB1, while DB2 will have assets reflecting the extent that experience is more favorable or less favorable than expected at the outset.

Q: What benefit can the employee expect to receive?

In each year of retirement a pensioner will receive one half the scheduled plan benefit from DB1 and an experience modified variation of the scheduled plan benefit from DB2. If an entering plan participant would prefer to have a level benefit rather than the two-part benefit as described, he/she may elect an option to receive, say, 90% of DB1 benefits from DB2 and thereby receiving 95% of the benefit value to which he/she is entitled in retirement. Accordingly, the DB2 component of the plan will be provided a 10% “fee” for taking the risk of paying a larger benefit than the benefit to which the pensioner was entitled over the years of retirement. The 90% component can be more than 90% if the actuary for the plan is satisfied that a higher percentage is justified based on his/her appraisal of the risk.

We thank you for your continued interest.  Please don’t hesitate to bring additional questions to our attention.

Double DB® – The Answer to a DB Plan’s Funding Volatility and More

Level cost, as a percentage of payroll, is the preferred basis for financing any retirement plan obligation, which is why 401(k) type defined contribution systems have become the nation’s most prevalent retirement vehicle.

Aware of this development and concerned about pre-retirement spending of accumulating funds by participating employees (loans, premature withdrawals), a group of us have confronted the culprit issues: pension cost volatility and resultant perilous pension indebtedness due to prior underfunding (see Illinois, NJ, and a host of other plans).

We have developed an over-arching, patent pending answer to all of it – Double DB®, which;
(1) Provides pensions, not “employee accessible” cash.
(2) Is “percentage of payroll” financed.
(3) Easily “manages” debt from past underfunding.

While accomplishing the above tasks, Double DB also removes the individual from having to manage these retirement assets.

If you would like to have a conversation about how a conversion of a current defined benefit plan to a Double DB® plan might work, please ask and we can send illustrative language or provide contact with our attorney / actuary.

Finally, It may be of interest to note that Chief Counsel’s Office of IRS regards the Double DB® concept favorably.

Another Unintended Consequence?

Today, the Illinois Supreme Court struck down pension reform law as unconstitutional.  The December 2013 law was designed to lift retirement age, cap pensionable salaries, and reduce cost-of-living increases.  On the surface this will be viewed as a victory for the DB participants, but is it truly?  The law’s intent was to help municipalities manage more appropriately contributions into the system.  Through this appeal process “victory”, I fear that Illinois public systems will come under greater scrutiny, likely leading to more pressure to freeze or terminate DB plans for both existing and future employees.  Instead of helping to secure a longer life for DB plans, which we feel is an absolute necessity, this court action may be the death knell.

Any movement to reduce participation in DB plans, while forcing future employees into DC-like programs, will further exacerbate a retirement crisis that is quickly unfolding in the US. We’ve discussed at great length the pitfalls of an employee-lead retirement program, so we won’t cover that here, but would encourage you to go to the KCS website at to view the many articles in our Fireside Chat series.

Lastly, if a DB system is not likely to be sustained, we would encourage both plan sponsors and board trustees to explore the benefits of alternative DB-like structures (hybrids), including Double DB, a fixed-cost retirement plan design, before migrating your employees to a DC plan.  Asking an untrained employee to manage a very difficult assignment is just not fair, and the financial outcome will likely fall far short from what the participant would have experienced if they’d remained in a DB plan with a monthly annuity feature.

KCS May 2015 Fireside Chat – Do You Know The Answer?

We are pleased to share with you the latest edition of the KCS Fireside Chat series.

This article is the 34th in our series.  In this piece we explore whether or not the US Federal Reserve is likely to raise interest rates in the near-term – the $64,000 question.

The uncertainty surrounding this action continues to challenge DB plan asset allocation decisions.  Level to falling US rates will continue to harm DB plan funded ratios.

We hope that you find our insights thought provoking.  Please don’t hesitate to reach out to us with any comments and / or questions, or if we can be of any assistance to you.