Can variable income annuities help ease the anxiety defined-benefit plan participants are feeling about outliving their retirement savings?
What if plan sponsors could guarantee participants life-time retirement income without creating the volatile funding liabilities that have driven so many employers away from traditional defined-benefit plans?
One leading thinker in the retirement industry says it’s possible.
Donald Fuerst, a senior fellow at the American Academy of Actuaries, is the author of “Retirement Shares Plan: A new model for risk sharing,” a paper that suggests a way forward for funding defined benefits with variable annuities.
His is one of the many ideas that lawmakers and academics have offered lately to address what many see as inadequacies in a system that leaves employers exposed to income-statement ravaging liabilities and leaves benefits in question.
Of course, pension promises, and the investment risk and interest rate risk that makes funding those liabilities such a burden, were large motivators of the shift from defined-benefit to defined-contribution plans. Among other things, that move also shifted what’s known as longevity risk to employees.
In Fuerst’s way of thinking, by providing workers shares in variable annuities, defined-benefit plan sponsors could supply a monthly benefit, guaranteed for life, which would be indexed to the underlying investments in the annuities they own.
If those investments outperform benchmarks, participants get a benefit increase. If they underperform, it comes out of their accrued benefits.
Moreover, the investment liability that encouraged so many sponsors to terminate their defined-benefit plans is shifted to the participant, and would have “little or no effect” on a sponsor’s funding obligations under the RSP plan, Fuerst wrote.
That wouldn’t be anything new for 401(k) participants, who absorb investment risk as account values fluctuate with market returns, he notes.
They also suffer that mounting longevity risk, which isn’t getting any better in light of recent mortality tables suggesting the average baby boomers will live well into their 80s.
Fuerst’s proposal addresses that problem by providing a guaranteed benefit, albeit one that will vary with market performance.
Participants in an RSP would have some say in how investments are structured relative to individual risk tolerance.
According to Fuerst’s idea, two subaccounts would be established: a diversified account and a stable account. The former would involve riskier assets, the latter more predictable, fixed-income investments.
Fuerst provides an example of a worker making $50,000 a year and a sponsor who funds 1 percent of pay annually to the Retirement Shares Plan.
At the end of the year, the benefit is $500, which is converted to a number of shares based on that year’s value of the shares. If valued at $12.50, the participant gets 40 shares.
In the example, at retirement, the worker has accumulated 1,200 shares. The benefit would be calculated by multiplying the number of shares by the value of a single share. So, if that value were $16, the annual benefit would be $19,200.
Fuerst acknowledges the drawback of his plan is in the variability of benefits paid out. “Sponsors or individuals who highly value the certainty of a fixed benefit will not appreciate the volatility” of his plan, he wrote.
But the benefits, he says, are concrete. Participants get some guaranty of benefits in light of mounting longevity risk, while sponsors get a way to provide protection without carrying the investment and interest rate risk of a traditional defined benefit plan. Companies already offer RSPs, though their numbers are few. Unlike so many other reforms that have surfaced in the past couple of years, Fuerst’s won’t take an act of Congress.
Source: Benefits Pro