Cash Balance Plans Need Different Administration Systems Than Traditional DB Plans

The characteristics of cash balance plans that are similar to defined contribution plans create a need for different technology than traditional defined benefit plans.

Cash balance plans are defined benefit (DB) plans, but are different than traditional DB plans in that they have characteristics of defined contribution (DC) plans.

For this reason, using traditional DB plan administration systems for cash balance plans can be complex and costly.

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Kravitz President Dan Kravitz, based in Los Angeles, says since 1984 when Bank of America implemented its cash balance plan, DB administration providers would take some programming from DC plans and overlay that with the DB plan system. Some plan sponsors developed their own systems. In addition, actuaries would do manual work in an Excel spreadsheet and input that into traditional DB plan systems.

“DB plan administration providers would do workarounds—we did for years—but that is not efficient,” Kravitz says.

Monica Gallagher, partner at October Three, who leads its defined benefit administration services practice and is based in Jacksonville, Florida, explains, “Pension administration systems built to handle traditional pension plans naturally focused on complex calculations. These pension benefit calculations generally involved looking back at years of data (e.g., 5 to 10 years of pay, complete service history from date of hire including any breaks in service etc.). Some complex formulas also involved items such as Social Security benefit offsets or coordination with Social Security Covered Compensation. As a result, many existing pension administration tools were built using robust mainframe systems. These traditional pension benefits were generally payable as an annuity at a future early or normal retirement date and the focus was on individual accrued benefits generally calculated once a year.”

Kevin Palm, retirement plan sales consultant with Kravitz and an enrolled actuary, based in Los Angeles, points out that this differs from cash balance plans. With traditional DB plans, the focus is on an annuity benefit and all other optional forms of distributions, including lump sums, come second; whereas with cash balance plans, the lump sum is presented first. “Cash balance plan software has to calculate a participant’s benefit similar to a DC plan style—opening balance, interest crediting rate, ending balance. An actuary calculates the distribution in the form of an annuity and joint and survivor benefit,” he says.

According to Kravitz, cash balance plan participants expect the same service and information from their pension plan as from a DC plan. “With a traditional DB plan, to find out the value of their benefit, participants call an 800 number and can get a statement,” he says. “The beauty of cash balance plans is they are much easier for participants to understand. Participants can go online to see their account balance. On the system we built participants can go online and see the value of their account daily, just like with a DC plan.”

Gallagher adds that while traditional DB plans are generally focused on an individual calculation at the time of a participant’s request or retirement, cash balance plans are focused on regular, recurring batch calculations for all pension plan participants. The focus is on a cash balance account that is updated frequently, at least monthly, and now that some cash balance plans are providing market returns, in lieu of a prescribed interest credit, they are being updated daily. “This level of transparency not only supports participant confidence but helps participants appreciate the value of their growing pension benefit,” she says.

Cash balance plan sponsors may also choose different plan designs. For example, Kravitz says when using market rate of return for the interest crediting rate, plan sponsors can apply different investments to different groups of participants—conservative investments for older participants and vice versa. He says this is based on rules finalized in 2014. Cash balance plans may also differ based on which interest crediting rate plan sponsors choose, and if they choose market rate of return, plans can differ based on how many and which investments are chosen.

When choosing an administration system, plan sponsors want to look for a firm that specializes in cash balance plans; for some companies, that is not their core focus, Kravitz says. In addition, some firms may offer only one cash balance plan design, and firms may not offer multiple investment solutions. According to Kravitz, a big thing to look for is that the firm has actuaries on staff; some outsource actuary work. Kravitz says larger and mid-size plan sponsors have a strong desire to use market rate of return as their interest crediting rate and that requires special expertise.

In addition, Gallagher says, web-based and mobile capability is extremely valuable for cash balance plans now, but not generally a priority for a traditional plan where the accrued benefit is only updated annually. Since cash balance plans allow lump-sum distributions, technology advances providing increased self-service are important.  “Participants want the ability to go online to start and complete their retirement, or their lump-sum benefit distribution, process. Avoiding snail mail on both the front end (i.e., initiating the process) as well as on the back end (i.e., uploading required documentation) saves time and allows participants faster access to their benefits/money,” she says.

According to Gallagher, newer web-based technology, rather than traditional mainframe systems, provide plan sponsors with these mobile and online capabilities as well as other technology enhancements, including better transparency for plan sponsors too, allowing increased oversight of outsourced administration. Additional plan sponsor enhancements include direct access to call recordings, cases/case management system, participant data and key dashboard information (e.g., status of retirements/benefit distributions in-flight).  “An added benefit for plan sponsors, is that new web-based technology is more cost-effective than legacy systems to both build and maintain and therefore, translates to lower ongoing pension administration costs,” Gallagher says.

Palm states that cash balance plans have some room to catch up to the DC plan website experience, and that will be the next wave of software improvement.

Future Regulation Holds the Key for Lifetime Income Options in DC Plans

The safe harbor provision in the Retirement Enhancement and Savings Act would safeguard plan sponsors from liability issues stemming from any losses from the insurer’s ability to meet financial obligations.

As 2018 comes to a close, the retirement industry offers lists of what plan sponsors and providers may expect as the new year rolls in. One, as the industry saw early in March, includes the bipartisan-supported, comprehensive yet widespread bill involving potential retirement reforms—otherwise known as the Retirement Enhancement and Savings Act (RESA).

While the bill contains many provisions regarding retirement plans, one aspect—the safe harbor provision—would add a fiduciary safe harbor to plan sponsors for the selection of lifetime income providers in retirement plans. Michael Kreps, principal at Groom Law Group, says the proposed provision answers concerns from employers about an insurance company’s inability to pay an annuity, while requiring plan sponsors to review considerations prior to offering the lifetime income options, in order to avoid fiduciary liability.

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“What they were concerned about was what they had to do with the insurer’s ability to pay,” he says. “They were worried that if they put annuities in a plan and then the insurer wouldn’t be able to pay many years later, the plan sponsor could be liable.”

According to Kreps, plan sponsors fear that if they offered in-plan annuities, but the insurer was not be able to complete the financial obligation, or pay for the annuity, they could be held liable for the outstanding annuity, and possibly sued by plan participants. While several pieces of guidance have been issued to avoid possibly unsafe annuity purchases, including a 2008 Department of Labor (DOL) safe harbor provision and a 2015 Field Assistance Bulletin (FAB), the 2018 proposed regulation is the only one that would safeguard plan sponsors from liability issues stemming from any losses from the insurer’s ability to meet financial obligations.

Major differences among these regulations include how plan sponsors can effectively vet financially stable insurance companies. The 2008 DOL provision required plan sponsors to conduct objective, thorough and analytical searches for select providers, consider engaging with experts to evaluate providers, and “appropriately conclude” that the insurer would be able to fulfill all future payments. This requires an extensive and at times meticulous process for plan sponsors—who may have little experience—to carry out successfully.

“The current guidance requires employers to conduct an exhaustive financial appraisal of annuity providers,” says Roberta Rafaloff, vice president of Institutional Income Annuities at MetLife. “An appraisal that most companies have neither the resources nor the expertise to perform.”

While the 2015 FAB recognized a majority of the 2008 DOL considerations—aside from an instruction requiring plan sponsors to understand the reasonableness of fees—the safe harbor provision of RESA differentiates itself by including protection for plan sponsors acting as liable fiduciaries.

Additionally, whereas RESA mandates plan sponsors to obtain several indications of an insurer’s financial good standing, including a report indicating the insurer is not under supervision by the state and has not been for the past seven years, the previous FAB stated that plan sponsors were “only responsible for relying on information about the insurer available at the time of the selection of the annuity.”

“With respect to the insurer’s ability to pay, [the safe harbor provision of RESA] also lays out a few things that plan sponsors need to consider,” adds Kreps. “This includes a written report from the insurer stating that the insurer is licensed to issue the contract and received audited financial statements in accordance with state law.”

Another feature of the provision measures a provider’s credit worthiness, to see whether the entity has completed financial obligations in the past, Kreps says.

Next: The future of safe harbors

An Employee Benefit Research Institute (EBRI) report found almost half (48%) of workers are either very or somewhat interested in annuities. However, a MetLife survey showed less than 10% of employers currently offer these solutions to their participants. Rafaloff credits this lack of enthusiasm to current DOL guidance, which limits protection for employers. 

“[It] creates barriers for businesses looking to offer retirement income options to their employees. Plan sponsors are looking for common sense guidance,” she says.

Employers believe the DOL should offer safe harbor provisions in order to expand lifetime income options to their plan participants. Rafaloff adds how in the MetLife study, 92% of DC plan sponsors agreed on the importance for the DOL to provide a workable safe harbor for annuity carrier selection criteria.

Moving forward, should RESA be applied in 2019 or in the future, the retirement industry can expect an uptick in annuity purchases, says Rafaloff.

“The legislation will help enhance employer-sponsored retirement plans by removing regulatory obstacles and expanding access to lifetime income solutions,” she says. “We believe the safe harbor provision in RESA will significantly advance the adoption and availability of annuities within DC plans.”

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