Administration July 17, 2017

There Is No Single 'Right' Measurement for DB Plan Funding

The purpose of the measurement determines which number is “right,” according to the American Academy of Actuaries.
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“A single number often cannot comprehensively address an issue as complex as the obligation or funded status of a pension plan,” the American Academy of Actuaries notes in an Issue Brief. 

The academy notes that news reports may indicate that a defined benefit (DB) retirement plan of a major local employer is underfunded by $50 million, while the employer’s leadership reported in an interview the previous week that the plan was in solid financial shape and consistent with its financial plan. Both could be telling the truth.

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“The primary reason why there is more than one right number [for reporting pension funding] is that different measurements of actuarial obligations can communicate very different information,” the paper says. “Settlement” measurements can include measurements designed to show how much it would cost a plan sponsor to transfer the responsibility of supporting a plan to an insurance company or other financial institution; the amount of assets that would be necessary to back the pension obligations with a dedicated portfolio of low-risk bonds with cash flows that are aligned with the projected pension benefit payments; or the price at which pension obligations would trade, should a market exist on which they could be bought and sold. A “budget” measurement could represent an estimate of how much money the plan would need to have in order for a projection to show that the assets are expected to be sufficient to cover projected benefit payments.

One difference between a budget measurement and a settlement calculation is that the budget approach includes an estimate of the future investment returns that the plan assets will earn, including any expected incremental return from investing in risky assets. The paper notes that for most diversified investment portfolios, such an estimate is inherently uncertain, and assumptions can vary among those making the calculation. “A settlement valuation relies only on financial information available in today’s financial markets,” the paper explains.

A plan that is 100% funded on a budget basis is subject to the risk that experience may be less favorable than anticipated, which could cause the plan to become underfunded in the future and may jeopardize the security of participant benefits. Being 100% funded on a settlement basis means that the actuary has concluded that a plan holds sufficient assets to transfer the responsibility for supporting the plan’s obligations to a third party. “This suggests that it is possible, and perhaps likely, that a lesser amount of assets would be sufficient to pay all benefits if the plan sponsor were willing and able to take on risk. Therefore, the sponsor of a plan that is 100% funded on a settlement basis may have contributed more to the plan than was actually needed to pay all participant benefits,” the brief says.

NEXT: The purpose of different measurements

Understanding the purpose of the measurement is a prerequisite for selecting the methodology or multiple methodologies most useful to satisfying that purpose, the academy points out. 

According to the paper, some of the key questions to consider include:

  • Can the plan sponsor afford the downside risk of increased cost if assumptions are not realized?
  • Do participants expect there is 100% certainty that their benefits will be paid?
  • Is it critical that there be no risk of an obligation being unmet?
  • Is it more important that scarce resources are allocated between competing priorities?
  • Is determining when resources will be allocated to a particular purpose most important?

For example, some DB plan sponsors may focus on guaranteed benefit security, while also taking into consideration expected cash flow needs, a desire for level expenditures, and the ability to liquidate assets. In some cases, the continuing viability of the entity sponsoring a pension plan might be a concern, so ensuring the solvency of the plan to pay all promised benefits may be paramount. In such a case, the measurement might use risk-free rates of return and the other conservative assumptions. 

Alternatively, for a sponsor that is economically healthy with strong growth prospects, creditworthiness and/or fluctuation in cash contributions to the plan may not be a significant concern. According to the paper, the measurements needed in these cases may focus on planning for how much will be contributed to the plan and for when those contributions will be made. Assumptions that reflect a higher level of risk may be acceptable within that context. 

Another example the academy gives is a situation in which investors are considering acquiring an enterprise that sponsors a pension plan. If they intend to terminate the plan, the measurement of the plan obligation that is most important is likely to be a settlement measurement that considers the cost of placing the pension obligation with a third party. If they will continue sponsoring the plan, then determining future contributions in a manner that reflects their anticipated investment strategy may be appropriate. 

Important points to note, according to the paper, are:

  • For many plans, multiple obligation measures must be calculated and used in different ways to assess plan funding levels;
  • Regulators do not always agree on the best measurement type for a given purpose; and
  • The type of measurement used for a given calculation can, and often does, change over time.
“Because there is more than one right number, an informed follower of pension issues would want to become familiar with the measures commonly used in each area,” the academy concludes.
Compliance July 17, 2017

ERISA Suit Challenging Voya Stable Value Funds Rejected

The lawsuit unsuccessfully alleged Voya does not disclose to its retirement plan clients and their respective participants the amount of stable value fund spread it collects.

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The U.S. District Court for the District of Connecticut has dismissed without prejudice a class-action Employee Retirement Income Security Act (ERISA) challenge filed by a participant on behalf of the Cedars-Sinai Medical Center 403(b) Retirement Plan.

Darlene Dezelan, the lead plaintiff, alleged in the suit that Voya Retirement Insurance and Annuity Company improperly profited from stable value funds offered to the plan through annuity contracts.

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According to the original complaint, Voya sells group annuity contracts to retirement plans which include what it labels and markets as stable value funds, referred to in the complaint as “SVAs.” The SVAs periodically credit a certain amount of interest income to retirement plans and the participants in such plans who invest their retirement plan accounts in SVAs. This income, generally expressed as a percentage of the invested capital, is determined pursuant to the “Crediting Rate.” The Crediting Rate varies in each Crediting Period, and Voya sets a Crediting Rate for all money in and added to its SVAs in that period.

The lawsuit alleged that Voya set the Crediting Rate “well below the internal rate of return (IRR) on the plan’s deposits to the SVAs, guaranteeing a substantial profit for itself through both the retention of the spread between the two rates and/or the use of the spread for its own purposes.” Further, the lawsuit suggested, “Voya does not disclose to its retirement plan clients and their respective participants the amount of the spread, so it collects hundreds of millions of dollars annually in undisclosed compensation.”

As laid out in the district court decision, important to the outcome of this case is that Ms. Dezelan “does not allege that she has withdrawn money from the Separate Account or receives annuities from Voya. Rather, her allegations concern the accumulation phase of her Plan’s Contract. She alleges that Voya breached its fiduciary duties to the Plan during this period, reducing the amount of Plan funds that would eventually be available for her to withdraw.”

The decision further clarifies: “Ms. Dezelan makes three claims against Voya. The essence of all three claims is that Voya unlawfully profited by setting the Crediting Rate for its stable value funds for its own benefit. First, Ms. Dezelan alleges that Voya violated Section 406(a)(1)(C) of ERISA, which provides that a fiduciary shall not cause a plan to engage in a transaction if it knows that the transaction constitutes direct or indirect furnishing of goods or services by a party in interest to a plan. … Second, she argues that Voya violated Section 406(b)(1) of the law, which prohibits a fiduciary from dealing with plan assets in his own interest or for his own account. … Finally, she argues that Voya breached the fiduciary duties it owed to the Plan, in violation of Section 404(a)(1).”

NEXT: Voya’s successful counter arguments 

Against these arguments, Voya countered that Ms. Dezelan’s claims concerning its general account stable value funds should be dismissed because she does not in fact have standing to bring the claims: “Ms. Dezelan lacks standing because Voya did not offer general account products to her Plan, and because she cannot bring this claim on behalf of purported class-members who did invest in these products … Voya also moves to dismiss Ms. Dezelan’s claims concerning the Separate Account product in which she invested, arguing that she fails to state a claim upon which relief may be granted.”

In short, the court agrees with Voya’s take. Here is how the broad strokes of the decision are explained: “Voya argues that Ms. Dezelan’s claims concerning its general account stable value funds should be dismissed because it did not offer any general account products in the Cedars Sinai Plan, and because Ms. Dezelan does not have standing to pursue claims concerning plans in which she did not participate. Ms. Dezelan responds that courts routinely certify classes, brought by plaintiffs who did not purchase every product encompassed within a class definition … Because she has standing to bring her own claims against Voya, Ms. Dezelan argues, she can represent class-members who purchased general account products, even if she herself did not. The Court agrees with Voya. Ms. Dezelan does not have standing to bring her claims concerning Voya’s general account products. She also does not have class standing to bring these claims on behalf of potential class members who invested in those products.”

The decision goes into significant detail regarding the court’s move to dismiss, highlighting the theme that to successfully bring an ERISA suit to trial, a plaintiff “must demonstrate both constitutional standing and a cause of action under ERISA.”

“To demonstrate constitutional standing,” the decision explains, “the plaintiff must have (1) suffered an injury-in-fact; (2) there must be a causal connection between the injury and the conduct at issue; and (3) the injury must be likely to be redressed by a favorable decision … Because Ms. Dezelan did not own any general account stable value funds, she cannot show that any of Voya’s alleged misdeeds concerning those funds caused her to suffer a distinct and palpable injury, and therefore lacks standing to bring all three causes of action to the extent that they relate to those products.”

The decision clarifies that Ms. Dezelan importantly “does not dispute Voya’s contention that it did not offer a general account stable value fund through the Cedars Sinai Plan. While her Complaint concerns hypothetical general account products, she does not allege that she was a participant, beneficiary or fiduciary of a general account stable value fund, and therefore does not have standing to bring claims concerning these products.”

The full text of the decision is available here. 

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