The challenge: Reducing pension expense while helping employees save for retirement, and addressing pension administration concerns

A Connecticut-based nonprofit founded more than 100 years ago was concerned about maintaining its traditional defined benefit (DB) plans. The organization offered different plans to different types of participants, including management, collectively bargained employees, and sales force groups. Each plan used the traditional pension plan model, where benefits were based on final average salary and length of service.

The organization felt these existing DB plans were costly and that their benefits exceeded those provided by competitors. In addition, all benefits and related calculations were managed by an in-house expert who was approaching retirement. The nonprofit’s leaders worried about the workload impact on remaining staff after this individual’s departure.

Given these conditions, the organization wanted to explore potential changes to its retirement benefit offerings. However, leaders also were mindful of the need to balance the promises made to current employees with the desire to stabilize and reduce costs. A key factor in the organization’s favor was the ability to take a longer-term view of the situation without having to face pressure from shareholders, given its status as a nonprofit.

All told, the organization wanted to:

• Continue to provide meaningful lifetime income and highly competitive benefits
• Reduce the benefit cost impact of late-career salary increases
• Maintain current participants’ benefits to the extent possible
• Move to a program that was relatively simple in design and easily explained to participants

The organization turned to Milliman’s employee benefits experts for help.

The solution: A cash balance retirement plan for new staff members

Milliman began by performing a study that addressed the following topics:

• Competitor benchmarking. Benefits were compared to those provided by the organization’s main competitors.
• Program design. Various program designs were presented to the organization for consideration. These designs included modifications to the existing benefit formulas, the Milliman Sustainable Income Program (SIP), cash balance solutions, and defined contribution approaches.
• Participant relevance. A benefit replacement rate study was performed for participants with different combinations of age, service, and compensation.

One of the proposed plan designs was a DB cash balance plan, which defines the promised benefit in terms of a stated account balance, similar to what is provided in a 401(k) plan. In a cash balance plan, participants earn pay credits (such as 5% of annual compensation) and interest credits on any account balance. Cash balance plans have the following advantages:

• If a cash balance plan provides a fixed interest credit, the participants’ account balances will never decrease. This can provide a safe core benefit when combined with a 401(k) plan, which permits employees to take on more risk in their 401(k) plan if they so choose.
• The employees are able to accumulate benefits in a predictable manner, while the plan sponsor manages the asset allocation. A plan sponsor with a significant investment horizon can retain the market risk and weather market variances, which generally results in favorable long-term asset returns.
• Benefit communications are generally easier when compared to a traditional DB plan. Employees see a hypothetical account balance, which feels familiar—much like a 401(k) plan statement—yet the benefit retains the safety and security provided in a DB plan environment.
• Cash balance plans provide the ability to convert the account balance to an annuity. This can be a cost-effective solution for retirees who are looking for a steady source of income.
• Employer costs for cash balance plans are more predictable and manageable. In a cash balance plan, the cost of the plan is comparable to the pay credits provided in that year and can be less if the earnings on plan assets exceed the cost of the interest credits. This is quite different from a final average pay plan, where increases in current compensation can significantly increase the benefits for longer-service participants and cause plans to become quite expensive as the workforce ages, especially during periods of high inflation.

The outcome: Revised retirement program and modernized plan administration

In the end, the organization elected to change the retirement benefit program in the following ways:

• Current employees would continue to remain covered and earn benefits under their existing DB plan formulas.
• Employees hired after the program change date would earn cash balance benefits.
• The cash balance design would provide fixed interest credits.

The client decided that while costs were important, it was equally important not to backtrack on benefits that had already been offered to and accepted by the current employees. The revised benefit program permitted the organization to maintain the benefits for the current employees while also realizing cost savings over the long term. The organization appreciated the benefit simplicity and stability provided by the cash balance design.

The client also decided to move the plan administration work to Milliman. Milliman offers full-scale, cost-effective benefit administration services, with a web-based retirement platform that provides an interactive participant experience. These updated services were previously unavailable to plan participants and were well received. Milliman worked closely with the nonprofit’s benefits department during the transition period to the new program and was able to provide full administrative services for the plan before the key individual’s retirement.