Case Study

Risk has become a focal point in pension plan management in recent years. Plan sponsors’ obligations for retirement benefits have been affected by a number of risks. One of the primary risks, investment risk, was borne out by the 2008-2009 financial crisis and continues to play a role due to a slower than expected economic recovery. When investment risk is further considered together with longevity risk and other material financial risks, plan sponsors may certainly wonder what solutions are available to avoid fiscal uncertainty or distress. The State of Utah state legislative pension committee came to GRS with this very inquiry.

Historically, the state and participating employers of the cost sharing system were responsible for all of the cost and risk associated with financing the defined benefit pension liability. Due to the 2008-2009 financial crisis, the state and participating employers had clearly felt the fiscal pressure that resulted as unfunded actuarial accrued liabilities and contribution rates rose. The pension committee asked that we help them develop a more equitable risk sharing arrangement between the employer and employees. The solution that GRS helped them design was accepted by the employers, labor representatives, and employees.

The design for new employees involved a choice where the employee could elect to participate in a hybrid plan design (i.e. a retirement program providing a defined benefit and defined contribution feature) or a defined contribution plan. Under this design, the state and participating employers contribute a fixed 10% of pay to fund benefits, either to the hybrid or defined contribution plan.

The advantages of the innovative design are clearly demonstrated in the operation of the hybrid structure. Under this design, when the actuarially determined contribution rate for the defined benefit plan is less than 10%, the difference goes to the employees’ defined contribution account. Conversely, if the cost of the defined benefit plan is equal to or exceeds the employer’s fixed 10% of pay contribution rate, the contribution to the defined contribution plan is eliminated and employee contributions are required to finance the cost of the defined benefit plan in excess of 10%.

In this way, the employers and employees share in the risk and rewards of the pension plan. Employers are now able to limit their downside risk for new employees’ pension benefits. New employees will continue to have access to a guaranteed benefit, while also receiving an upside reward (increased contribution to their DC) when investment markets are performing particularly well.