shared risk pension plans – a case study: saint john energy
TRANSCRIPT
Paul T. Lai Fatt, FSA, FCIA Marta Kelly, CA, MBA
Principal, Morneau Shepell VP Finance & Administration, Saint John Energy
September 19, 2013
Shared Risk Pension Plans – A Case Study
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Introduction
• The theme of this year’s conference is Powering the Future of Pension and Benefit Plans - You’ve heard a lot about Shared Risk Pension plans (or SRP’s) over the last year
or so and the concepts behind SRP’s may be representative of the future of pension plans
• While there has been plenty of talk about the SRP concept, legislation, mechanics and actuarial theory, we wanted to take a more practical approach
• Today we wanted to share the perspective and experience of a plan sponsor (and a plan member) through their SRP conversion journey - It is difficult to tell the story in 45 minutes or less, so we’ll try to tell the “short
version”
- Anyone who wants the “long version” can feel free to contact either of us
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Agenda
• History
• Process - What alternatives were considered and what were the considerations
when examining each?
- How was the SRP designed?
• Reaction
• Lessons for others
History
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History
• Saint John Energy’s (SJE) defined benefit pension plan was established on January 1, 1933
• Historically well funded - January 1, 1991: 103.5%
- January 1, 1994: 118.2%
- January 1, 1997: 131.8%
- January 1, 2000: 144.9%
- January 1, 2003: 108.1%
- January 1, 2006: 113.3%
• Benefit improvements made between 1994 and 2008 totaled about $13M
• Contribution holidays taken between 1994 and 2008, both employees and the employer combined, totaled about $13M
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History
• Then came 2008 - Very poor year in investment markets
- Bond rates (which drive solvency funding) at very low levels
• In the January 1, 2009 actuarial valuation the going concern funded level had dropped to 83% from 113% as at January 1, 2006
• Minimum employer contributions went from nothing (for the past 18 years) to 22.3% of payroll and employees began contributing again at the rate of 8.3% of payroll - Consider the impact on an employer if payroll costs unexpectedly
jumped 22.3% from one year to the next
- Consider the impact on an employee of an unexpected pay cut of 8.3%
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History
• While markets have been up and down since 2008, interest rates have continued to drop - Resulting in increased solvency funding requirements
• Preliminary valuation results as at January 1, 2013 revealed a solvency deficit requiring minimum employer contributions of 54% of payroll over 5 years - Compared to the 22.3% the employer had been paying for 4 years
- Plus employees were paying 8.3% of payroll into the plan
- Total employee and employer minimum contribution requirements were 62% of payroll
Process
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Process The problem
• There are many problems inherent in traditional DB pension plans - Rising costs - Benefit risk - Accounting volatility - Intergenerational inequity - Etc.
• For SJE, the main problem that needed a solution was unsustainable contribution requirements - 54% of payroll for 5 years, with a risk that they actually
increase
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Process Alternatives Considered
1. Status quo 2. Maintain DB but reduce benefits 3. Wind-up the DB plan and create a DC plan 4. Consider conversion to a Shared Risk Plan
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Process Alternatives Considered
1. Status quo - Considerations
› Employer contribution requirement of 54% of payroll for 5 years with continued risk that this actually increases
› Compared to 22.3% of payroll from 2009 – 2012 › The impact on SJE’s business would have been some
combination of: – Staff layoffs – Power rate increase – Deferred capital projects – Etc.
- Decision › The Board of SJE decided that this level of contribution was not
affordable and that, therefore, the status quo was not sustainable
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Process Alternatives Considered
2. Maintain DB but reduce benefits - Considerations
› Even if all future benefits eliminated minimum employer funding would be 40.5% of payroll for 5 years with a risk that it increases – Practically speaking, employer contributions were limited to the
range of 40.5% and 54% under a traditional DB plan
› Issue with intergenerational inequity in that active members pay much more for much less than their predecessors
› Still have all DB risks
- Decision › The Board of SJE decided that “tweaking” the DB plan would still
result in a prohibitively high contribution requirement while not being a real long term solution to general DB problems
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Process Alternatives Considered
3. Wind-up the DB plan and create a DC - Considerations
› Immediate wind-up deficiency contribution requirement of $14M (about 2 x payroll)
› HR concerns regarding DC – Benefit adequacy – Too much individual risk – Recruiting and retention compared to other public utilities
- Decision › The Board of SJE decided that the financial and HR costs made
this not a viable option
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Process Alternatives Considered
4. Consider conversion to a Shared Risk Plan - Considerations
› Board could set an employer contribution level they felt they could afford
› Contributions would forever be stable within a pre-defined range – Compared to their DB which had gone from 0% for 18 years to 54%
over a 4 year period
› Members would still continue to pool risk (unlike the DC alternative) – Pensions still based on salary / service – Monthly life pensions continue to protect members against
longevity risk
- Decision › The Board of SJE decided that conversion to SRP was the best
alternative available
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Process SRP Design Process
• SJE wanted to engage our employees in designing the new SRP
• The Board set the employer contribution level SJE was comfortable with as an employer - 9% permanent contribution - 8.5% temporary contribution for 15 years
› So 17.5% total compared to the current 22.3% and the required 54% if they did nothing
- Set the range of possible future changes at +/- 2%
• Then commissioned an employee working group to recommend an SRP design for this contribution level
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Process SRP Design Process
• Employee working group met over two months and made recommendations for: - Employee contribution rate - Benefit accrual rate - Retirement age - Disability benefits (if any) - Bridge benefits (if any) - Forms of pension, both normal and optional - Etc.
• Working group made their recommendations to the Board that were accepted and implemented
Reaction
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Reaction
• The process was very open and transparent - Open education sessions
› October 2012 discussing SRP’s and general DB pension issues
› Early April 2013 discussing Jan 1, 2013 valuation results and the Board’s decision making process
› Late May 2013 to disclose the newly designed SRP
- The employee working group gave each subset of plan members representation in the design process › Union
› Non-bargaining
› Retirees
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Reaction
• While reaction wasn’t explicitly positive, there wasn’t nearly the negative reaction that some other plan sponsors have seen - People felt they were engaged in the process and had
opportunities to ask questions and get involved
- People generally understood why change was needed and that the status quo was not sustainable › Status quo contribution requirements were unaffordable
› Can’t rely on taking investment risks to pay benefits
› Can’t expect to contribute for 30 years and collect for 35
- People generally understood that of the available alternatives, SRP was the best choice › Today’s reality was different than the reality of the mid-90’s
Lessons for others
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Lessons for others
• Understand the problem you’re trying to solve before you try to solve it - Cash contribution problem?
- Accounting volatility problem?
- Intergenerational inequity problem?
- Risk problem?
- Recruiting / retention problem?
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Lessons for others
• Be as open and transparent with stakeholders as possible - Communicate the problem(s)
› You have to make stakeholders understand there is a real problem that needs to be solved before they’re going to entertain a solution
- Clearly identify who gets to make the final decisions › Helps set clear expectations for “collaboration” versus “negotiation”
- Communicate the options for solving the problem(s) and the pros/cons of each
- When communicating the decision / solution clearly explain why the decision was made and what it means for each group of stakeholders (employees, retirees, etc.)
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Lessons for others
• Try to focus on real long term sustainable solutions - Address the problems of today while designing a solution that
hopefully avoids a repeat of those problems in the future
- Finding ways to reduce contributions (solvency funding extensions / exemptions, aggressive actuarial assumptions, etc.) for an unchanged benefit promise / structure just makes the benefit less secure › True long term cost of the pension plan remains unchanged
- Think about a funding policy and a flexible benefit design that will allow the plan to adapt to future events without having to “go back to the drawing board” each time
- Consider the interests of current, past and future plan members when designing a solution › Current legislation in most jurisdictions protects the past members at the
expense of current and future members
Questions and Discussion
Contact Paul T. Lai Fatt, FCIA Principal, Morneau Shepell [email protected] (902) 474-3236