An interview with Patrick Baumann, CFA Treasurer from Harris Corporation - part of the Pension Plan De-Risking, North America 2017 report.
David Grana, Head of North American Media, Clear Path Analysis: What were the most notable provisions of the Pension Protection Act of 2006 (PPA)?
Patrick Baumann, CFA Treasurer, Harris Corporation: While the PPA had several meaningful provisions, the most notable were the creations of a safe harbor protection for using target dates as the QDIA (Qualified Default Investment Alternative), providing safe harbor protection when mapping funds and implementing automatic enrollment.
David: Do you feel like the higher premiums that the PPA required plan sponsors to pay to the Pension Benefits Guarantee Corporation (PBGC) was a motivator for plans to move towards de-risking and to a defined contributions model?
Patrick: Higher premiums could be a factor in the decision making. But I believe one of the main drivers to de-risk stems from plan sponsors’ desire to reduce funded status volatility by aligning the duration of plan assets more closely with the liability duration, diversify equity and increase the fixed income allocation with corporate and inflation-indexed funds. De-risking the plan is a strategy aimed to immunize the plan from the effects of interest rate changes on the funded status.
It seems more plan sponsors are moving toward a DC model vs a DB plan and that DC plans are beginning to incorporate many of the DB features. A DC plan structure is more flexible, portable and becoming a growing trend. This could be attributed to pension reforms combined with plan sponsors’ aim to incorporate DB features as a mean to retain as well as attract talent, in particular when a plan sponsor offers a generous company contribution match.
David: What do you feel are the biggest accomplishments of the PPA?
Patrick: The PPA brought improvement, clarity and cemented several funds as the Qualified Default Investment Alternative (QDIA) of choice. In particular, the target dated fund. The PPA also made features like auto-enrollment acceptable. This is a very useful tool to stimulate participants with low saving rates or inertia. Another feature that the PPA brought is protection for fund mapping. The fund mapping safe harbor is important, in particular, when plan sponsors want to transition fund assets or merge plans. Under the fund mapping provision, plan sponsors can re-enroll participants or allow new participants to make choices. If they don’t make an active decision, then those new assets under the old plan will be automatically mapped towards the QDIA, which in most cases is a life cycle fund.
David: Has qualified default investment alternative (QDIA) been working since its implementation? How would you grade its effectiveness?
Patrick: It has been very effective and I would give it a high mark. The PPA was a breath of fresh air. It gave guidance for plan sponsors to fight plan participants’ inertia. The PPA brought clarity to the plan sponsors to designate a default fund and obtain safe harbor protection. That is a step in the right direction. It also provided clarity for participants as to the type of vehicle a plan sponsor would default participants into, who opted not to make an active investment decision.
David: From a risk management perspective, do you feel that the provisions set forth for QDIA are favorable enough for plan sponsors to stay in the pension game?
Patrick: While the PPA enhanced the DC plans by providing explicit guidelines and safe harbor protection, many argue that the PPA weakened DB plans by making them more expensive and onerous to manage. A positive trend is that DC plans are becoming DB-like in a couple of ways. Target date funds are getting more sophisticated and there is a growing emphasis on income replacement. Plan sponsors should review the plans to form an opinion about industry best practices. The outside investment consultant and subject matter experts can assist with the review of the investment policy statement, fund structure and fee evaluation. I would recommend reviewing the QDIA regularly and undertaking a suitability analysis to test the appropriateness of the target date glide paths and level of diversification.
David: How do DB plans of yesteryear differ from DC plans of today?
Patrick: The main differences between DB plan and DC plans are in the investment decision making process and the retirement security component. In a DB plan, the plan sponsor promises to pay a specific amount of benefits in the future. That benefit represents an obligation of the plan sponsor to the plan participant. The plan sponsor is responsible for making contributions to the plan and ensuring they have enough assets to pay for the benefits. Whereas, in a DC structure, the contributions are made to the plan participants. The contributions/assets are invested per plan participants’ instructions. As DC plans are becoming the key vehicle to participants’ retirement, plan participants are tasked to make their own investment decision and understand if they can accumulate sufficient funds to last through retirement.
Plan sponsors should provide a robust, but easy to understand, fund line up with exposure to growth assets during the wealth accumulation stage and address the probability of plan participants outliving the assets post retirement. The plan fund line up should be diversified, with a mix of fixed income, equity products and perhaps inflation-hedging funds, along with broad investments across the risk spectrum.