An international banking firm sponsored a defined benefit plan (DBP) for the pensions of its employees working in branches in the United States. The covered population included several expatriates and other highly compensated employees. The bank wanted to continue offering a competitive DBP but believed that it could not sustain a plan with contribution amounts that were both volatile and steadily rising. The retirement committee contacted Milliman for plan design alternatives that would allow the employer to continue to offer a competitive level of benefits.
Identifying cost increases and volatility
Milliman consultants analyzed the features of the employer’s current plan with its objectives. The employer wanted the retirement program to reward longer service employees and provide stable retirement income at a target level. Consequently, we did not consider a change from the defined benefit to a defined contribution plan design. Instead, Milliman focused on identifying specific sources of cost increases and volatility.
Cost-control measures that sustain benefits
The Milliman team observed that the plan used a total-pay definition resulting in a pensionable pay amount that could swing wildly because of year-end bonuses, which created contribution volatility. Much of the covered population was highly paid and the fact that Internal Revenue Code (IRC) funding rules do not allow advance recognition of expected increases in the maximum compensation limit resulted in additional annual contributions as the limit was indexed. Therefore, we considered design options that would limit portions of compensation to address employer concerns while still providing a meaningful benefit.
Twofold strategy: modify pay definition and freeze pay cap
The plan design strategy took two directions:
- It modified the definition of pensionable pay to recognize base compensation and limited bonus amounts; and,
- It froze the plan’s pensionable pay cap at the current IRC statutory limit.
Although these changes would limit overall benefits for the highly paid, they would allow the plan to remain competitive and reduce contribution volatility.
The employer agreed with the Milliman strategy and considered it a favorable compromise compared with the other option of completely excluding bonuses from the plan’s pay definition. With the pay cap frozen, the employer could avoid additional layers of past-service liability adding to the minimum required contribution each year. At any time in the future, the employer could choose to recognize a higher pay limit to maintain its competitive edge, when it considered the raise prudent and affordable.
Benefits stabilized but still competitive
The plan redesign made plan contribution requirements more predictable and stable, and it equipped the employer with the cost-control measure it was looking for, thereby allowing it to sustain the plan. The option of raising the plan’s frozen pay limit to a higher level in the future, as IRC pay limits continue to rise, allows the employer to control the timing of increases to ensure a competitive level of benefits.
