Common Retirement Plan Risks

There are many economic and non-economic risks inherent in retirement plans. All professionals involved with retirement plans look to measure, and to varying degrees, manage risk. No matter how carefully a plan is designed, there is inherent uncertainty associated with every benefit program that cannot be avoided. Below is an attempt to identify some of the risks involved in retirement plans and compare the various risks based on the type of plan involved.

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Abbreviations

DB = Defined Benefit
DC = Defined Contribution
VB = Variable Benefit
PBGC = Pension Benefit Guaranty Corporation
QLAC = Qualified Longevity Annuity Contract
ERISA = Employee Retirement Income Security Act
PBRB = Pilot Benefit Review Board
FASB = Financial Accounting Standards Board
IRC = Internal Revenue Code
FDX DB
(Current DB)
Variable Benefit Plan DC
Interest Rate Risk
A low interest rate environment may dampen the overall investment return on plan assets. Low interest rates can also affect actuarial assumptions, like those used to determine the actuarial value of vested benefits and total plan liability. Changes in interest rates lead to changes in plan liability. When interest rates go down, plan liability goes up and when interest rates go up, plan liability goes down. Plan liability in excess of plan assets is reflected on the corporate balance sheet as unfunded liability.
The risk of interest rate fluctuation is assumed by FDX during a participant's active employment years, as well as during retirement. The risk of interest rate volatility could be borne by either FDX or the participants, depending on the VB plan design. If there is a floor benefit, some interest rate risk stays with FDX. If there is no floor benefit and the benefit is fully variable, interest rate risk is shared by FDX and participants. Implementing a stabilization reserve tempers interest rate risk and the plan's investment policy could further reduce interest rate risk due to asset-liability matching investment strategies. The risk of interest rate fluctuation is assumed by participants both pre-retirement and post-retirement, though the positive or negative impact of interest rate changes greatly depends on the asset classes the individual participant is invested in.
Inflation Risk
Increases in the cost of living before and after retirement can erode the purchasing power of a fixed defined benefit payment.
Inflation risk is assumed by participants both pre-retirement and post-retirement. The risk of inflation both pre-retirement and post-retirement depends on market returns on the VB plan investments and on participant pay raises, when compared to inflation. The VB plan offers some protection, as it has the opportunity to keep pace (up or down) with inflation as a function of investment returns. The inflation risk both pre-retirement and post- retirement depends on the market return of an individual participant's investment. The effect of inflation on a DC account means that participants have to withdraw larger amounts to maintain a level standard of living, thus increasing the likelihood that they will outlive their account balances.
Investment Risk
This is the impact of fluctuating or less-than-expected investment returns in a plan. This risk can be mitigated, though not eliminated, via professional investment management. This is standard in all DB plans listed below and is available in the DC plan through many avenues.
The risk of investment loss falls solely to FDX, which could result in unpredictable contribution rates. This could secondarily impact participants through negotiated wages and benefit packages through the establishment of benefit levels. The risk of investment loss and the reward of investment gain in a VB plan falls to the participants, both pre-retirement and post-retirement (unless the participant elects the level benefit). Lower than expected investment returns could cause a VB plan to become underfunded, causing benefits to decrease. Higher than expected investment returns could cause a VB plan to become overfunded, causing benefits to increase. Since benefits of active participants and retired participants increase/decrease in the same manner, there is no active-to-retiree subsidy or support. The risk of investment loss and the reward of investment gain in a DC plan falls to the participants, both pre-retirement and post-retirement (unless the participant purchases an insurance annuity).
Longevity Risk
This is the possibility that retirees will live longer than projected by mortality and life expectancy tables may impact the funding liability of a pension plan. From a plan funding perspective, increases in life expectancy tables could cause any type of DB plan to become underfunded. Decreases in life expectancy tables could cause any type of DB plan to become overfunded.
Longevity risk falls to FDX, but is mitigated by the pooling or sharing of longevity risk. As long as gains in life expectancy are foreseeable and they are taken into account when determining pension funding, there should be negligible impact on pension plan liability. This means that retirees can count on income in retirement no matter how long they live. Longevity risk falls to FDX, but is mitigated by pooling or sharing longevity risk. As long as gains in life expectancy are foreseeable and they are taken into account when determining pension funding, there should be negligible impact on pension plan liability. Plans could adjust due to adverse experience, by increasing funding, but this would require negotiations. The participants bear longevity risk in a DC plan, because the risk is not shared, thus running the risk of outliving their funds in the DC plan. This risk can be mitigated by using DC monies to purchase an annuity (immediate, deferred, QLAC).
Employment Risk
This is the risk to a participant's retirement benefit when the participant experience a termination of employment prior to the planned retirement date.
A participant's vested and accrued benefits are protected, but there are no future benefit accruals after separation from employment. The benefit accrual is fixed as of the date of separation from employment. A participant's vested and accrued benefit in a VB plan remains subject to market returns. But there are no future benefit accruals after separation from employment. A participant's vested and accrued benefit is protected, subject to market return on investments. But there are no future benefit accruals after separation from employment.
Bankruptcy Risk
This is the risk that a plan may be terminated or frozen due to corporate bankruptcy. In the event a plan does not have enough money to pay all benefits owed participants, a bankruptcy court judge may direct that it be terminated in a distress or involuntary termination if it meets certain conditions, such as the company cannot continue unless the plan is terminated.
Regardless of the type of termination, future benefit accruals cease. The PBGC guarantees a certain benefit amount and protects benefits above the guarantee to the extent they are funded. However, protections differ depending on age (pilots age 58 and higher have senior claim to plan assets before the rest of the pilots). Due to the VB plan’s self-correcting nature, the possibility of underfunding is reduced. Regardless of the type of termination, future benefit accruals cease. The PBGC guarantees a certain benefit amount and protects benefits above the guarantee to the extent they are funded. Like a traditional DB plan, PBGC protections differ depending on age (pilots age 58 and higher have senior claim to plan assets before the rest of the pilots). A corporate bankruptcy or plan termination would only put future employer contributions to a DC plan at risk. In the event of a plan termination or freeze, accrued benefits are protected.
Fiduciary liability Risk
This is the risk that a trustee or plan fiduciary does not perform their duties as required by federal law (ERISA), or act in the plan participant's best interest. The FDX CBA provides for a joint Pilot Benefit Review Board (PBRB) to hear claims under the FDX DB and DC plans and a joint Retirement Board that reviews the status and administration of the plans to mitigate this risk to all plans.
There is a possible fiduciary liability risk, but the CBA requires FDX to provide ALPA with periodic actuarial valuation reports, financial reports, fee disclosures, annual funding notice, and other information so that ALPA may monitor the plan and its fiduciaries. It may be possible to negotiate increased fiduciary and plan transparency (member on board, ALPA third-party actuarial and financial review, etc.) to mitigate this risk. In addition to the PBRB, a joint Investment Committee makes recommendations to the plan fiduciary regarding investment choices.
Laws, Regulations, and Accounting (FASB) Risks
Laws and regulations, as well as the FASB accounting rules, can have an impact on plan contributions, administration, accounting costs, and benefits for retirement plans. Any of these may require a reevaluation of plan design and plan costs.
There is a potential risk due to future adverse accounting practices or cash funding rules. There is a potential risk due to future adverse accounting practices or cash funding rules. The Flat Dollar formula will mitigate the risk of a lower benefit due to the IRC 401(a)(17) compensation limit. The IRC 415(c) contribution limit may restrict the amount a participant and employer can contribute to a pilot’s account. The IRC 401(a)(17) compensation limit may also restrict the amount of contributions to a DC plan. There is a risk that both of these limits may be lowered by Congressional action.