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Adjustable pension plans offer a defined benefit alternative

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A defined benefit pension plan design that reduces employer risk while assuring participants a guaranteed minimum lifetime benefit is attracting increased interest from certain business sectors.

Known as an adjustable pension plan, the design derives its name from the fact that the benefit earned by participants is based not just on employees’ compensation and years of service, but also on returns on investment of plan assets like in defined contribution plans.

Unlike defined contribution plans, though, participants do not decide how plan assets are invested. The plan assets, like defined benefit plans, are invested by the plan sponsor rather than participants.

Also, unlike defined contribution plans, adjustable pension plan participants receive at the very least a guaranteed so-called floor monthly retirement benefit set by a formula, such as years of service multiplied by a dollar amount. The actual benefit could be higher than the floor benefit, if the investment returns on plan assets exceed a set interest rate.

“Basically, the plan provides a guaranteed floor benefit, but the benefit can be higher depending on investment results,” said Gene Kalwarski, chief executive officer of benefit consulting firm Cheiron in McLean, Virginia. Cheiron has helped to design several adjustable pension plans, including one covering the newspaper guild-represented employees working at the New York Times.

By contrast, in defined contribution plans, the final benefit earned by a participant will depend on both how much money the employer and/or employees contribute during working years and investment results on a participant’s 401(k) account balance.

And another big difference between adjustable pension plans and 401(k) plans: In adjustable plans, participants at retirement receive a monthly benefit for life, rather than a lump-sum, as often is the case with 401(k) plans, which depending on the amount and investment results, could run out.

Experts say the most interest in the design is coming from public entities, such as state and local governments, and unions, whose members participate in multiemployer plans.

In those sectors, traditional defined benefit plans still dominate, but there is a growing recognition due to the unpredictable costs of those plans that it may be time to move to a new design that assures a minimum benefit to participants, but shares investment risk between participants and employers.

“The design is not going to sweep the pension world, but it could be the right answer in some situations,” said Bruce Cadenhead, a partner and chief retirement actuary with Mercer L.L.C. in New York.

“This can be a good compromise between going solely to a defined contribution plan and sticking with a traditional defined benefit plan,” said Jamie Knopping, a senior consultant with Towers Watson & Co. in Parsippany, New Jersey.

Still, there are challenges, especially communicating the design to workers associated with adjustable pension plans. Elements that have to be communicated include unit values, floor benefits and variable benefits.

“Communications can be a challenge,” Mercer’s Mr. Cadenhead said.