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Insurer shows support for defined benefit plan

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HARTFORD, Conn.—Bucking a recent trend, a major life insurer and annuity provider is revamping its defined benefit pension plan rather than phasing it out.

Effective July 1, Hartford, Conn.-based Phoenix Cos. Inc. is converting its traditional final average pay plan to a pension equity plan, so named because the plans are designed to provide a relatively steady accrual of benefits.

Under Phoenix's plan, which Mercer Human Resource Consulting helped design, employees will receive annual credits that will increase with service. Employees will receive a 2% annual credit for the first four years of service, with the credit rising to 4% for each year from five to nine years of service and 6% for each year from 10 to 14 years of service. The annual credit will increase to 10% for between 15 and 19 years of service and 14% for 20 or more years of service.

To determine the benefit an employee is entitled to when he or she terminates employment or retires, the credits are added up and multiplied by the employee's final average pay, which is the average of the highest five consecutive years of annual total compensation out of the last 10 years of employment. The result would be payable as a lump sum benefit, which employees could take in cash or rollover into an individual retirement account, among other things.

The new design would apply to service starting on July 1 and cover all new employees and current employees under age 50 with less than 10 years of service. Employees age 50 and older with at least 10 years of service will have a one-time choice to remain in the current plan or move to the new plan.

Phoenix's shift to a new defined benefit plan design comes at a time when a growing number of employers, including such well-known names as Hewlett-Packard Co., IBM Corp. and Lockheed-Martin Corp., have decided to phase out their defined benefit plans in favor of enhanced 401(k) plans.

While Phoenix, which has about 1,500 employees, also is sweetening its 401(k) plan, it says defined benefit plans still have a role.

"We believe retirement income planning is a shared responsibility and chose the defined benefit plan approach as our way of continuing to offer a company-provided base benefit," a Phoenix spokeswoman said.

From the perspective of employees, the new retirement program gives them greater flexibility and control, the spokeswoman noted.

From a corporate perspective, the principal benefit of the new design is that it reduces the volatility of pension plan expense, the spokeswoman added.

Pension equity plans can, for several reasons, have less volatility and risk than traditional final average pay plans, pension actuaries say. One reason is that the overwhelming majority of employees take their benefit as a lump sum rather than as a lifetime annuity paid starting at retirement.

That means changes in interest rate assumptions, as well as asset investment results, will have less of a financial impact compared to a traditional plan of the same size because fewer beneficiaries will remain as participants after they leave the company.

"Effectively, you have a smaller plan," said Kevin Wagner, a senior consultant in the Atlanta office of Watson Wyatt Worldwide.

Additionally, because most pension equity plan participants take their benefits as a lump sum, the company does not face so-called longevity risk—the risk that retirees live longer than expected.

Pension equity plans emerged in the early 1990s as an alternative to cash balance and traditional final average pay plans. Employers adopting them said the plans, with their smooth benefit accruals, would be fairest to increasingly diverse workforces comprising a mix of short-service, midcareer hires and longer-service employees.

Still, while some major employers adopted the plans, pension equity plans never achieved the popularity of cash balance plans at least in part because their benefit formulas were not as easy for employees to understand, said Sheldon Gamzon, a principal with Pricewaterhouse-Coopers L.L.P. in New York.