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Pension plan designers seek middle ground

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Worried about employers' ongoing move away from defined benefit pension plans, benefit experts are working on a new design they say could recharge employer interest in offering the plans.

The design borrows elements from defined benefit and defined contribution plans. From defined benefit plans, the design would provide a guaranteed minimum pay-related amount.

Employers would decide the plan's design in allocating investment income to participants' account balances. For example, the interest credit could be based on the yield of a target date fund.

For that second component, the design would shift investment risk entirely to employees.

If, for example, the target date fund did poorly, employers would not be liable.

On the other hand, if a selected investment did well, the employee would receive the entire gain. No matter what, the employee's account balance would be at least the amount generated by pay-related credits.

Benefit experts say the new design is a middle ground between traditional defined benefit plans in which employers bear all the investment risk and defined contribution plans in which all investment risk is shifted to employees.

“It is a middle ground. It is a sharing of risk,” said Alan Glickstein, a senior retirement consultant in the Dallas office of Towers Watson & Co.

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If employers did not “have to shoulder all the investment risk, there is a much higher probability that they would” sponsor a defined benefit plan, said Richard Shea, a partner with Covington & Burling L.L.P. in Washington.

Experts say if that happens, employers and employees would benefit, noting some of the negative consequences as employers have shifted to offering only defined contribution plans.

For example, if employees invest poorly or not enough, the odds increase that they won't have earned a big enough benefit to retire at a normal retirement age. The problem is exacerbated if employees withdraw or borrow funds or simply do not contribute enough to the plans.

“That is the fundamental problem with defined contribution plans,” said Larry Sher, a partner in the Morristown, N.J., office of benefit consultant October Three L.L.C. “There is a lot of leakage.”

That can have serious workforce management issues for their employers. If employees stay longer because they lack sufficient retirement plan savings, that can block the advancement of younger employees.

“When you shift all the investment risk to employees, that can come back to haunt you,” Towers Watson's Mr. Glickstein said.

Conversely, the workforce management issue can work both ways, Mr. Glickstein said. When the economy is booming and defined contribution plan investment results are skyrocketing, employers may lose valued and needed employees to retirement just when they need them the most.

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For employees, having a minimum guaranteed benefit, as they would through the new plan design, would ease another problem associated with a defined contribution plan-only approach: the risk that they will outlive their account balance, said Jim McHale, a principal with PricewaterhouseCoopers L.L.P. in New York.

“Longevity risk is the risk employees can least likely bear,” Mr. McHale said.

At this early stage, it is impossible to gauge precisely the level of employer interest in a new defined benefit plan design.

Still, employers embraced the most recent redesign of a defined benefit plan—cash balance plans that emerged in the 1980s. In all, more 1,000 employers set up cash balance plans, typically converting existing final average pay plans to the new design.

The popularity of cash balance plans waned beginning around 2000 amid numerous lawsuits alleging the plan design was age discriminatory. Federal lawmakers later made clear that the plans were not age discriminatory. While such plans never regained their popularity, a few big employers, including The Coca-Cola Co. and Dow Chemical Co., have set up new plans in recent years.

The new plan design would require regulatory approval, and employers would not adopt the plans without such approval, Mr. Shea said.

“Employers would need regulatory clarity, and it would be nice if this approach could be allowed to develop before there is a retirement income crisis,” Mr. McHale said.