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WHITE PAPER
THE FUTURE OF DEFINED BENEFIT PLANS WILL CHANGE
DRAMATICALLY — FOR THE BETTER
EXECUTIVE SUMMARY
The last 10-15 years have been difficult for employers who have maintained a Defined Benefit plan as
part of their overall retirement program. This is all about to change. The factors and economics that
caused significant increases in required contributions to Defined Benefit plans are showing signs of
slowing down and reversing themselves. The impact of the Pension Protection Act of 2006 (PPA) is
behind us, as the provisions of this law have been fully phased in. Historically low interest rates, which
cause plan liabilities to increase every time they drop, appear to have nearly hit bottom and are
poised to begin rising as soon as the Federal Reserve suspends the accommodative support of
growth through an expansionary monetary policy. Other underlying macroeconomic trends such as
the 30-year bull market in bonds, the decade-long stagnation in the equity markets and the lack of
viable options to extend duration for pension investment managers, all exhibit signs of changing
for the better.
WHAT DOES ALL THIS MEAN? IT MEANS THE FUTURE OF DEFINED BENEFIT PLANS IS BRIGHT; AND LOWER,
MORE STABLE FUNDING REQUIREMENTS ARE AHEAD.
Most Defined Benefit plan sponsors have struggled with the costs of maintaining these plans for
several years.
Various actions have been taken by employers to reduce and control the cost
increases. These actions included reducing benefits, “soft freezes” and “hard freezes.”
But these
trends are slowing down, and recently we had a client elect to “unfreeze” its plan and begin
enrolling new employees.
WHY? BECAUSE EMPLOYERS ARE BEGINNING TO REALIZE THAT THERE IS NO BETTER TOOL TO ATTRACT
AND RETAIN EMPLOYEES AND PREPARE THEM FOR RETIREMENT THAN THE DEFINED BENEFIT PLAN.
The financial crisis that began in 2008 caused sponsors of retirement programs to begin to rethink their
strategies. It became clear that relying solely on defined contribution plans like 401(k) plans provided
inadequate retirement benefits and resulted in participants being unprepared for their retirement
years. In addition, terminating the Defined Benefit plan at this time was, and still is, analogous to
selling out of the market after a major downturn. What we have all needed was a change in the
influences impacting employer costs and those changes are underway.
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Even Congress recognizes the importance of Defined Benefit plans as a recent bill passed by
Congress will permit plans to use a higher liability interest rate in determining Minimum Required
Contributions, thus lowering employer contributions. See below for a further discussion of this newly
enacted legislation.
At Pentegra, it is our responsibility to help clients make educated and informed decisions.
Understanding what has driven Defined Benefit plan costs to the historically high levels is paramount
in making those decisions.
The economic conditions over the last 10-15 years have been the
principal driving force behind the cost increases.
We firmly believe the Defined Benefit plan
economics are shifting and will afford employers the opportunity for lower funding costs, thereby
positioning Defined Benefit plans to once again become one of the most cost effective methods of
providing adequate retirement income to your employees.
We encourage you to take the time to read this white paper and, more importantly, let our expertise
and experience help you address both the concerns of your management and your Board of
Directors. The remainder of this paper provides further insights as to why we believe conditions are
changing for the better for Defined Benefit plans, why these types of plans are so vital for the future
retirement of your employees, and how different types of Defined Benefit plan structures assist
employers in meeting their retirement goals.
WHY DEFINED BENEFIT PLAN COSTS WILL BE LOWER IN THE FUTURE
Over the last 10-15 years, employers have found it increasingly difficult to provide their employees
with pension benefits as costs have risen to levels that many find difficult, if not impossible, to
adequately fund. Controlling these costs has taken many forms, including reductions in benefits, both
‘soft’ and ‘hard’ freezes on plan participation, and plan terminations. Although employer responses
to this crisis have received much press, far less attention has been paid to some of the most important
underlying macroeconomic trends that drove costs higher in the first place.
These include:

A 30-year bull market in bonds, driving the discount rate lower and pension liabilities higher, and
rapidly increasing the present value of future benefits

A lack of viable options to extend duration for pension investment managers for most of the
period

A decade-long stagnation in equity market returns

Bond and Equity market correlations that increase the volatility of the funding ratio rather than
mitigate it
We believe each of these secular trends may be coming to an end, and that to the extent they
reverse, or revert to a long-term median level, funding costs for Defined Benefit pension plans should
fall over the coming years.
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The most obvious reason for increases in long-term pension liability costs is the tremendous decrease
in the value of the discount rate used to value plan liabilities. As illustrated in the graph below, the
yield on long-term US Treasury bonds has fallen steadily for some 30 years, from a high in excess of
14% in 1982 to a low of 3% in the last few months. Note as well that the trend has been remarkably
consistent; rates in 1990 hovered around 8%, moving to 6% in 2000, and finally falling below 4% during
the financial crisis of 2008.
As an example, a 30-year liability of $100 discounted at 14% semi-annually results in a present value of
only $1.72 today. If the discount rate is decreased to 8%, the prevailing 1990 rate, then the present
value of the $100 liability rises to $9.51. In other words, a 43% decrease in the discount rate creates a
553% increase in the value of the liability—and subsequently in the cost to the employer of providing
that $100 benefit.
What is the impact on pension plan liabilities if discount rates increase? Consider this- for every 100
basis points increase in discount rates, plan liabilities are reduced by 12-14%, while Target Normal Cost
(TNC) is reduced by 14-16%. For a plan with $10M in liabilities and a TNC of $500K, rates moving from
5.5% to 6.5% will reduce liabilities by $1.2-1.4M and TNC will decrease by $70-80K. Amortizing the
liability reduction over 7 years, as required by PPA, will result in an additional annual decrease in the
employer’s Minimum Required Contribution of $190-220k.
The table below illustrates these cost
savings at various increases in interest rates.
Discount Rate
Liabilities
Reduced
Reduced Target
Total Reduced
Amortization
Normal Cost
Employer Contribution
1% Increase
$8.7M
$200K
$75K
$275K
2% increase
$7.4M
$400K
$150K
$550K
3% Increase
$6.1M
$600K
$225K
$825K
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COMPARING DEFINED BENEFIT (DB) AND DEFINED CONTRIBUTION (DC) PLAN COSTS
In the current economic environment there appears to be a clear cost advantage to maintaining the
typical DC plan compared to the typical DB plan. Based on our cost data, our typical DC plan cost is
5-6% of plan payroll versus 17% for the typical DB plan. Keep in mind however; the typical DB plan is
providing greater retirement benefits to participants. But what happens if interest rates change? The
table below illustrates the impact of changing interest rates on Funding Targets, Target Normal Cost
and Funding Ratios.
Interest Rate
Impact on Funding
Target (Liability)
Impact on Target
Normal Cost
Funded Ratio
(if 80% at 5.89%)
Target Normal Cost
as Percent of Pay
+14%
+18%
70%
21%
0%
0%
80%
17%
6.89% (+1%)
-12%
-14%
91%
15%
7.89% (+2%)
-21%
-26%
101%
13%
9.89% (+4%)
-36%
-44%
125%
10%
11.89% (+6%)
-47%
-56%
151%
8%
4.89% (-1%)
5.89% (current)
We examined the impact of interest rate changes on the DB pension liabilities, employer contributions
(Normal Cost) and Funded Ratios. No material changes in markets were assumed. The results were
eye-opening:

A 100 basis point increase in interest rates decreases liabilities by 12% and increases Funded
Ratios by 11%

A 200 basis point change takes a plan with a Funded Ratio of 80% to 100% fully funded

This same 200 basis point change also reduces the employer’s Normal Cost by 26%

In a rising interest rate environment the DB plan becomes more cost effective very quickly

Funded Ratios exceeding 100% create a surplus which is used by the employer to reduce its
out-of-pocket plan contribution and may even reduce employer contributions to zero (a
common occurrence in the late 1980s and 1990s).

Factor in improved market conditions and investment returns, DB plans become even more
cost effective in a shorter amount of time
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AT WHAT POINT DOES A DB PLAN BECOME MORE COST-EFFECTIVE THAN A DC PLAN?
As it turns out, the answer is very quickly assuming interest rates rise 200 basis points and market
conditions improve. Recall that one of the major differences between a DB and a DC plan lies in the
ownership of risk.
In DC plans, investment risk and underfunding risk have been off-loaded to
employees. In a DB plan, the plan sponsor or employer owns the risk – that is, the employer ‘owns’ (at
least economically) the surplus or the deficit in plan assets over plan liabilities. Today, most DB plans
are underfunded due to the factors outlined in this paper, and employers who keep these plans must
make up the deficits. However, in the cases above where rates rise and the funded ratios exceed
100%, employers will be able to use plan surpluses to fund the annual Target Normal Cost (calculated
in the far right column). Rising rates mean deficits turn into surpluses for DB plans, surpluses that
employers will economically own.
As can be seen in the chart above, interest rate increases of 300 to 400 basis points (roughly
equivalent to rates that prevailed in 2006-2007) would put the typical plan in a surplus of 115% to 125%
of liabilities. At that point, plan sponsors would have reduced their normalized costs by 30% or more
and would be able to use excess plan assets to fund these costs for several years – eliminating
required contributions for the plan sponsor, and making the DB plan far cheaper than a DC plan
where costs are locked in. To the extent that investment returns also return to a more ‘normalized’
long-term level, the crossover to cheaper-to-offer DB plans would occur even sooner.
The National Institute on Retirement Security released a paper titled, “A Better Bang for the Buck,”
which further discusses the economic efficiencies of DB plans. The entire article can be viewed by
clicking here.
A lost decade of sub-par equity market returns and a historic 30-year bull market in bonds, driven by
steadily declining interest rates, have conspired to produce a perfect storm of cost increases for
Defined Benefit pension plans. There is strong evidence that both of these secular trends have nearly
run their course.
Interest rates might already be rising if not for the Fed’s accommodative monetary policy. To the
extent this policy remains in effect into 2014, it is likely that interest rates will not rise materially.
Nevertheless there is very little room for further interest rate declines and the downside risk of larger
funding obligations due to falling interest rates is largely capped.
To the extent that plan sponsors believe that interest rates will rise (or at least stop falling) and that
equity markets are poised to at least begin making some headway after more than a decade of 0%
real returns, it stands to reason that the costs of Defined Benefit plans will decrease. The challenges
that plan sponsors have faced for the last decade are subsiding and a return to normalcy would
make Defined Benefit plans one of the most cost effective and attractive employee benefits. For a
further explanation on the anticipated economic impact on Defined Benefit plans, please refer to our
white paper, “Headwinds No More.”
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FUNDING RELIEF
As indicated above, Congress passed new legislation which President Obama signed on July 6, 2012,
providing pension funding relief. The new law titled Moving Ahead for Progress in the 21st Century
(MAP-21) significantly increases both liability interest rates and PBGC premiums.
Recognizing that historically low interest rates have caused dramatic increases in the value of
pension plan liabilities and minimum required contributions, the new law provides funding relief in the
form of interest rate stabilization. The primary impact of the new legislation is summarized below:
1.
Effective interest rates are projected to increase by 140-170 basis points
2.
The 24 month segment rates are replaced by a 25 year average
3.
The value of plan liabilities is estimated to decrease by 15-20%
4.
Minimum Required Contributions are estimated to decrease by 15-25% or more
5.
Funded ratios will increase
6.
The new rates are optional for 2012, mandated for 2013 and beyond
Pension funding relief and interest rate stabilization are good news for defined benefit plan sponsors.
For the next several years they provide reduced plan liability values and lower contribution
requirements. More importantly, they provide additional time for the Federal Reserve to allow rates to
rise and further favorably impact funding requirements. Despite lower required contributions as a
result of the new law, some employers may want to consider contributing more than the new
minimum. The new law does not change the ultimate cost of a plan which is equal to the benefits
paid plus administrative expenses less investment earnings. Paying less now in accordance with the
new interest rates could mean paying more later. Employers should carefully consider what course of
action is in their best interests.
WHY DEFINED BENEFIT PLANS REMAIN THE MOST EFFECTIVE WAY TO PROVIDE
RETIREMENT BENEFITS FOR YOUR EMPLOYEES
The dilemma: Millions of workers today may not have enough money to sustain themselves during
their retirement years. Studies continue to show that even with 401(k) plans and Social Security, many
Americans will not have enough retirement income to meet reasonable lifestyle goals. The causes are
multiple—longer lifespans, fewer/lower pension benefits, reliance on defined contribution plans and
volatile markets. Add the threat to our Social Security program and the future retirement of our aging
population looks bleak. Experts feel we will need 70-90% of our preretirement income to maintain our
lifestyles in retirement. The question: Who is going to pay for this shortfall?
Defined contribution plans, such as the 401(k) plan, were never intended or designed to replace the
Defined Benefit plan—they were meant to complement it. 401(k) plans permit access to funds while
employed and experience shows that many employees draw on these plans to pay for college
education, medical expenses and even home ownership. Couple these limitations with the fact that
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401(k) plans place all the investment risk on the employees. We have asked today’s employees to
not only shoulder the responsibility for their own retirement well-being but to become professional
money managers at the same time. Ask the baby boomers, who were planning on retiring in 20082010 and relying on their 401(k) plans, how well that worked out. It is simply unrealistic to assume the
average American is, or ever will be, an investment expert.
The solution: Defined Benefit plans provide an ideal way to help your employees build a secure
future because they provide a known level of guaranteed income at retirement. There is simply no
better plan in terms of meeting the goal of income replacement at retirement, particularly when you
look at how much employees would have to save on their own to match the benefits provided by a
pension plan. A pension plan provides a guaranteed secure income that you cannot outlive and it
places the responsibility of managing the assets into the hands of professional money managers. A
recent “Issue Brief” published by the National Institute on Retirement Security underscores these points
and suggests several solutions and policy changes which can revitalize Defined Benefit plans. The full
article can be accessed by clicking here.
Historically, Defined Benefit plans have been the mainstay of corporate retirement efforts. These plans
still provide retirement income to a significant percentage of retirees nationwide. Beyond that, these
plans provide important advantages to the employer.
Defined Benefit plans:

Reduce employee turnover, thereby reducing costs to acquire new talent

Attract and retain employees

Provide significant advantages to highly compensated, longer service employees

Provide inflation protection and lifetime income

Provide PBGC insured benefits

Can be used to maximize tax shelters

Provide more comprehensive benefit coverage

Offset employer costs by favorable investment performance

Facilitate orderly retirement and succession by providing employees with the financial ability to
retire
DEFINED BENEFIT PLANS PROVIDE CONSIDERABLE DESIGN (AND COST) FLEXIBILITY
We have discussed how market conditions are poised to change, which will help stabilize and reduce
future costs. In addition, employers still have considerable design flexibility that can help reduce plan
costs today. There are a number of different plan design options available to you. Each of the plan’s
features—plan salary definition, benefit formula, early retirement, death, disability and post-retirement
features—adds a different dimension to the program’s costs.
In reviewing benefit programs, employers should consider their current and future needs, employee
demographics, and benefit objectives. Maintaining a Defined Benefit plan can provide the best of
both worlds for the employer and the employee. The Defined Benefit plan provides employees
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guaranteed retirement security while giving the employer a vehicle to allocate the greater portion of
plan contributions to higher paid, longer service employees.
Developing the right "benefits blend" for your organization involves addressing not only adequacy
and competitive considerations but also cost considerations. If you find that your costs have risen
beyond the range you planned for, and are hesitant to wait for the inevitable improvement that will
result from the aforementioned changes in the market conditions, there are many redesign options
that can be employed. Benefit programs can be restructured and modified to meet your
organization's cost and benefit objectives.
TRENDS IN THE RETIREMENT INDUSTRY—MULTIPLE EMPLOYER PLANS (MEPS)
When it comes to plan costs—particularly Defined Benefit plan costs—one of the most effective ways
to control plan costs is through the use of a multiple employer plan. Interestingly, MEPs are the most
compelling trend in the retirement industry today. Historically, the majority of workers without
retirement plan coverage are those who work for small and medium size businesses. Retirement plan
management for these companies is an administratively burdensome prospect. Lack of in-house
benefits expertise, coupled with the fiduciary and legal issues surrounding a complex regulatory
environment, often make it difficult for these employers to sponsor a plan. Yet the absence of
adequate benefits is often cited as a reason for high turnover among organizations, with employees
leaving these jobs for positions with organizations that offer more comprehensive benefits packages.
MEPs offer an ideal solution to these challenges and address the complexities these businesses face in
offering a retirement plan—especially where common businesses can take advantage of economies
of scale by participating in these types of programs.
MEPs are not a new concept and these plans have been in existence for many years. What has
changed, and why is there renewed interest in these programs? Today, fewer employers sponsor
Defined Benefit pension plans. With small businesses expected to generate the greatest percentage
of job growth in the future, the need for retirement plan coverage for employees of these businesses
takes on an even greater urgency.
HOW DOES A MEP WORK?
A MEP is a retirement plan that covers employers that are not commonly owned. These employers
become “Adopting Employers” when they elect to join the MEP. These plans can be Defined
Contribution or Defined Benefit plans.

Section 413(c) of the Internal Revenue Code and the regulations thereunder establish
guidelines for MEPs. A MEP is essentially a single qualified trust established by the plan sponsor
that allows unrelated co-adopters to adopt the plan. Under a MEP, each adopting employer
can maintain an individual plan design.
Compliance testing is also performed on an
individual basis for each adopter, but a single Form 5500 is filed for all participating employers.
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There are significant advantages gained by participating in a MEP, including:

Elimination of primary fiduciary responsibility

Investment fiduciary protection—relief of responsibility for selecting and monitoring plan
investments

Economies of scale in the form of buying power of a single large plan vs. smaller plans and
greater negotiating power when buying investment and other plan services

Cost savings

Simplified Accounting Treatment- no need for separate FAS 87 Valuation Report

Eliminates need for annual plan audit for individual employers

Eliminates 5500 filing for individual employers

Only a single plan document is maintained

Single source solution for plan services

Ease of use for participating employers
ADMINISTRATIVE EASE
MEPs deliver administrative ease for employers, as nearly all of the administrative tasks relating to the
Adopting Employer’s plan can be shifted to the Plan Sponsor. With a single plan document that
participating employers adopt on an individual basis, a MEP approach eliminates the need for
individual plan audits and government filings, including individual Form 5500s. Also, for Defined Benefit
MEPs, generally there is no need or cost associated with separate FASB Expense reporting.
Typically, MEPs provide the adopting employer with a comprehensive package of plan services.
These services include fiduciary protection, plan design and document support, plan consulting,
administration and recordkeeping, legal and technical support, regulatory compliance and
government reporting, investment management and sponsor and participant communications.
Because administration is streamlined, participating employers can also realize significant economies
of scale that may result in lower plan costs.
ANOTHER KEY BENEFIT –THE MEP SPONSOR’S FIDUCIARY ROLE
Today’s regulatory environment and compliance challenges make fiduciary oversight more
important than ever. One of the key benefits of a MEP is fiduciary relief— the MEP sponsor (in our
case, Pentegra’s Board of Directors) assumes the principal fiduciary responsibilities associated with
sponsoring a retirement plan. The MEP sponsor also ensures that the plan remains in full compliance
with IRS and DOL regulations, providing plan amendments and regulatory updates as needed. The
level of ERISA fiduciary protection a MEP offers not only relieves plan sponsors of the due diligence
and ongoing monitoring of plan investments but also protects advisors—acknowledging their role
with their clients.
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TYPICAL MULTIPLE EMPLOYER PLAN ADMINISTRATIVE AND FIDUCIARY SERVICES

Comprehensive Fiduciary Relief

Plan Design & Document Support

Conversion & Implementation

Administration & Recordkeeping

Regulatory Compliance & Government Reporting

Legal & Technical Support

Investment Management
-
Investment Policy Statement
-
Investment Valuation and Selection
-
Ongoing Monitoring of Funds
-
Performance Reporting

Advisor & Plan Sponsor Reporting

Education & Communication Materials
HOW ARE PLAN INVESTMENTS TYPICALLY HANDLED?
Under a MEP, typically the sponsor also serves as the investment fiduciary. As the investment fiduciary,
the MEP sponsor evaluates, identifies, selects and monitors plan investments, offering a fiduciary
process that includes an investment policy statement, investment evaluation and selection, and
ongoing monitoring and performance reporting. As an investment fiduciary, MEP sponsors offer the
benefit of careful oversight of the plan’s investments that are regularly scrutinized for appropriateness,
and the benefit of due diligence built around the fiduciary responsibility that the sponsor assumes to
ensure that plan investments are appropriate for a qualified retirement program. A MEP provides a
single Investment Policy Statement that covers all adopting companies. Fund monitoring is done at
the MEP Trustee level on behalf of all adopters. Documentation of fiduciary decisions is critical due to
increased scrutiny by adopters and regulators.
WHEN DOES A MEP MAKE SENSE?
MEPs are an ideal retirement plan solution in many situations, particularly where fiduciary liability is an
issue, when there is no current plan in place because of the complexities involved in offering one, for
bona fide employer groups, where clients with multiple payrolls are looking for synergy, and in
organizations looking for value-added services for members or affiliates.
WHY PENTEGRA SHOULD BE THE PROVIDER OF CHOICE FOR A MEP
Pentegra is one of the few providers, if not the only one, that offers more than 65 years of experience
and expertise in administering MEPs. Not only is our Board the Plan Sponsor and principal fiduciary,
but our President serves as the ERISA- named Plan Administrator. We offer a MEP solution with a
tangible difference including the benefit of experienced professionals and experts in plan
investments, administration and fiduciary services, and managing both Defined Benefit and 401(k)
plans in accordance with the highest standards, which sets us apart from other MEPs.
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A MULTIPLE EMPLOYER PLAN VERSUS A SINGLE EMPLOYER PLAN
The differences between operating under a MEP and a single employer plan fall into the following
areas:

Principal Fiduciary Responsibility

ERISA-named Plan Administrator Role

Costs

Investment Control and Responsibility

Plan Design Control

FASB Expense Accounting

Plan Audit
Pentegra offers employers the choice of operating a plan under either approach. As previously
described, a MEP relieves participating employers of the principal fiduciary and ERISA-named plan
administrator roles and responsibilities.
This is accomplished with significant cost savings due to
economies of scale, filing one 5500 report and the elimination of individual plan audits. Employers
participating in a single employer plan structure gain additional control over the plan investments
(however, they will have less access to investment managers due to lower investable plan assets
compared to the multiple employer pool of assets) and plan design, but will have the added
expense of plan audits (if over 100 lives), individual Form 5500s and separate FASB Expense reports.
The MEP operates on a bundled service basis (all services from one source), while a single employer
plan may operate on a similar basis or on an unbundled basis (the required plan services are
provided by several providers).
Ultimately, the decision comes down to plan control versus relief of fiduciary responsibility and cost
versus additional plan flexibility.
ORPHAN LIABILITIES UNDER THE PENTEGRA DEFINED BENEFIT MEP (the “Plan”)
Some employers have expressed concerns over the orphan liabilities and their impact on the Plan. In
reality, there is minimal risk to participating employers, and this risk has been immunized due to
Pentegra’s policies and procedures. For funding purposes, an equal portion of orphan assets and
liabilities are allocated to a participating employer, resulting in a positive effect on their individual
funding ratio, thereby reducing plan contributions.
WHAT IS AN ORPHAN LIABILITY?
An Orphan is “a Member or former Member with an accrued benefit under the Plan whose Employer
has previously withdrawn from the Plan without establishing a Qualified Successor Plan (QSP) to which
the liability for the Member’s or former Member’s benefits under the Plan has been transferred.”
Essentially, orphans are retired or terminated participants with vested benefits that remain the
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obligation of the Plan. The Plan will pay their earned retirement benefit now or sometime in the
future.
HISTORY
In the early days of Pentegra, all participants of the Plan who retired or terminated with a vested
benefit received their retirement income from Pentegra.
Since Pentegra retained these liabilities, the annual Actuarial Valuation continued to value these
liabilities and the resulting actuarial experience and impact were commingled and shared among all
participating employers. Subsequently, Pentegra modified its employer withdrawal procedures to
permit employers to withdraw from the Plan with a QSP. Today, no new orphans can be created
when an employer voluntarily leaves Pentegra as either:
1.
An employer leaves with a QSP and all assets and liabilities associated with the employer are
transferred to the QSP, or
2.
An employer leaves with no QSP and annuities are purchased for all active, retired and
terminated vested members associated with the employer
CURRENT ORPHAN LIABILITY POLICY
Effective July 1, 2005, an employer could no longer withdraw from the Plan and leave liabilities
behind. As a result, there can be no new orphans created at the time an employer leaves. With
respect to existing orphans, any subsequent gains or losses are allocated to employers that
participated in the Plan as of or prior to July 1, 2005. Accordingly, employers that adopt the Plan
after July 1, 2005 do not share in any experience on the existing orphans. As such, new employers do
not run the risk of incurring any losses on existing orphans and will forego any opportunity for gains on
such liabilities.
The Plan instituted procedures effective July 1, 2006 to allocate assets and liabilities to orphanresponsible employers. The funding target includes assets and liabilities for the orphan pool that were
allocated to orphan-responsible employers according to the percentages that appear in the
“Allocation of Orphan Adjustment” table of the Plan’s Regulations.
Allocating an equal number of orphan assets and liabilities for funding purposes has the positive
affect of increasing an employer’s funding ratio and reducing Plan contributions.
In addition to prohibiting further orphan creation at the time of withdrawal, when an employer
withdraws it is required to fund the difference between the orphan liabilities at the valuation rates
and these liabilities valued at either annuity rates or PBGC rates (settlement rates). By requiring this
additional contribution, the Plan insulates the remaining employers from potential losses.
As of the latest actuarial valuation (July 1, 2011), the orphan liabilities were $600 million. Of this
amount, approximately $350M are in the Plan’s Cash Flow Match (CFM) portfolio. The CFM portfolio is
a high-quality bond portfolio structured to match the future cash inflow from coupons and bond
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maturities against future cash payouts for benefits to the majority of current retirees and beneficiaries.
This strategy helps to immunize the Plan’s liabilities from interest rate risk, further reducing overall
orphan risk to our participating employers.
The July 1, 2011 orphans represent 20.33% of total liabilities. As we expected, these liabilities have
decreased as a percentage of total liabilities from 22.61% in 2009 to 21.67% in 2010 to 20.33% in 2011.
This represents a 10% decrease over the three-year period and we expect this trend to continue in the
future.
THE MISCONCEPTION OF THE “LAST MAN STANDING”
As previously discussed, the Pentegra Defined Benefit Plan for Financial Institutions is considered a
multiple employer plan and is governed by IRS Code Section 413(c). The Plan maintains a single trust
and all contributions are commingled and invested on a pooled basis. All amounts payable by the
Plan are a general charge upon all its assets.
These provisions and Plan structure have led some participating employers to believe that as an
employer withdraws from the Plan, its share of orphan liabilities become the responsibility of the
remaining employers. Therefore, they believe the last remaining participating employer in the Plan
would be responsible for the entire orphan liability, hence, the “Last Man Standing” concept.
The Plan has taken several steps (see Current Orphan Liability Policy above) to protect and insulate
remaining participating employers from additional orphan liabilities:
1.
Effective July 1, 2005 a withdrawing employer could no longer leave liabilities behind. A
withdrawing employer must either purchase annuities for all liabilities or transfer all assets and
liabilities to a QSP. As a result, no new orphans may be created.
2.
To address the fact that when an employer withdrew from the Plan the employer was no
longer responsible for any existing orphan liabilities, effective July 1, 2006, the Plan was
amended to require the employer to pay off its portion of orphan liabilities.
3.
A withdrawing employer that joined the Plan prior to July 1, 2005 is required to make an
additional Plan contribution known as the “Orphan Adjustment.” The Orphan Adjustment
represents the difference, if any, between orphan liabilities calculated at the valuation rate
and the orphan liabilities calculated at settlement rates (estimated annuity or PBGC rates).
Current settlement rates are lower than the ongoing valuation rates resulting in an additional
Plan contribution at the time of withdrawal.
4.
Since July 1, 2005 seven employers have withdrawn from the Plan and have made Orphan
Adjustment contributions of about $6M. The Plan will purchase annuities for this segment of
the orphan population, thus eliminating these liabilities.
5.
In addition, the Plan instituted immunization strategies, as set forth below that further protect
participating employers from the impact of failed institutions.
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The above amendments and procedures will ensure that participating employers will not be harmed
when an employer withdraws from the Plan by having to bear a greater proportion of the orphan
liability.
It is important to note that an employer’s amount of orphan liabilities can increase or
decrease as liability interest rates decrease or increase, the same general impact rising and falling
interest rates have on overall liabilities.
IMMUNIZATION STRATEGIES
As ERISA-named Plan Administrator and principal fiduciary for the Plan, Pentegra’s President and
Board of Directors are responsible for ensuring that the interests of all participating employers as well
as the participants and beneficiaries of the Plan are protected.
As such, given the economic environment over the last several years, the Plan added certain
protections in an effort to shield participating employers from being responsible for the funding
shortfalls of any potential employers placed into receivership by a Regulatory Authority. Pentegra has
established a very diligent process that identifies financially troubled institutions and requires that they
take clear action to mitigate possible losses (letters of credit, required plan contributions). This protects
the Plan and other participating employers.
A key measure of financial soundness is an institution’s capital ratio. An analysis of our participating
financial institutions has shown that the financial strength of our client base is well above that of the
industry in general. In fact, 91% of our financial institutions have a capital ratio greater than 8% and
97% have a capital ratio greater than 6.5%. Only one very small financial institution, representing less
than 0.5% of the total Plan’s unfunded liabilities, has a capital ratio under 5% and we have mitigated
the risk of that bank’s underfunded position through a letter of credit. The combination of the
financial strength of our customers and our immunization strategies minimizes the impact or exposure
of a failed institution on the Plan, resulting in minimal risk to our participating employers.
Finally, we want you to know that we also have a diligent review process in connection with our sales
efforts. Specifically, our sales force will not solicit new business from a financial institution that exhibits
financial weaknesses, as determined by our internal monitoring process. In this way, we reduce the
likelihood of allowing a new customer into the multiple employer plan that has any potential to
create the need for us to execute a mitigation strategy (like obtaining letter of credit protection).
WHY SHOULD PENTEGRA BE THE VENDOR OF CHOICE FOR YOUR DEFINED BENEFIT
PLAN?
Today, Defined Benefit plans remain one of the most significant assets that many employees own.
Few other retirement programs provide a predictable and secure benefit for life. And few, if any,
other providers offer 65+ years of experience built working with your industry to deliver retirement plan
solutions focused exclusively on your needs. The Pentegra Defined Benefit Plan for Financial
Institutions, a Defined Benefit MEP, is one of the most economical, efficient and effective ways for a
financial institution to offer a Defined Benefit pension plan.
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OUR UNIQUE FIDUCIARY ROLE

The Pentegra Defined Benefit Plan for Financial Institutions offers a distinct advantage—the
opportunity to completely outsource primary fiduciary responsibility for the management of your
retirement program.

In this unique role, our President and Board of Directors— Presidents and CEOs of participating
institutions—prudently monitor and document all decisions affecting the Plan and its investments.

As plan fiduciary, we ensure that the Plan is administered according to the highest standards and
that the Plan remains in full compliance with changing IRS and DOL regulations.
AN UNPARALLELED LEVEL OF OVERSIGHT

A Board of Directors comprised of our clients—your peers—is charged with the oversight of the
Plan.

As both participants and plan fiduciaries, Board members have a vested and very personal
interest in ensuring that the Plan is managed according to the highest standards.

While the Plan is not regulated by the Securities and Exchange Commission (the “SEC”) and does
not fall under the mandate of the Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley”), the Board of
Directors and Management recognize the importance of plan governance and look at the SEC
and Sarbanes-Oxley requirements from the standpoint of best practices. As a result, the Plan
complies with some of the SEC and Sarbanes-Oxley requirements.

As a multiple employer program, the Plan seeks to not only protect the interests of each
participating employer in the Plan but also to preserve the financial soundness, integrity and longterm viability of the Plan itself.
A DISCIPLINED, PROVEN INVESTMENT STRATEGY

Our due diligence is built around the fiduciary responsibility that we assume to ensure that
investments are appropriate for a qualified retirement program.

Today in the post-PPA environment, pension investing should be more a process of aligning assets
to liabilities, with the ultimate objective being to pay retirement benefits. A plan’s investment
policy should be structured to invest plan assets in such a way that will meet those benefit
obligations (liabilities) and not simply reach for returns.

We are intimately familiar with this approach since it is part of the investment strategy we have
had in place for many years.

The Plan’s liability driven investment strategy is a duration-matched approach that is designed to
reduce volatility of funded ratios and pension contributions. As a result, the Plan’s funded ratio as
of June 30, 2011 was 90.0%, which is significantly better than the average plan’s funded ratio.

The Plan has never missed a benefit payment in its 69-year history. 15
ECONOMIES OF SCALE

The Plan’s multiple employer plan approach delivers significant cost savings for participating
financial institutions.

One of the many benefits of a multiple employer program is the collective buying power of a
cooperative arrangement. As a multiple employer program, we are able to leverage the buying
power of hundreds of organizations to offer our clients numerous economies of scale, producing
tangible benefits for customers in the form of lower retirement program costs and investment
management fees.

Only a single actuarial valuation, plan audit, 5500 filing and plan document are required—
eliminating the need for individual plan audits, valuations and government filings and reporting.

As a result, our cost of services is often considerably less than that of our competitors. Our size
affords us access to the top investment managers in the world—well beyond the scope of what a
single employer plan could access on its own, making it affordable and practical for a financial
institution of any size to offer an institutional-quality retirement program for its employees.
AN INDEPENDENT APPROACH

Unlike most other retirement plan providers, Pentegra is neither owned nor controlled by an
investment management, mutual fund or insurance company.

Pentegra’s retirement programs continue to earn the endorsement of industry trade
organizations, including the American Bankers Association through its subsidiary, the Corporation
for American Banking, the National Association of Federal Credit Unions (NAFCU) and state trade
organizations nationwide.
CONCLUSION
If costs were not an issue, most employers would have a Defined Benefit plan as the cornerstone of
their retirement program. For the 50-60 years following the Great Depression, Defined Benefit plans
were the mainstay of corporate retirement efforts and provided the foundation for a secure
retirement future.
Why?
Because Defined Benefit plans provide a known level of guaranteed
income that employees cannot outlive and the benefits produced by these plans for participants are
not subject to market volatility. The Defined Benefit plan was, and still is, the most cost-effective
program available when it comes to providing income replacement at retirement.
Circumstances began to change over the last 15-20 years as a combination of market conditions,
decreasing liability discount rates and pension law modifications all conspired to increase the cost of
maintaining Defined Benefit plans.
At Pentegra, we believe there is strong evidence that these
secular trends have run their course and are positioned to reverse themselves. As interest rates rise
and equity markets return to more historic levels, Defined Benefit pension costs will decrease. Volatility
also will be much reduced in the future as we execute our Liability Driven Investment (LDI) strategy.
The question again will become, what is the most cost-effective method to administer these plans?
For small to midsize employers the MEP, with its fiduciary relief, economies of scale, simplified
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administration and financial accounting, and the single source approach to providing all the
necessary services required to manage the program, provides a truly affordable, top of the line,
retirement plan option for employers.
This can be a key differentiator for companies seeking to
attract and retain top talent, particularly seasoned management level talent. Workers are again
looking for employers with Defined Benefit plans as evidenced by a recent Towers Watson survey.
The article and survey results may be viewed by clicking here.
The future is bright for Defined Benefit plans and Pentegra is well positioned to be at the forefront of its
resurgence. Few other providers offer 65+ years of experience as the principal fiduciary and ERISA
named Plan Administrator. And with a Board made up of participating employers, Pentegra is an
independent operation with the sole objective of serving the best interests of our client base.
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