The challenge: incentivizing a workforce reduction

A Milliman client sponsored two frozen defined benefit plans. The larger plan had approximately 4,000 participants, 60% of which were active or terminated vested employees; the smaller plan had approximately 300 participants, 35% of which were active or terminated vested employees. Both plans had been frozen for at least 10 years and had been sufficiently overfunded such that neither had a Minimum Required Contribution for approximately 10 years.

The client wanted to reduce their workforce as a part of a larger corporate restructuring. An early retirement window offer to allow lump sum payments would not be an option, as both plans already allowed participants to elect their retirement benefit as a lump sum. Further, the client felt that many participants were not likely to voluntarily retire early without an additional inducement. The challenge was to find another way to incentivize employees to elect early retirement.

The solution: early retirement incentives and benefit increases

After consultation with the client, it was determined that the plan sponsor could incentivize participants to retire by including a benefit increase in the window offer. This benefit increase would be structured so that the additional liability would still leave the plans overfunded, thereby requiring no additional cash contributions from the plan sponsor.

The Milliman team performed numerous demographic analyses of the plans in order to determine the optimal group to whom to offer the incentive. The plan sponsor wanted to balance the cost of any benefit increases with the reduction in payroll and benefit costs for the target group. In addition, several options were considered to increase the frozen benefit amounts, such as adding years of service or increasing final salaries. Based upon the age and service distributions of the plans, it was determined that the incentive would be offered to certain active participants based on an attained age criterion. It was further proposed that the incentive be structured so as to increase a participant’s benefit by a certain percentage for every year of employment, such that even a participant hired shortly before the plan freeze could still see a valuable increase in his or her benefit. Participants could elect their enhanced benefit in any of the plans’ optional forms, including a lump sum payment.

The Milliman team performed preliminary nondiscrimination testing based upon the assumption that 100% of those offered the incentive would accept it and take their benefit as a lump sum. This assumption was used in order to estimate the maximum potential payments from the plan during the window period and the workforce management implications for the plan sponsor. The Milliman team conducted further preliminary studies to determine the impact on the plans’ funded status on an accounting basis and the effect on the plans’ future net periodic pension cost.

As the incentive program was refined, the client expanded it, after consultation with their attorney, to also include current employees who met the age criteria but were no longer active plan participants because they either had previously terminated employment and received their benefit as a lump sum or as an annuity and were then rehired after their respective plan froze, or had been eligible for an in-service distribution. The Milliman team calculated the incentive in the same manner as for other participants but it was based upon their benefit at retirement and the percentage increase was based on elapsed time since their original date of hire, but excluding any time not employed by the plan sponsor.

An additional component of the retirement incentive was the offer of continued employer medical coverage until Medicare eligibility (age 65) for the employee and covered family members, if applicable. Employees not participating in employer medical coverage or who were already Medicare eligible would receive a one-time cash payment.

The outcome: successful workforce reduction to meet business goals

The incentive was ultimately offered to approximately 300 individuals, of which approximately 180 took advantage of the incentive, for a take-up rate of 60%. Of those who took the offer, approximately 75% elected a lump sum.

The incentive continued to pass nondiscrimination testing under the actual election circumstances. From an accounting perspective, the retirement window resulted in several special events: a curtailment due to early retirement on the parts of the participants, a settlement due to the payment of lump sums, and special termination benefits due to the benefit enhancement and health care bridge benefits.

The client was pleased with the result of the incentive program on both their workforce and on the plans’ balance sheets. Milliman was able to tailor a solution that satisfied regulatory constraints, kept the plans in a strong funded position, and met the client’s broader business goals.