CSI PENSION TASK FORCE RECOMMENDATION AND REPORT. September 2017

Transcription

1 CSI PENSION TASK FORCE RECOMMENDATION AND REPORT September 2017

2 CSI PENSION TASK FORCE RECOMMENDATION AND REPORT Executive Summary The CSI Pension Task Force ( TF ) recommends the following: 1. The CSI Pension Plan ( Pension Plan ) be hard frozen as of August 31, This has the following consequences: No new employee will be eligible to become a participant in the Pension Plan after August 31, A participant in the Pension Plan will retain the participant s benefits earned as of August 31, 2019, but will not earn any additional benefits after August 31, Each participating employer must continue to make contributions to the Pension Plan after August 31, 2019 to fund the participants earned benefits as of that date. 2. CSI establish a defined contribution plan ( DC Plan ) as of September 1, 2019 to provide retirement benefits earned after August 31, The DC Plan could be a 401(k) plan or 403(b) plan. The advantage of the DC Plan is that participating employers have flexibility on a year-to-year basis to determine the amount of the participating employer s contributions. This Recommendation and Report discusses the reasons for these recommendations. The following should be noted about this Recommendation and Report: 1. The TF recommended that the hard freeze of the Pension Plan be implemented as of August 31, But, at its July 2017 meeting, the CSI Board of Trustees adopted a resolution that any action (if any) regarding the TF s recommendations be effective no earlier than September 1, The Recommendation and Report refers to specific provisions in various reports prepared by Mercer, the actuarial firm for the Pension Plan. Mercer informs us that the best understanding of one of their reports is obtained by reviewing the entire report. Copies of the Mercer reports discussed in the Recommendation and Report are available upon request to CSI. 1. The Pension Plan Background Information Christian Schools International ( CSI ) maintains the Christian School Pension Plan ( Pension Plan ) to provide retirement benefits for eligible employees of participating employers. The term participating employer includes CSI and any CSI member school

3 in the United States that elects to participate in the Plan. CSI member schools in Canada have a separate pension plan. The Pension Plan is a defined benefit pension plan. It is structured as a single plan for the many participating employers -- a participating employer does not establish a separate plan for its employees. This type of plan is typically called a multiple employer plan. The Pension Plan is subject to the rules of the Employee Retirement Income Security Act of 1974 ( ERISA, also referred to generically as federal pension law or federal law ). Although CSI is closely associated with the Christian Reformed Church in North America, the Pension Plan is not considered a church plan within the meaning of ERISA or the Internal Revenue Code of 1986 ( Code ), which if applicable could exempt the Pension Plan from certain requirements of ERISA and the Code. Under the terms of the Pension Plan, each participating employer agrees that CSI has the duties and powers of the sponsor and administration of the Pension Plan. This includes the power to amend the Pension Plan. Any amendment to the Pension Plan adopted by CSI applies to, and is binding on, all participating employers. Each Pension Plan amendment is adopted by the CSI Board of Trustees ( CSI Board ), based upon the recommendation of the Christian School Pension Trust Fund Board of Trustees ( Pension Trustees ). The Board of Pension Trustees has 12 members who are appointed by the CSI Board. The Pension Trustees have an important role with regard to the Plan. The CSI Board has delegated to the Pension Trustees the responsibility for administering the Pension Plan and managing the investment of the Pension Plan s trust fund. Some of the Pension Trustees are current or former investment professionals. The Pension Trustees are the named fiduciary of the Pension Plan and work with CSI s Vice President of Employee Benefits in carrying out their duties. The Pension Trustees retain professionals to assist them in carrying out their fiduciary responsibility. This includes: Mercer, an international benefit consulting firm, provides actuarial services for the Pension Plan. The law firm of Warner, Norcross & Judd provides legal services for the Pension Plan. Goldman Sachs has recently been retained by the Pension Trustees as Outsourced Chief Investment Officer. Goldman Sachs is replacing Mercer, which previously served as an investment consultant to the Pension Trustees. Goldman Sachs will select and monitor the investments for the Pension Plan acting in a fiduciary capacity under ERISA Section 3(38). The investments will be based upon the investment policy statement jointly established by the Pension Trustees and Goldman Sachs. -2-

4 2. The Amount of a Participant s Pension Benefits Under a defined benefit pension plan, each participant earns a benefit under the terms of a formula in the plan document. The formula describes the benefit payable to the participant beginning at normal retirement age (typically age 65) under the plan s normal form of payment (typically a single life annuity -- a monthly benefit for the participant s lifetime that ends upon the participant s death). The Pension Plan also permits payment of reduced benefits to a former employee before normal retirement age and in optional forms of payment. Under the formula in the Pension Plan, a participant s annual benefit payable beginning at age 65 in the form of a single life annuity is the sum of the following: 60% of the contributions made by a participant (or deemed to have been made by the participant) before September 1, 2005; plus 50% of the contributions made by a participant (or deemed to have been made by a participant) after August 31, This formula applies to benefits earned before September 1, As discussed in Section 4, this formula is being modified for benefits earned after August 31, Some important observations should be made regarding a defined benefit plan: Unlike a 401(k) or 403(b) plan, the participant does not have an account under the Pension Plan for the participant s entire benefit. Other than a refund of the participant s contributions, the participant has only a promise to receive benefits at retirement based upon the formula in the Pension Plan. Also unlike a 401(k) or 403(b) plan, the entire benefit earned by a participant is not portable to another employer (other than another CSI school) if the participant changes employers. The participant s benefits are not affected by the Pension Plan s investment results. Instead, the participating employers, in providing the funds for the payment of all promised benefits, bear the risk of lower-than-assumed investment returns and receive the benefit of higher-than-assumed investment returns. The participant receives a monthly benefit for the participant s lifetime. And, depending upon the election made by the participant before benefit payments begin, monthly benefits may continue after the participant s death to a surviving spouse or other beneficiary. The lifetime nature of these benefits provides additional financial security to a retired participant. 3. The Funding of Pension Benefits Federal law requires that a participant s benefits be funded over the participant s career while working in an eligible job. The amount of the annual required contribution is -3-

5 actuarially determined, based upon a series of assumptions. This includes assumptions about a participant s life expectancy and the projected investment results from investing the funds set aside to pay all participants pension benefits. The funding of the Pension Plan assumes that the long-term average investment return will be 7.5% per year. A plan sponsor retains an actuarial firm to determine the annual required minimum contribution and make other recommendations regarding the funding of the plan. Federal law imposes tax penalties if the required minimum contribution is not timely made. Under a typical single employer pension plan maintained by a company, the plan s actuary provides the range of permissible contributions, and the employer chooses the contribution amount. These contributions may widely fluctuate from year to year based upon interest rates, investment results, mortality assumptions and other factors. The funding of the CSI Pension Plan is completely different from the funding of a typical single employer plan. The participating employer chooses a contribution percentage for its participants. For each participant, this percentage may range from 2% to 7% of the participant s eligible compensation. The participating employer contributes an amount equal to its participants contributions. In addition, the participating employer may make the participants contributions on their behalf. These employer and employee contributions provide a stable annual funding into the Pension Plan. As with other plans, the Pension Plan is still required by law to contribute a legislatively determined minimum amount. If the contribution formula in the Pension Plan is insufficient to satisfy the minimum contribution requirement, the participating employers would be required to contribute the difference. A key responsibility of the Pension Trustees is to ensure that the Pension Plan is adequately funded by making recommendations to the CSI Board regarding contribution rates for participating employers. A participating employer is contributing a specific percentage of its participants compensation, unrelated to whether those amounts will satisfy the minimum funding requirements. Therefore, it is important that the Pension Plan be funded to include a cushion in case the Pension Plan s current contributions for a plan year are less than the amount necessary to pay the required minimum contribution and the Pension Plan s annual administrative expenses. And because the participating employers are primarily schools that already operate on tight approved budgets that likely cannot be adjusted until the next budget cycle, the Pension Trustees realistically cannot assess excess contributions to each participating employer in the case of an annual shortfall in funding. Excess contributions are employer contributions in addition to those based upon participants compensation. These excess contributions will not increase the participants benefits. 4. Funding Legislation for CSEC Plans The Pension Protection Act of 2006 ( PPA ) generally required faster and increased funding of pension plans subject to ERISA. A plan s underfunding was required to be -4-

6 funded in seven years. Further, the PPA requires plan sponsors to use funding interest rates that are closely tied to market-related bond yields. These changes would have required significantly larger contributions to the Pension Plan. A follow-up Mercer study dated April 20, 2017 included the following statement: If CSI were subject to PPA funding rules, IRS minimum funding requirements would have already been financially unsupportable. The Cooperative and Small Employer Charity Pension Flexibility Act of 2014 ( CSEC ) provides funding rules for pension plans maintained by cooperatives and tax-exempt organizations that maintain multiple employer plans (including the Pension Plan). Because of the CSEC legislation, the Pension Plan was allowed to be funded under requirements in effect before the PPA. The Pension Plan is slightly more than 100% funded based upon CSEC-permitted actuarial assumptions. But the CSEC law applied only to funding the Pension Plan. It did not provide any relief regarding the calculation of the PBGC variable rate premium discussed in Section 5 of the Reasons for the Recommendation section. The variable rate premium is calculated based upon the requirements that apply to most single employer and other multiple employer sponsors of ERISA pension plans (i.e., there is no CSEC-type relief from the PBGC premiums for pension plans subject to ERISA). It is important to note that CSEC status does not reduce the amount of funding that ultimately will be needed to pay for all earned benefits under the Pension Plan. CSEC status is properly considered to provide funding flexibility, particularly in the near term, rather than funding relief or reduction. 5. The Pension Plan Amendments Once each five years, the Pension Trustees have requested Mercer to conduct a 20-year stochastic study regarding the Pension Plan. The purpose of this study is to determine whether the Pension Plan will be financially sound during the next 20 years under thousands of different scenarios, and to review the types and likelihood of circumstances under which the Pension Plan could no longer be financially sound. Mercer completed a regular 20-year study during mid The following risks to the long-term funding health of the Pension Plan were noted: New updated mortality tables provide for longer life expectancies. Based upon this fact, participants are assumed to live longer and, consequently, to receive more pension benefits. This will require larger contributions to the Pension Plan. Low interest rates and volatile investment markets have resulted in investment results in recent years averaging less than the 7.5% anticipated rate of return. The September 2016 report to member schools ( Keeping the Pension Plan Healthy ) stated that the investment performance for the three, five and ten years ending on June 30, 2016 was 5.7%, 5.1% and 4.4%, respectively. -5-

7 The Pension Plan is required to pay premiums to the Pension Benefit Guaranty Corporation ( PBGC ), a governmental insurance company that is part of the U.S. Department of Labor. The PBGC takes over under-funded private sector pension plans in limited situations and pays benefits to participants in amounts up to a specified monthly dollar limit (which often are significantly less than the level of benefits that can be earned under a PBGC insured pension plan). A sponsor of a pension plan is required to pay premiums to the PBGC to purchase the required pension insurance. But, because of recent federal laws, the Pension Plan s annual PBGC premiums have increased from under $1 million to $6 million in This amount could increase to $9 million in the next few years. A substantial portion of the annual PBGC premiums is a variable premium amount tied to the funding status of the Pension Plan. While the Pension Plan remains at least 100% funded based on the Pension Plan s funding assumptions, its funded status is not sufficient to escape the application of the variable premiums. Mercer estimated recently that it would require approximately $350 million in additional funding to eliminate the variable premium component of the PBGC premium calculation. The total contributions to the Plan for the plan year ending August 31, 2017 will be approximately $20 million. The increased PBGC premiums are significantly reducing the funds available to fund pension benefits. Based upon this study, the Pension Trustees recommended in 2016 that the CSI Board approve a Pension Plan amendment that made the following changes to improve the Plan s funding: Increase a participating employer s contributions to the Pension Plan by 50% of the amount contributed by that participating employer (employee and employer contributions). This increase would take effect as of September 1, 2017 and remain in effect for 10 years. The additional contribution would not increase participants benefits. For service after August 31, 2017, a participant s pension benefit would increase by 40% of the participant s contributions (instead of the previous 50%). A participating employer could not decrease its contribution level (for example, from 6% to 5%). A withdrawal liability payment would be required if a participating employer stopped participating in the Pension Plan. This Amendment to the Pension Plan was approved by the CSI Board in August 2016 and included changes described in the third and fourth bullets above. The first and second bullets were deferred for consideration as part of the Amendment. -6-

8 CSI and the Pension Trustees provided extensive communications to the participating employers and participants about the pension changes. Not surprisingly, many participating employers reacted with surprise and concern. As a result of the feedback from participating employers, the CSI Board and Pension Trustees jointly met during December 2016 to review the Amendment and discuss the proposed Amendment. The following actions were approved by the CSI Board: An independent pension task force would be appointed by the CSI Board to review the pension changes. (This is discussed more below.) The 50% additional contributions recommended by the Pension Trustees when the Amendment was approved, except that the period for these contributions was fixed at two years instead of ten years. The two-year period was intended to provide time for the pension task force to provide its opinion regarding whether the additional contributions needed to be continued. A participating employer could reduce its contributions by one or two levels, beginning with the plan year. However, the 50% additional contribution would continue to be based upon the participating employer s contributions during the plan year. The latter two changes were included in the Amendment to the Pension Plan. As described in more detail in the following sections of this report, the final amendment, and particularly the limitation of the 50% supplemental contribution to two years, has not meaningfully altered the projected funding problems associated with the Pension Plan. Mercer has projected that, with a 5% annual return on investments (consistent with the most recent five-year average return of 5.1% as of June 30, 2016), and a two-year 50% supplemental contribution, the funded status of the Pension Plan will drop below 100% in 2020, and an additional $102 million will be needed by Although Mercer assumes a 7.5% investment return, a return of 5% in the short term would have an immediate impact on the Pension Plan s funding requirements. 1. Pension Task Force Members Pension Task Force During February 2017, the CSI Board appointed the independent pension task force. The Pension Task Force ( TF ) was intended to include individuals with significant experience and expertise regarding pension plans. The CSI Board appointed the following individuals to serve as task force members ( TF members ): Justin Bonestroo, an enrolled actuary from California. Jim Bruinsma, an employee benefits attorney and member of the CSI Board. Jim is from Michigan. -7-

9 Ralph DeJong, an employee benefits attorney from Illinois. Ralph is also a former adjunct assistant professor of employee benefits at the University of Notre Dame Law School. Dirk Pruis, a Calvin College finance professor and one of the Pension Trustees. Dirk is from Michigan. Randy Reitsma, an enrolled actuary from Michigan. Chris Veenstra, an enrolled actuary from Michigan. Jay Woudstra, a head of school from South Dakota. 2. Mandate to the Pension TF The CSI Board provided the following mandate to the TF: The Task Force shall assess the effects and implementation of the adoption of Amendments and of the U.S. pension plan, with an interim report no later than October 2017 and a final report no later than February The Task Force shall review Amendments and , including the data and calculations underlying them, and recommend the best retirement vehicle for the future for our U.S. schools. The TF members are not Pension Plan fiduciaries. Their role is limited to providing advice, and making limited recommendations, to the Pension Trustees, as the named fiduciaries of the Plan, and to the CSI Board on behalf of CSI as plan sponsor. Under this mandate, the TF was not authorized to retain an independent actuarial firm to redo or supplement the work already done by Mercer. This approach would have been very expensive and would have greatly extended the time for the TF to complete its work. Instead, the TF was charged to review the work already done by Mercer and request additional information as necessary to carry out its mandate. 3. Process Used by TF The following actions were taken by the TF in performing its work: Review of an initial notebook of background materials regarding the Pension Plan and the history of how it got where it is now. The notebook contained about 800 pages of materials, including all letters and s regarding the Pension Plan changes that were sent to CSI since Fall The TF members were also provided all other communications regarding the Pension Plan from CSI schools after the TF began meeting. The TF met on the following dates during 2017: March 9, April 11, May 1, May 18, June 14, July 11 and September

10 The TF requested the Pension Trustees to have Mercer prepare additional studies and reports to provide other information that would be relevant to both the TF and Pension Trustees. The TF members viewed the live stream of the meeting held by the Pension Trustees in Chicago on May 12, The purpose of this meeting was to provide updated information to the CSI schools regarding options for the Pension Plan. The TF reviewed a report prepared by the Pension Plan s attorneys regarding certain issues relating to PBGC insurance and required premiums. As previously discussed, in some situations, the PBGC insures some benefits in private sector ERISA pension plans if a plan is unable to pay benefits in full. Although Howard VanMersbergen and a Mercer representative attended the beginning of some meetings to provide factual information requested by the TF, they were not present during any deliberations by the TF. They also had no role in the decision-making process or in the preparation of this Recommendation and Report. Similarly, Joel Westa and David Dykhouse attended many of the TF meetings but did not participate in the deliberations by the TF. The TF acted independently. Recommendation by TF The TF members include five professionals who work extensively with pension plans. They understand the advantages to a participant of monthly pension benefits that continue for the participant s lifetime and may also provide a monthly survivor benefit. And they understand the financial efficiency to an employer of using a pension plan to provide retirement benefits for employees. See the Why the Plan Is a Good Value section in the September 2016 report to member schools entitled Keeping the Pension Plan Healthy. Despite these facts, the TF recommends the following to the Pension Trustees and CSI Board: The Pension Plan be hard frozen as of September 1, If this recommendation were adopted, no Pension Plan participant would earn any additional benefits under the Pension Plan after August 31, 2018, and no eligible employees would join the Pension Plan as new participants after August 31, Each existing Pension Plan participant would retain any benefits earned as of that date, and no additional contributions after that date would affect the benefits earned as of August 31, The participating employers would have an ongoing obligation to fund the benefits that are already earned. This means that required pension contributions would continue, and PBGC insurance premiums would continue to be required, even though no new benefits are being earned. 1 An earlier version of this Report was provided to the Pension Trustees and CSI Board for review and discussion at their respective July 2017 meetings. The CSI Board adopted a resolution at its July 2017 meeting which provided as follows: In lieu of the Task Force s recommendation for action effective as of September 1, 2018, the Task Force and the U.S. Pension Board of Trustees are requested to proceed with their deliberations and determinations for action (if any) to be effective as of no earlier than September 1,

11 The TF recommends that the 50% additional contribution be made for the plan year. CSI establish a multiple employer defined contribution ( DC ) plan as of September 1, The DC plan could be either a 401(k) plan or a 403(b) plan. If this recommendation were adopted, all retirement benefits earned or provided after August 31, 2018 under a CSI-sponsored plan would be under this DC plan. Each participating employer would have flexibility to determine the amount of contributions for its participants, and the amounts of these contributions (for all participants of a particular employer) could vary from year to year. The next sections of this report contain the reasons for this two-part recommendation. 1. Impact of PBGC Action Reasons for the Recommendation While the Pension Plan must pay premiums to the PBGC, in the TF s view, it is extremely important that CSI keep the Pension Plan as far away as possible from PBGC action: The Pension Plan cannot be terminated in a standard termination (under ERISA) because there are insufficient assets to pay all the benefits in full. This shortfall is currently over $550 million. The amount of this shortfall is based upon actuarial assumptions required to be used by the PBGC, which are much different from those used to determine the Pension Plan s funding (as an ongoing plan), especially much lower interest rates that are required to be used in a plan termination. It is unlikely that the Pension Plan can be voluntarily terminated in a distress termination (again under ERISA). A distress termination is permitted only if: The plan sponsor is bankrupt; or The plan sponsor is unable to stay in business unless the pension plan is terminated. The report from the Pension Plan s attorneys describes the lack of clarity regarding the application of these rules to a multiple employer plan. But that report concludes that the PBGC is unlikely to take over the Pension Plan unless each participating employer satisfies the financial distress criteria and the risk to the Pension Plan is imminent. If the PBGC were to voluntarily or involuntarily take over the Pension Plan, the PBGC would have a claim against the participating employers (including any entity under common control with a participating employer) for the amount the Pension Plan is underfunded (approximately $550 million). This potentially -10-

12 would mean that each participating employer would need to disclose all current and potential assets to, and negotiate a financial settlement with, the PBGC. Further, the participating employers would owe a termination premium of $1,250 multiplied by the number of participants in the Pension Plan. This amount would be due each year for three years. Based upon the Pension Plan s current 12,327 participants, the three-year amount is about $46 million. All or any part of the liability for the termination premium could be assessed against any participating employer. See pages in Exhibit 2. In short, a distress termination of the Pension Plan would be a financial disaster for CSI and its member schools. While CSI has been advised by experts familiar with the PBGC that it is unlikely that the PBGC would take any action before the funding status of the Pension Plan becomes significantly worse, it is important that the Pension Plan avoid any reason for the PBGC to become involved with the Pension Plan. If the PBGC were to take over the Pension Plan, it would affect the participants in the Pension Plan. The PBGC generally would pay participants vested pension benefits, but some participants would not receive all of their benefits: A participant who has less than five years of service would likely receive the portion of the participant s benefit funded by the participant s contributions (or, for employer contribution plan schools, deemed participant contributions). However, the participant would lose the opportunity to vest in the remaining portion of the participant s benefit that is funded by employer contributions and is unlikely to receive any benefit attributable to those contributions. This would affect approximately 2,500 participants in the Pension Plan. If a participant s rate of benefit accruals increased, the PBGC s guarantee of the increase is phased-in over five years. A portion of the increased accrual that occurred during the five years before the termination date would not be guaranteed. It is likely that the PBGC would apply this limit to increases in contribution levels (for example, from 4% to 5%). The PBGC guarantees benefits up to a specific maximum monthly amount. There are about 20 participants who may not receive their full benefit guaranteed by the PBGC. See pages in Exhibit

13 2. Pension Plan s Current Funding Status There is a wide range of actuarial assumptions (especially interest rates and funding methods) that potentially apply to a pension plan. For the same pension plan, there may be different assumptions for: Funding the plan on an ongoing basis. Determining the plan s funded status for financial reporting purposes (i.e., accounting rules). Being subject to, and calculating, PBGC variable rate premiums (see discussion in Section 5 of this Reasons for the Recommendation section). Determining the plan s liability if the plan were terminated and all benefits were to be settled by buying annuity contracts or paying lump sum amounts. Each of these approaches result in significantly different liabilities and funding statuses. As previously indicated, the Pension Plan is more than 100% funded under the CSEC funding rules. This is a good thing. But excess contributions may be required if the Pension Plan s funding slips below 100%. Because of the factors discussed in Sections 3 and 5 of the Background Information section, the Pension Plan s funding cushion in excess of 100% has been significantly reduced. By comparison, it is important to note that although the Pension Plan is 100% funded under CSEC, Mercer reports that the Pension Plan is $550 million underfunded on a plan termination basis (based upon current interest rates). Because the CSEC rules allow the use of higher interest rates to fund earned benefits over a longer period, they created an appearance that the Pension Plan is better funded than it actually is. Ultimately, all the benefits that have been earned under the Pension Plan need to be funded. The CSEC rules have legally permitted the funding to be delayed or smoothed out over a longer period. Whether over a longer period or a shorter period, the Pension Plan needs to be funded to reduce and eliminate the prior unfunded benefits. Further, although the Pension Plan s current 7.5% asset return assumption is net of investment-related expenses, it is not net of other administrative expenses. And when the Pension Plan s liability is measured, only the present value of future benefit payments to participants is included. Annual administrative expenses and the annual PBGC premiums are not included in the liability. While this certainly is an appropriate approach for many purposes, including calculation of PBGC premium liability and calculation of the Pension Plan s funding liability, the TF wants to recognize the current liability for these future, required, non-participant payments from the Pension Trust. The TF very roughly approximates the liability for these payments to be significantly greater than $100 million. Once again, the TF is not suggesting that the liability be increased by the present value of these payments that will continue to be paid annually through employer -12-

14 contributions. The TF merely wants to point out that their fixed nature is worth considering informally as a liability. 3. Too Expensive for Participating Employers The TF perceives that significantly increasing the Pension Plan s funding for an extended period of time is not affordable for the participating employers. This conclusion is based upon: The Plan is currently slightly more than 100% funded (and only slightly more than 100% funded) based upon the CSEC actuarial assumptions that are permitted to be used for funding purposes. These permitted assumptions include an assumed annual rate of return on invested assets of 7.5%, which has not been met over the past ten years. The Plan currently has a credit balance, which means that the contributions have exceeded the minimum required contributions in prior years. The credit balance can be used to offset any shortfall if actual contributions are less than the minimum required contribution. The credit balance has been used for this purpose in some recent years. It is important for the Pension Plan to have an overfunding surplus to use the credit balance. The Pension Plan s funded status has decreased from 118% to slightly more than 100% since September 1, See page 16 in Exhibit 1, which describes the reasons the overfunding surplus has been significantly reduced. This includes: The average return on the actuarial value of assets was 5.6% over the past five years instead of the target amount of 7.5%. Changes in the mortality assumption increased liabilities by 8%. PBGC premiums have increased over 500%. The result has been that annual costs have exceeded contributions by 20% since If the credit balance were exhausted and the actual contributions then are insufficient to satisfy the required minimum contributions plus annual administrative expenses, excess contributions to the Pension Plan will be required. This will require significantly increased ongoing contributions. Excess contributions are likely if the 50% additional contributions are discontinued after two years, as currently provided in the Amendment. See page 21 in Exhibit 2. And there is a significant risk of -13-

15 excess contributions even if the 50% additional contributions were continued indefinitely, depending upon the assumed rate of return and the number of schools that drop down one or two contribution levels. See pages 20 and 22 in Exhibit 2 and page 27 in Exhibit 1. More contributions are necessary to build the overfunding surplus to offset years when the combination of actual contributions and investment results are less than the necessary amount. Numerous s and other communications from participating employers expressed concern regarding whether they could afford the 50% additional contributions, particularly without the ability to drop down two contribution levels. Based upon Mercer s projections for future years, the TF members believe the 50% additional contribution would be necessary for an indefinite period of time if the Pension Plan were to remain an ongoing plan with new participants and new benefit accruals. Approximately one-half of the participating employers are reducing their contributions for the plan year by one or two levels, with most going down two levels. Here is the most recent information: 72 schools are staying at the same contribution level. Two schools are going up one contribution level. 23 schools are dropping one contribution level. 45 schools are dropping two contribution levels. The Amendment permits a participating employer to drop up to two contribution levels. This provides a way for the participating employer to at least partially offset the cost of the 50% additional contribution. However, the impact of dropping one or two contribution levels affects the Pension Plan s future funding. If all participating employers drop two contribution levels, the Pension Plan is not sustainable at a 7.5% annual investment return. See page 23 in Exhibit 1. Also, page 27 in Exhibit 1 states: The difference between maintaining the current plan percentage or dropping one or two plans may be the difference between being greater or less than 100% funded. Schools are limited in how much they can increase tuition paid by parents. And they are unlikely to be able to make excess contributions if there is a funding shortfall. Because funding contributions will nevertheless have to be made, any inability of some schools to meet funding calls would have to be satisfied by other participating schools. -14-

16 4. Assumed Rate of Return One of the actuarial assumptions used for the Pension Plan is that the investments will earn 7.5% per year, net of investment-related expenses only. Since 1987, the Pension Plan s average rate of return has been 7.6%. However, a Mercer study dated April 7, 2017 showed that the probability of achieving or beating a 7.5% rate of return over various periods from 1-year to 20-years ranged from 51% to 55% (see page 25 in Exhibit 1, and see information provided earlier in this report concerning the average annual rate of return for the previous three, five and ten years as of June 30, 2016). This means that there is a significant likelihood that the 7.5% rate of return will not be achieved. If so, any overfunding cushion could be eroded and excess contributions could be necessary. 5. PBGC Premiums PBGC annual premiums are determined based upon the following: A flat dollar amount for each participant in the plan. This amount is $69 per participant for the plan year, and will be $74 per participant for the plan year. After that, these premiums will be increased for inflation. For the plan year, a variable amount equal to 3.4% of a plan s underfunding. For the plan year, the variable amount will be 3.8%, plus inflation. The Pension Plan is currently slightly over 100% funded based upon the CSEC funding rules that apply to the Pension Plan. But PBGC premiums are based upon different assumptions, and the Pension Plan is significantly underfunded under those assumptions. For example, the PBGC assumes that the assets will earn an AA bond yield (closer to 4%) instead of 7.5%. As previously noted, the Pension Plan s PBGC annual premiums have dramatically increased during recent years. And these premiums are expected to increase to $9 million in a few years. CSI is working with other sponsors of CSEC pension plans to seek legislative relief from the large PBGC premiums. The goal is to have the PBGC variable rate premium calculated based upon the same actuarial assumptions that the CSEC law permits to be used for funding purposes. If this legislation were enacted, it would provide significant relief to the Pension Plan. But there is no certainty that a legislative change will occur. The TF believes that it is not prudent to assume that this relief will be enacted. 6. A Hard Freeze Significantly Reduces the Minimum Required Contributions The annual required contribution to the Pension Plan is based upon a series of expenses: Administrative costs, such as actuarial and investment management fees. PBGC premiums. -15-

17 The normal cost, which primarily is the cost of new benefits earned during that plan year. Amortization of any unfunded liability. If the Pension Plan were to be subject to a hard freeze, there would be no additional normal cost relating to additional benefit accruals that would need to be funded. This would substantially reduce the amount that must be contributed each year to satisfy the required minimum contributions. It is important to point out that the other three components of the annual contribution would continue to apply, and would continue to be subject to factors that increase those costs such as increases in PBGC premiums, lower-than-assumed investment returns, and increases in life expectancy. Mercer reports show that, with a 7.5% average annual return and under current PBGC premium rates, a frozen plan would still require an indefinite annual aggregate contribution of $17 million. If the average annual return were to decrease to 5% (consistent with the five-year average as of June 30, 2016), the indefinite annual aggregate contribution would increase to $33 million. These costs have to be met, even if the Pension Plan were completely frozen. Implementation of a Hard Freeze If the Pension Plan were hard frozen, ongoing contributions would be necessary for many years to pay administrative expenses and any unfunded liability. These contributions must be made by the participating employers because participants are not permitted to contribute without earning additional benefits. The implementation of a hard freeze is beyond the scope of the TF s mandate. Other Options Were Not Considered Viable The TF considered many other options during its review and deliberative process, and as it considered the information and data to request from Mercer. The principal other options (i.e., other than the hard freeze option being recommended) that were considered are summarized in the following paragraphs. 1. Status Quo (i.e., No Change from Current Structure) The TF recognizes that one option is not to change the status quo in other words, to continue the Pension Plan s active accrual status, to implement the amendments that were adopted in 2016, and to continue to monitor the Pension Plan s funded status. The TF does not believe the status quo is a viable option, either in the near term or in the long term. The May 12, 2017 CSI webinar slides indicated that, under the current structure (where active accruals continue and the 50% supplemental funding contribution is made for two years), if no schools drop down plan levels, the funded status of the Pension Plan is projected to drop below 100% in 2022 even if a 7.5% average annual return were achieved. If the average annual investment return, under this status quo scenario, were 5% (which is more consistent with the Pension Plan s history for the most recent three, -16-

18 five and ten years), the funded status of the Pension Plan would drop below 100% in And if the funded status drops below 100%, a significant additional funding contribution will be required (for example, an additional $103 million projected in 2024 if the average annual return is 5%). The TF further took into consideration the likelihood of other factors that would further erode the Pension Plan s funded status: that PBGC premiums are more likely to increase than to decrease or stay at current levels, that administrative and investment costs are more likely to increase than to decrease or stay at current levels, and that life expectancies are more likely to increase than to decrease or stay at current levels. All these factors would increase the cost of plan liabilities relative to plan asset values, and would make it more likely that the Pension Plan s funded status will go to less than 100%. Despite the changes that already have been made, the TF believes that the status quo is not sustainable, and that additional changes are necessary. The TF further believes that the 50% supplemental funding contribution, if made for two years only, is not enough to fundamentally alter the need for more significant change. As demonstrated above, even with the additional contributions, there is a significant risk of required excess contributions within the next three to eight years. 2. A Soft Freeze of the Pension Plan The TF members extensively reviewed the possibility of a soft freeze of the Pension Plan. Under this approach, the participants already in the Pension Plan as of August 31, 2018 (or some other date chosen for the soft freeze ) would continue to earn benefits under the Pension Plan (for changes in compensation and service after that date). However, no new participants would be permitted to join the Pension Plan after August 31, It would be necessary to provide benefits for these new employees under a DC plan. A soft freeze is attractive because it provides a transition from the current Pension Plan to a DC plan over a period of years. And each of the current participants continues to earn benefits under the Pension Plan. But, in the opinion of the TF members, the positive aspects of the soft freeze were outweighed by other considerations: If a soft freeze were implemented, the average age of the active participants will rise over a period of time. Further, the cost of new benefit accruals for older employees is much greater than for younger employees. As a result, the cost of new benefit accruals for the remaining participants is likely to increase. The current Pension Plan contributions that are funded as a percentage of participants compensation are likely to become inadequate. -17-

19 If no new participants are added to the Pension Plan, it will be necessary to fully fund all benefits under the Pension Plan before the last participant retires. This is likely to require increasing contributions over a period of time. In addition to the increasing cost of funding the Pension Plan, it would be necessary for the participating employers to make contributions to a replacement DC plan to provide retirement benefits for new employees. This cost is likely to be significantly greater than the cost saved for new employees in the Pension Plan (particularly for young new employees). This strategy essentially takes the least expensive participants out of the Pension Plan and provides them with a more expensive defined contribution amount. It is likely that the cost of a soft freeze would be the most expensive option available for the Pension Plan. 3. Continue the Pension Plan with Reduced Benefit Accruals Under federal law, it is impermissible to amend the Pension Plan to reduce benefits that have already been earned. However, it is permissible to amend the Pension Plan to reduce future benefit accruals. The Amendment reduces future benefit accruals from 50% of the participant s contribution to 40% of the participant s contribution, beginning September 1, The April 20, 2017 study from Mercer discussed alternative strategies to reduce the Pension Plan s future costs. One of those options was reduced future benefit accruals. The Mercer study stated that an optional reduction would be around 35%-40%. See page 20 in Exhibit 1. Despite that fact, the TF members received information from Mercer about the possibility of further reducing benefit accruals under the Pension Plan from the 40% rate that will take effect September 1, 2017 to a lower rate such as 15% of the participant s compensation. Mercer projected that the cost of an ongoing 15% benefit accrual rate would reduce the normal cost (i.e., the cost of funding the new benefits being earned) by approximately 50%. The TF members also received information from Mercer regarding the possibility of changing the method for calculating future benefit accruals. This alternative approach is based upon a cash balance benefit accrual. Under this approach, a participant has a bookkeeping account which is credited with a percentage of the participant s compensation earned during a specific year. The percentage would be equal to the participant s prior contribution percentage. This amount is increased annually for interest at a fixed rate tied to an external benchmark (generally a conservative fixed income rate typically not exceeding 5% per year). The TF members were initially interested in the cash balance approach because it provided a level cost for each participant s benefit accruals during a year, instead of variable costs based upon the participant s age. The cash balance approach would -18-

20 provide larger benefit accruals for younger employees and reduced benefit accruals for older employees. Based upon the specific formula for which information was provided, the cash balance approach also would reduce the normal cost by 50%. The use of a reduced benefit accrual formula had some attraction because it allowed all participants to continue earning additional pension benefits and new employees to become participants in the future. And if a participating employer thought the reduced benefit accrual was inadequate for its employees, it could supplement those benefits with contributions under a DC plan. But, ultimately, the TF members preferred to eliminate the funding risk associated with a normal cost, as well as to move the risk of investment loss from the employer to the employees (as in a defined contribution approach). This further reduces the amount that a participating employer will be required to contribute. It also provides more flexibility to a participating employer to determine the amount of additional benefits provided under a DC plan. Further, the TF members were concerned about a fairness issue. Many participants fund 50% of their benefits. If benefit accruals were further reduced to 15% of compensation, a significant portion of a participant s contribution would not be used to provide a substantial benefit for the participant. 4. Convert to a Church Plan If the Pension Plan were classified as a church plan, it would no longer have PBGC insurance or be required to pay PBGC premiums. The avoidance of the PBGC premiums would be a significant cost savings to the Pension Plan. CSI previously applied for church plan status during The request was pending with the IRS for many years and was finally withdrawn in about The reason for the withdrawal was that the IRS indicated that it probably would have denied the church plan ruling request. In addition, this occurred at the time the CSEC legislation was passed. Historically, the IRS had granted church plan status to plans maintained by churchaffiliated organizations. But beginning during 2013, there was a series of court cases which held that the plans maintained by these church-affiliated organizations were not church plans under federal law. The IRS was unwilling to grant a favorable church plan ruling for the Pension Plan, given the level of common bonds and affiliation between the Pension Plan and a church. But there was good news during June The U.S. Supreme Court overturned the prior holdings in the lower courts regarding the plans sponsored by church-affiliated organizations. It held that a church is not required to be the plan sponsor in order for a plan to be classified as a church plan. A plan potentially could be sponsored by a church-affiliated organization. -19-