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Pension Plan Reform (Maybe)

Pension Plan Reform (Maybe). Contributions + Investment return = Benefits + Expenses C + I = B + E. Recent Activity in California. Recent Activity – Round One. ACA 5 (Richman), December 6, 2004 ACAX1 1 (Richman), January 6, 2005 Jarvis Taxpayers Assn. initiative, January 5, 2005

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Pension Plan Reform (Maybe)

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  1. Pension Plan Reform (Maybe)

  2. Contributions + Investment return = Benefits + ExpensesC + I = B + E

  3. Recent Activity in California Recent Activity – Round One • ACA 5 (Richman), December 6, 2004 • ACAX1 1 (Richman), January 6, 2005 • Jarvis Taxpayers Assn. initiative,January 5, 2005 • Endorsed by Governor Schwarzenegger

  4. Round One: Richman/Jarvis Round One: Richman/Jarvis • NoDB Plan coverage for public employees hired after July 1, 2007 • NewDC Plan instead

  5. Round One: Richman/Jarvis, cont. • Opposition focuses on: • Survivor and disability benefits • Cost of closing DB plans • Employer organizations (counties and cities) develop reform proposals • April 8: Governor withdraws support

  6. Round Two: Legislature • ACAX1 8, April 14, 2005: “Hybrid” Plan • Actually a combination DB plus DC plan • Slightly higher contribution limits • No early retirements! • Normal is 65 general, 55 safety

  7. Round Two: Legislature, cont. • ABX 3, April 14, 2005: Pension Reform • CalPERS, CalSTRS, County systems • Benefit improvements for future service only • Minimum 5 year asset smoothing • No more ‘excess earnings” based benefits

  8. Round Two: Legislature, cont. • ABX 3, April 14, 2005: Disability Reform • No benefit if member takes a similar job • Benefit capped at 50% of pay • Offset in workers’ comp benefits

  9. Round Three: Pension Funds • CalPERS leading discussion • Longer asset smoothing periods • Longer amortization periods for gains/losses • Minimum contribution for plans in surplus • Pension Stabilization Account

  10. Terminology Issues • From ACA 5: But is it true? • DB: “System providing a pension benefit determined by a formula based on age, service credit, and final salary” • DC: “System providing a pension benefit that is equal to the combined employer and employee contributions plusinterest, less administrative expenses” • Tradition - and Webster - define “pension”: • “a fixed sum paid regularly to a person”

  11. Shift in Terminology • “DB vs DC” obscures the issue • The Nature of the Promise • DB: Income Replacement • DC: Capital Accumulation • The Basic Form of Benefit • DB: Income • DC: Account Balance • Fundamentally different, not interchangeable

  12. DB Plans in the USA • Corporate, Multiemployer and Public • Multiemployer generally “Taft-Hartley” • Larger Corporations have not abandoned DB • 346 of the S&P 500, 50% of Fortune 100 • Multiemployer: alive, stable and well • Public: DB still dominant, but under fire

  13. Pros and Cons of DB v. DC • Many Comparisons Available • Volatility of Investment Risk • Longevity Risk • Portability • Benefit Levels • Inflation Protection • Design Flexibility • Return on Investment • Expense of Investment

  14. Pros and Cons: Volatility Risk • DBInvestment volatility risk is on Employer (The “I”) • Diversification, smoothing, amortization • Note: only Diversification available to Members C + I = B + E

  15. Pros and Cons: Longevity Risk • DBLongevity risk is on Employer (The “B”) • Easily manageable at Employer level • Intrinsically unmanageable by Members C + I = B + E

  16. Pros and Cons: Portability • DB plans are not portable, but … • Reciprocity • Service purchases for “other gov’t svc.” • DC plans are portable, but there is “leakage” • Nebraska: 68% of terminating members cash out instead of rolling over

  17. Pros and Cons: Level of Benefits • Younger members need more time in DB plan to be better off than in DC plan, if one . . . • Assumes comparable investment returns • Assumes no “leakage” on termination • Assumes no “leakage” while employed • Hardship and other in-service distributions C + I = B + E

  18. Pros and Cons: Inflation Protection • Pre-retirement: pro DB for career members • Benefits based on “final pay” formulas • Post-retirement: pro DB for retirees • COLA’s • DC – requires purchase of CPI indexed annuities

  19. Pros and Cons: Design Flexibility • Pro: DB • Allows substantial benefits for later hires • Allows substantial benefits for interrupted careers • Survivor benefits • Disability benefits • Service breaks to focus on family

  20. Pros and Cons: Return on Investment • Cost of delivering benefits: Pro DB! C + I = B + E • DC plans have lower investment returns (“I”) • All studies – invest earnings 2% higher in DB plans • Diversified, professional asset management -DB • Overly conservative asset allocations • Inferior asset management

  21. Pros and Cons: Expenses C + I = B + E • DC plans have higher expenses (“E”) • DB investment and administrative costs 50bp • DC investment and administrative costs 150bp

  22. Q U E S T I O N S

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