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HomeMy WebLinkAboutDocumentation_Pension General_Tab 13_04/24/2006One Towne Square 248.799.9000 phone . Gabriel lZucrler Smith t~: C;c~mlrutl' 248.799.9020 fax - Suite 80U R ~ ~"""~'~"'~` ~` ~`~"''~"' Southfield, M148076-3723• www.gabrielroedeccom January 31, 2006 The enclosed GRS News Scan and Research Memo were developed by Gabriel, Roeder, Smith & Company to inform our clients and other be P fit on f f nd our about important events in the benefits industry. We hoe y information clearly written and useful'in your professiona'. activities. ublications electronically, send an email to To receive our p web admin(~i'>?abrielroeder.com with the message "SUBSC'RIBE_NF,WS SCAN" in the subject line. To stop receiving our publications via email, Sena the message "LJNSUBSCRIBE NEWS SCAN" in the same ~vay. Please turn to our web site at w_w~~'.g~1?~"-elr~eder.com foi other publications • related to pensions and benefits. Sincerely, ~~~~ Paul Zorn Director of Governmental Research Enclosure • ~~ I a ~ • The following news summaries were developed by Gabriel, Roeder, Smith & Company to inform clients and other benefit professionals of news in the benefits industry. Our thanks to Mary Ann Vitale for her diligent work on this issue. To receive this publication electronically, send an email to web.admin,'ci-~~abrielroeder.com with the message "SUBSCRIBE NEWS SCAN" in the subject line. To stop receiving this publication electronically, send the message "UNSUBSCRIBE NEWS SCAN" in the same manner. Copies of this and other benefit-related publications are available on the GRS web site at www Qabrielroeder.com. II~S L`pclates >Federal-titate 12efcrencc C:uide. On December 5, 2005, the Internal Revenue Service (IRS) announced an Federal-State Refere~ice Guide, providing guidelines for state and local Security and Medicare coverage, and related payroll tax withholding for government employees. Publication 963 is available on the IRS's website pdf'p963.nclf. 1't~)1., lst:cs 1:'inal fi~;F;21tr'~ i?cl;~slations update.. of Publication 963, the governments regarding Social state, local, and Indian tribal at: http~''•~+'~~'w• ir5 Gov/pub!irs- On December 19, 2005, the U.S. Department of Labor (DOL) finalized regulations implementing the Uniformed Services Employment and Reemployment Rights Act of 1994 (USERRA). USERRA is a federal law that establishes employment and reemployment rights for employees who voluntarily or involuntarily leave their civilian jobs to perform military service. The final rule covers both pension and group health plans as defined in the Employee Retirement Income Security Act (ERISA). Generally, employees who return to their jobs after military service have the right to the same seniority, status, pay and benefits they would have attained had they not been on military leave, provided certain criteria are met. Under USERRA, employers are prohibited from discriminating against employees on the basis of veteran status, military ,service or application for military service. Additionally, the DOL published final regulations requiring employers to provide employees with notice of USERRA's rights, benefits and obligations to be posted where employers normally place notices for employees. Both regulations became effective on January 18, 2006. The final USERRA regulations and Notice of USERRA Rights and Benefits for use by private sector and state government employers are available respectively on the DOL's website at: htt~ •~~w~~~dol<'o~`vet~~re«s ledre:;'fin•tl%USfRRA final Rule.p~ifand http ~~~~~a dol e~,~~'~'et5`prnRram,%u5crra:'[JSFRRA Pnvatc.pdi • 'The authors of these news summaries are not attorneys and the statements made are not intended as legal advice or opinion. Qualified legal counsel should be consulted to ensure plan provisions and documents comply with applicable laws and regulations. . ,~' ~#dif~r ~~ ..,'.~~~ ~.ai~El r L:~rl;i`: i~a~ ~ fStt+,~~~ ~~Si~;E 1 January 200~* • the PACE program costs the state $415 million to senior citizens who are ineligible for Medicaid. Currently, tans out of 29 rate but the Medicare Part D federal subsidies are a fp a tMedicareuprescnpt on' drug P ses. (nder the ope uali four or agreement, the state will identify and q fY available statewide) that will coordinate with PACE. 2005. Source: Bureau of National Affairs, Pension and Benefits Reporter, December 13, -d tii astt end Abuse RNA Publishes Special Relxn•t on Protecting )<9edicare Part D Plans Against F~.~i edicare rotectin M On January 10, 2006, BNA's Pension & Benefits Reporter featu ardtner wrthl WpeY Rein & Fielding LLP, Part D plans.. The report was written br vKirk,informaat onasecurity and insurance fraud issues. Despite the Centers or specializing in health care, compliance, p Y, 1 start date of the concern about fraud, waste and abuse (FWA) throughout the Part D implementation process, uidance before the January Medicare and Medicaid Services (CMS) had not issued F g lans from fraudulent practices and meet anticipan eCMn Part D program. In an effort to protect Part D p re uirements, Nahra outlines the top ten steps necessary for implementing an effective FWA comp P 9 The report also focuses on integrating internal and external anti-fraud efforts. Plans is available to Bureau of The Sky is Falling, the Feds are Coming: Top 10 Tips for Protecting Part D National Affairs subscribers at: http~~'~om 1lichigan Court Rules Coml~sny Cannot Eliminate Promised Retirie Health Benefits . ' i an cember 22, 2005, the U.S. District Court for the Eats a d older,oorhfor their survrvingtspouses and On De company cannot eliminate health benefits for retirees age Additionally, the court eligible dependents (Cole v. ArvinMerieduced aandlcane 11ed.r0etiree health benefi0ts in 200 erando200~ make • found that the company unlawfully r judge's injunction ordered reinstatement o ireese eurvivong spouses and dependeri sired th p Y full payment of health benefits costs for ret , e case involved an auto parts supplier in southeastern o erhigan. In 1962, the firm entered into a contraed - aid health benefits for retirees. These benefits Th with the United Auto Workers (UAW) establishing emp y P were im roved and expanded in later agreements. Then, in 2003 and 2005, the company unilateral y ca rccheir deductibles, co-payments, and out-of-pocket expenses. It P e 65 or over and fo -retiree dental and vision coverage, while increasing under Section 301 of also announced it would I mesaonseathe UAWtand sev eal ret0ireessuedtthe company spouses and depeement Relations Act (LMRA) and Section 301 of ERISA. the Labor Manag rantin the injunction, the judge cited precedents in bfoth retiree health c overage rwast duectlyrrelated th By g g recedents, whereby eligibility as the Golden-Meridian p licit lan ua e of the agreements ties retiree hea t pension entitlement. The court concluded that the "exp g g to erasion status and specifically promises, withouttion of retirement hat the health benefits `at the benefits p time of retirement...shall be continued thereafter' for the dura romise to provide lifetime retiree health benefits was reements and The court also established that the employer's p confirmed over several decades in numeCOUS documents such as collective bargaining ag n ted the company's argument that the contracts limit retot override summary plan descriptions. The court reJ enera] durational clauses do benefits to the durational clauses of the agreements and found that ` g specific promises of lifetime benefits." - eals. The company is planning to file an appeal with the U.S. Sixth Circuit Court of App • urce: Bureau of National Affairs, Pension and Benefits Reporter, January 10, 2006. So Page 3 k~:2QiQlEr-f.~alirit~l, F+.:~ucr, 1'~ a'~4~{~~1 j I • ~icc Credit'I'hruurh 403(h) end d>7(h) ~Transters . a ~er~ , Y 11.5 issues Letter Ruling nn Yurchasm~, rivate letter ruling (PLR 200550042) regarding s whether the 2005, the IRS issued a p issues: (1) On September 20, ermissive service credit" as ' ed b a govemmenta] plan. The IRS was arV ce't constituted `pkey tee-to- purchases proved Y urchased with direct trus plan's definitions of "other service" and "summ h tether the service could b m luded in the employee's gross defined in the Inte oin1403(b)uor 457(b) plans without the transfer being trustee transfers fr income. a overnmental retirement system that administers several contributory de me cers Plan Y), county employees, school The letter was issued to g to ees (Plan X), state police off ( p in one of more of Plan X provides that any employee partici attng benefit retirement plans for state emp y boards, and local governments (Plan Z). who has accrued at least 48 months of service at and who has at least 180 months of to anseN1ce may .the plans administered by the system prior to July 15, 2002, age 65 (or at least 60 months of service if under 65) urchasable under the p purchase up to five years of "other service" credit that is not otherwise p her education ear, may rovides that employees of schools, it fo~ le b thans~ 12rmontthstof service l~a rh Moreover, Plan X also p and who receive cred participating in Plans X or Z, to 3 months) needed to total one ye purchase the additional "summer months service" credit (up ice credit prior to July 1, 1992, half of the cost of the service credit may be pas for employees who have serv - by the employer. rovides that "permissive service credit" means servic srt cidant has not received Code § 415(n)(3)(A) p artici ant's benefit, which the P additional contribution lan for purposes of calculating a P p making a voluntary • governmental p artici ant may only receive by under the plan, and which the p p to fund the benefit attributable to the service credit. which does not exceed the amount necessary urchasing "other service to allow it only anent (in the public or private sector) that was not After discussion with the IRS, the system reriod oof employion for p reed that the plan's definition of "other if the purchased service corresp stemtoGiven this change, the IRS ag previously credited under the sy 415 n 3 A since it relates to an actual period of service" constituted permissive see lhas notlreceaved co edit under the(plan and which the member could only employment for which the memb contribution to the plan. purchase by making an additional voluntary "summer months service" constituted permissive service credit, la CeFurthermoreT The IRS also ruled that would not otherwise have received credit for the additional months of service un er t e p to contribution to receive the service credit. the member must make an additional volun ry or 457(b) plans, the .n urchases through direct trustee-to-trustee transfers fiom 403(b) rnmental 457(b) service credit p ermissive service credit within the Regards g dement or a gove arranb IRS found that since "other servicamountsstransferred fromsa 403(b) re oss income at the time of meaning of Code § 415(n)(3)(A), h a direct trustee-to-trustee transfer are not includible in a member s gr lan throug transferred amounts are used to pay the member's cost associated with P the transfer, to the extent that sue purchasing the service credit. not be ed that rivate letter rulings are only directed to the taxpayer requesting them and may It should be not P used or cited as precedent. • 1'agc 5 -~ ; 2ll-si - i;a?~ri::l, lt)~(1L'1'.:`+3iTl~h ~: 1:.'t,:Il~i'.Ilti Research Gabriel Roeder Smith ~. c°n,pa"~~ ~ Memorandum C;onsultantx ~ Accuarie~ January 31, 2006 From: Subject: Paul Zorn, Director of Governmental Research evelo meats Age Discrimination and Disability Retirement: Recent D P U.S. Sixth Circuit Court of Appeals ruled that disabilite Discrimina onftin On September 19, 2005, the em to ees did not violate the Ag Sheri s Dept, 6 Circuit, No. 03-6437 9/19/05). paid to certain Kentucky EEOCav. Jefferson County ff~ ~ Employment Act (ADEA) ( and Tennessee. The case is of interest becaa d to Michigan, Ohio, a discrimination means with reg The Sixth Circuit covers Kentucky, examines two fundamentally different perspectives on what ag benefits. a deputy retirement and disability claim filed by to meat Opportunity Commission (EEOC) Employees' The case stems from an Equal Emp Y erson County• Upon applying for disability benefits from the benefit because he was older sheriff in Jeff the de uty was informed he was ineligible for disab o ~' ions, employees who become Retirement System, P e Under the plan's disability p ears of ' than the plan's normal retirement ag . ears of normal retirement eligibility receive normal retirement benefits based on actub y al retirement eligibility receive additioner of ears disabled after service. However, those who are dtsabled before no e or 20 years of service), but not more than tel~ nb a for normal service credit up to normal retirement ag worked. As a result, younger workers who are disabled before becoming g already enefits than older workers who are eligible for normal retirement, even with retirement can receive hagd a u al years of service. the same final earning sheriff s claim and attempting conciliation, the EEOC filed suit m In 1999, after investigating the deputy alle in violation of the ADEA and naming Retirement Systems, and the Commonr,ealth of the U.S. District Court foriff s Departmennt,tthe Kentucky ky g co rt applied a previous "materially the district the Jefferson County Sher Kentucky as defendants. In deciding the c eals ruling (Lyon v. Ohio Education Association an indistinguishable" Sixth Circuit Court Ci E''P995). Professional Staff Union, 53 F.3d 135, 6 Lyon v. Ohio Education Association and Professional Staff Union Education Association with an early lan s onsored by the Ohio The Lyon case involved a retirement P Although eligibility for normal retirement rege irement at~age 60 . retirement provision called "Option B" to ee was eligible for early ears of service, under Option B an emp Y ears of service credit 62 or having 32 y 20 ears of service. Moreover, additional y disability with 5 y to ee has worked until age 62. As with the Kentucky ears of service, or after earning Y ears, as if the emp Y retirement were added to actual y 'o Education Association's early retiremenvopk r who retired under the early at norm plan, under the Oht ounger retirement age could receive lower benefits thae rs of service. s and y option, even with the same final earning to eat. b the Lyon court, there are essentially lowo forms of discrimination in emp urination er treats some employees less favorably than As explained Y in. "Disparate impact dtscn "Disparate treatment" discrimination occurs when o n tp'onal orig others because of their race, color, religion, sex, al advice or rovid~dl~cable laws and regu ations. • ' '1'}~e author of this me counsel should be consu ed regarding 9u~a°ns about a p opinion. Qualified legal . Page 1 p Cabriel, Roeder, Smith & Company 1131106 .~ ~ .. , Given that A's disability retirement pension woul earsathe Man al cloncludessthat theBbenefit are unequal. worked for the employer for the same number of y ~ to er would have to show that tt Since the benefits are unequal, the Manual goes on to say that the emp y costs as much to pay disability retirement to 55 year aldse rs o oservi eaitif an employer cannotsmake this pay disability to 30 year olds based on 30 addition y showing, it is liable for a violation of the ADEA.' Summary: Fundamental Differences As discussed earlier in this memo, the Lyon court held that a benefit based on credit for unworked service ees who start work to normal retirement age did not have d s ara~e impadr reflects the act that employ because o age. Moreover, the court held that any resulting p at an earlier age accumulate more years of service lan ties heamount of benefits provided toEhe number of with the Lyon analysis, stating.. Where a benefit p ears it will be before an employee reaches normal retirement age, it is explicitly age-based. This is facia Y discrimination that does not require additional proof of intent." In concluding its analysis of EEOC v. Jejj`erson Coun~ /line Sn the circulit~but addedathatea different result had a different result if the. Lyon case was, not con g would have troubling aspects. "Assuming ~anabl h worker pesires to accumulate aworking-irfe s wo 0 ant to rovide employees with assurance that such a retirement benefits, an employer might reaso . y `working life's worth' will be accumulated, against the risk that the employee will become disabled urmg his or her period of employment." The Sixth Circuit Court's opinion is at: htt :'!www.ca6.uscourts.sov;o inons. dfl0~a0397 -06. df ~ U.S. Equal Employment Opportunity Commission, EEOC Compliance Manual, Chapter 3, Section IV, D. October • 23, 2000. 2 EEOC Compliance Manual, Chapter 3, footnote 36. Page 3 1/31/06 ©Gabriel, Roeder, Smith & Company Gabriel Roeder Smith & Company ~ One Towne Square Suite 800 Consultants & Actuaries Southfield, MI 48076-3723 March 28, 2006 The enclosed GRS News Scan and Research Memo were developed by Gabriel, Roeder, Smith & Company to inform our clients and other benefit professionals about important events in the benefits industry. We hope you find our information clearly written and useful in your professional activities. To receive our publications. electronically, send an email to web ~dmin(n~gabrielroeder.com .with the message "SUBSCRIBE NEWS SCAN" in the subject line. To stop receiving our publications via email, send the message "UNSiJBSCRIBE NEWS SCAN" in the same way. Please turn to our web site at www a~ brielroeder.com for other publications • related to pensions. and benefits. Sincerely, `~~~. Paul Zorn Director of Governmental Research Enclosures 248.799.9000 phone 248.799.9020 fax www.gabrielroeder.com • arch 2006* M news summaries were developed by Gabriel, Roeder, Smith & Company to inform clients and The following .Our thanks to Mary Ann Vitale for her diligent other benefit professionals of news in the benefits induub cation electronically, send an email to work on this issue. To receive this p min abrielroeder.com with the message "SUBSCRIB~NE~SCRCIABE'NEW3 SCAN'i in theossazne wcL.ai receiving this publication electromcally, send the message Co ies of this and other benefit-related publications aze available on the GRS web site at manner. P •_,.:,.x, aabrielroeder.com. ~i'isconsin Legislative Council Publishes Public Retirement Systems Study er 2005, the Wisconsin Legislative Council published its "2004 Comparative Study of MaJor o ees In Decemb - ublic Em loyee Retirement Systems." The biennial su nd covers retirement benefits for genera emp y ucted since 1982, the study provides information P P tions, plan and teachers in 85 large public retirement systems. Co about retirement benefits, employer and employee contributions, actuarial methods and assump ceding, .and other relevant topics. • s stems covered more than 17.0 million active and ret~e~~p zinc eaansed 8 per en for the same In 2004, the y participants grew 2 percent from 2002 to 2004, while the number o ratio of active members to retirees declined from 2' ted as2foOlows? 24 in 2004. In 2004, the penod. The average funded ratio was 84.8 percent. Funded ratios were distn u 11 percent of the plans had funded ratios of 100 percent or more; 55 percent had funded ratios of 80 to 99 percent; 26 percent had funded ratios of 60 to 79 Per ercent; and 6 percent had funded ratios of less than 60 p 2 percent had funded ratios that were not determined. The study is available on the Wisconsin State Legislature website at: is.state.wi.us/lc/2 PUBLICATIONS/Other%24publications/Re orts%20B /°20Sub~ect/Em to h ://w•~vw.le timient%20and%20Occupations/04comparstudy.pdf Iowa house Approves Bill to Phase O~~t Taxes on Social Security and Pensions tate income taxes the Iowa House passed legislation (H.F. 2045) to gradually phase out s On January 31, 2006, eazs. The bill's sponsor, Rep. Jamie Van Fossen (R), on Social Security and retirement income over five y e le islation to address concerns that elderly residents as~e earng driven out of the state ue to introduced th g income tax on retirement benefits. He introduced similar legislation y • ttorne s and the statements made are not intended as legal advice or ' The authors of these news summaries are not a y le al counsel should be consulted to ensure plan provisions and documents comply with applicable opinion, Qualified g laws and regulations. Page 1 3/Z8/2UOG C~ 2006 -Gabriel Roeder Smith & Company tirement income for the first $6,000 tion on pension and re Income is ercent of So begs~g ~ 2007, an Currently, Iowa residents have a limited t~ ed filers. Additionally, 50 p these exemptions .would remain an ©ver the next four years, gle filers and first $12,000 for mare would be exempt from tax. t for all taxpayers. Under H.F. 2045, ercent of pension or retirement income Dints per year until 2011 when the state tax would be additional 20 p would increase 20 percentage p . uicome exempt from tax ated on pension and retirement income. a ers age 65 and completely elimin for elderly residents. TaxP Y le filers and rovides for a broader exemption from income tax t ension and Social fihe bill also p income tax if they have a net income of $36,000 or less for smg t from state net income, all otherwise tax-exemp P older would be exemp ed filers. In calculating $48,000 or less for marri Security income would be included. 'scal Services Division, the estimated cost for the state woul the Legislative Fi to about $2l0 million in lost revenue each year According to a fiscal note by lementation, increasing be $18 million in the first year of imp hase-out was complete. Searching for after the p :Jlvvw'~'~•1e is.state.ia.us/as X/Cool-ICE/Dis la Bills.htm Y H.F. 2045 is available at: h - •~HF2045 L,S. Cities Report Fiscal Conditions lmprov~ng hies released the results of its survey, City Fiscal Conditions a e of C fiscal conditions improved in 2005 for the first time On January 25, 2006, the National ~ ~ on of cities, tad found that, for the maj ~' ci finance officers reported their cities' fiscal conditico nt in 2005. The s Y e when only 19 P~ ercent of surveyed tY since 2001. In 2005, 63 P This is up draznatically from the 2003 surv Y, om the previous year alrnost 50 percent of U.S. otemrtaxes X26 P~~ n) S, unproved fr the past year, and increased p P reported similar improvements. Dunng services (48 percent) • including increased fees and charges for city e ed officials predicted their cirieco s~a~~ ~ar~onlcerns ear 2006, 59 percent of the surv Y Looking to fiscal y officials were cautious due Teal estate markets. Officialsloale from slowing u ward pressure on emp Y meet their financiI l erty taXHevenue~declnes resulting budgets, including P rovements, and about possible p P ativel affect city infrastructure imp identified severhae factors that could neg alth care costs, increasing Public safety needs, necessary wages, nsing increased pension and benefit costs. ~ 2005, the survey data was based on a a e,s ann a has been conducted since 1985. ual surv y The League advised Chats ~~and state aws The Le gu o ulations of 10,000 or more: onsibility, accounting Y S~npling of 276 cities with P P functional resp considered in light o re ~ utesnand expe d tares. which influence city •n S are available on the National League of Cities' website at. The survey finds g c iscalcondbrfp5. df h .JJwww.nlc.or content/Files/RMP e ar Aging Baby Boomers. Health Insurance Survey of Older Americans its report Health Coverag l i e the "boomers ), the Commonwealth Fund released older adults ages SO to 64 ( enditures of On January 20, 2006, a for working sis examined health insurance coverag a found that the health care exp The analy Danger adults. d focused on those with low and nthose of y comes. The surv an aging boomers are more than doub e • . Pace 2 200b -Gabriel Roeder Smith & Company 3/28/2006 ong the key findings for working older adults: osed with at least one of six chronic medical conditions (such as high .• • 62 percent have been diagn ~ 'Those with low or blood pressure, high cholesterol or arthritis). medical coverage. to er--based coverage. About 54 percent of 20 percent aze uninsured or have had troublo ha a emp y moderate incomes are significantly less likely orted a time when they were uninsured. This was also those surveyed with incomes under $25,000 rep ~ ercent of those with incomes between $25,000 and $39,99 . e case for 33 p sent more than $3,600 per year compared to only 16 55 percent of those with inde drov d d healthc are coverage. percent of those with employ P `,kill not be able to afford needed medical care in the future. 66 percent are concerned that they adverse health conditions. er risk of experiencing ocket health care costs may result in neglecting health. care needs, Older adults without adequate health insurance have a ~~ ave for retirement. To address these e and high out-of-p Unstable health coverag eo azdizing the ability of workers to s increasing medical debt, .and j P issues, the survey also examined support for several public policy solutions: caze and other non-covered health caze Establishing new Medicare savings accounts for long-term dicaze before age 65, plus a tax credit for health care costs; and, expenses; Allowing individuals to enroll in Me Disability Insurance to become ' ear waiting period for those on Social Security Eliminating the tWO Y eligible for Medicaze. would be interested in investing one percent of their income in a ercent of those surveyed said they would like to enroll in Medicare before age 65. Over 70 p ercentage said they Medicaze savings account. The same P _ . .. „~_.. ,.~+ ~nveraL~e akin _baby boomers.pdi The study is available at: n ~~~w°~ W •~""'"~-- SEC Documents Regardin ;Conflicts of Interest .for Pension Consultants EBSA Reviews of Labor Ann L. Combs released a letter written to ROeL eEmployee On February 3, 2006, Assistant Secretary D-~) confirming the Department of Labor's (D ) e Commission (SEC) regulations George Miller (D-CA) and Edward Markey ( Miller Administration (EBSA). review of Securities and Exchang Benefit Security ties of ension consultants. Combs' letter responded to the issues raised by regarding the fiduciary du P ension consultants. and Markey on conflicts of interest for p ension consultants' acrivities in accordancebwith statutes that contain differen le for administering and enforcing The DOL and SEC regulate p enc respons Act ERISA) in conjunction with the IRS and PBGC. definitions, authorities anRetirecment Income Security L a( y ws such as the Investment Advisers Act of Title I of the Employee and enforcing secunty la The SEC is responsible for administering 1940 (Advisers Act). e different fiduciary definitions under th re d tiered investmentRad ses is In the letter, Combs explained th ension .consultant who is a g clarified that endear thbuA~y not be a~fiduciary under ERISA. considered a fiduc ry, . of ERISA specifies that benefit plan fiduciaz~i SA ust act prudently and so e y considers a person to be a Among other provisions, Title I ' artici ants and beneficianes. Generally, in the interest of the plan s P •, en a es in certain "fiduciary" activities, such as exercising discretionary lan or its assets, without regard to title or position. Generally, fiduciary to the extent he or she g g or control over or control over the management of a p authority stered investment advisers who do not have sufficient authonty EBSA does not consider regi render investment advice with respect to plan assets for a fee or other plan assets to be fiduciaries unless they page 3 ~c~ 2006 - Glbriel Roeder Smith & Company. 3/28!2006 j t compensation. -She stated that a consultant's status as .a fiduciary depends on the particular facts and ~ircurnstance of the case. in interest" and that transactions between a plan However, she added that an investment adviser is a "party and a party in interest aze prohibited under ERISA t ensurenthat the re tions)uP betweenthe plan andllts fiduciary who hires or retains a service provider mus service providers meet ERISA's requirements for necessary and appropriate services with reasonable compensation. Assistant Secretary Combs' letter includes a fact sheet with tips to help plan fiduciaries select and monitor investment advisors and other investment consnlDants. ItP i ~(1Tletter%202.1.06.Udf Dercit .Reduction Act Increases PBGC Premiums. 8 2006, President Bush signed the Deficit Reduction Act of 2005 (DRA). According to the On February , Congressional Budget Office, the Act will reduce direct federal spending by $39 billion over the 2006-201 eriod, with over half of the reductions coming from changes to the Medicare and Medi Cod po atigran~s (Bl~) P billion), federal student loan programs ($8.3 billiori), and the Pension Benefit. Guaranty rp ($3.6 billion). In an effort to ensure the long-term solvency of the PBGC, after January 1e2007GC premiums for private- . sector pension plans. Effective for plan years beginning on o The annual flat-rate premium will increase from $19 to $30 anes participant for single employer plans and from $2.60 to $8.00 per participant for multiemployer p , The additional variable rate premium for underfunded pension plans will remain at $9 for every $1,000 of unfunded vested benefits; and, _ When a company transfers its underfunded pension p ean tears after plan terminationation premium of $1,250 per participant will be payable annually for thr y Several professionals specializing in private-sector pension Ranohere uotes Dal as Sallsburyupreside t of the effect on private pension plans. BNA s Pension`these increases, combined with changes m the variable rate Employee Benefit Reseazch Institute, as saying included in the .new Bush budget, will be weighed lfitsCounc 1, said he expected Congress to pass a more ahead" James Klein, president of the American Bene comprehensive bill that would supersede the PBGC provisions in the DRA. Source: BNA Pension & Benefits Reporter, February 14, 2006. CRS Updates Social Security Reforru. Issue Brief 23 2006, the Congressional Research Service updated its Sociand the Bush Administration have On January , Congress. According to the report, over the past several months Congress been focusing on budget reconciliation, federal relief for hurri vans S cl 02, the Stop thettRaid oneSocial Social Security reform. The most recent legislative proposa ersonal accounts funded by surplus Social Security Security Act. This legislation would establish voluntary P benefits based on the assets accumulated in the tax revenues -with reductions in traditional Sociilo Sosaa s included iii the report were: personal accounts. Other Social Security reform p p • isan Retirement Security Act-creating mandatory individual accounts funded by payroll taxes Bipart benefits. and modifying traditional Social Security Pa ;e 4 3/28/2UU6 ~ 2UOb -Gabriel Roeder Smith & Company - Individual Social Security Investment Program - -creating voluntary personal investment accounts financed by redirecting payroll taxes and modifying traditional Social Security benefits. • - Social Security-Forever Act -requiring wprkers and employers to ,contribute 3 percent of earnings above the taxable wage base and extending the pay-as-you-go requirement under the Balanced Budget and Emergency Deficit Control Act. - Growing Real Ownership for Workers Act - to revenue t the a countOsW" accounts for workers bom after 1949 and applying surplus Social Secunty Source: BNA Pension & Benefits Reporter, February 14, 2006. Seventh Circuit Rejects Retirees' Claim to Trial on Lifetime Health Benefits On February 8, 2006, the U.S. Court of Appeals for the Seventh Circuit ruled that retirees of the Ameren Co oration were unable to show that a "patent or latent ambiguity" existed in prior collective, bargaining rp g peals court affirmed the agreements that would entitle them ands found that the retirees were no entitthled to a trial on their claim. district court's summary judgm (Barnett v. Ameren Corp., 7`~ Cir., No. OS-1496, 2/8/06). was created in 1997 through the merger of two companies, both o ~~ute existed ag both companies, Ameren of providing health benefits to retirees. For at least a decade, an ongoing P them as with management claiming the right to change or terminate health caze benefits and retirees claiming lifetime benefits. While some changes were made to retiree health benefits before 2003, the changes did not provoke a lawsuit. In 2003, however, retirees sued when Ameren announced mieums bl 2009 tWhile the retirees acknowledged insurance premiums and SO percent of their dependent s pre Y • the overning bargaining agreement did not unambiguo ent tle them to a trial onetheir~claim. The retir~s g agreement had "patent and latent ambiguities that woul az ed that a patent ambiguity existed in a 1993 Stipulatio at for~1995 and "all subsequent years"Yretirees "vested service" to be eligible for retiree health care and would be required to pay 20% of the monthly major medical premium for dependents. The retirees also ar ed that a latent ambiguity existed because the agr Dm~ictpCourtefo~the Southern Districtof Illino s ~ the az ents, the changed by Ameren. Afteran ed s mmar}' Judgment to Ameren. found no ambiguities and gr In reviewing the case, the appeals court noted that the 1993 Stipulation was followed two months later by a . Supplementary Agreement (SA) providing that the company would "take such action as may be necessary to modify and to continue for the life of. the Labor Agrei mentferences toe `the yea~r1995 and all subsequent Moreover, the SA rephrased the benefit provision, remov g ears." Given that the SA allowed the company to change °e ected the retireesef claimeof atent ambiguity, Y that the benefits were not vested. The appeals court a so ~ holding that health benefits do not vest simply because a company had not reduced them in the past. The decision is available at: htm //caselaw lv findlaw com/data~/cires/7th/051496n.vdf Colorado Senator Introduces PERK Reform Legislation n Janu 31, 2006, Colorado Senator David Owen introduced Sen1ee o ied that6his b llf was supported by O ~' Senator Owen p Public Employees' Retirement Association (PERA). the overnor and state treasurer and would reduce PERA's $1 w uld•n shortfall more rapidly than the other • g proposed legislation. Under SB 06-162, the legislative changes pa ;e S , CD 2006 -Gabriel Roeder Smith &. Company 3128/2006 ~. • • i a e and service requirements for new hires to 35 years of service i ears of service at age 65. 'T'his change would • Increase the retirement eligibil ty g e 60, or 5 y 1, 2007. • regardless of age, 30 years of service at ag 1 to current members under age 40 who are not vested as o anuary also app y monthly benefits for new hires unless PERA is overfunded • Prevent annual cost-of-ro ed by at least two-thin of the board.~e defined benefit plan.. and the increase is app lan rather than ; oin a defined contribution p 3 • Allow new hires to j er board of trustees with an 11-member boE dom. m mbe sand r tiree cand four Replace the 16-memb the state auditor, the state treasurer, five members elected by members appo~ted by the governor. • Require PERA to hue an internal auditor. ~-house counsel, to provide legal advice to the board. Require the state attorney general, rather than Affairs committee and is available by SB 06-162 has been assigned to the Senate State Veterans and Military -162" at: h :/lwwv'•co ra.or era/aboutlle islationl20061e islation.stm selecting "Senate Bi1106 Colorado PERA Proposes Pension Reform Package ro osed a package of PERA) P P the actuarial to ees' Retirement Associ~c Pants while improving In late 2005, the Colorado PubloiteCEtmhe benefits of current~pfo Pent ("Tier 1") members and create a legislative reforms intended to Po sal would limit "spiking 1, 2007. soundness of the fun defined ben fit plan for employees hired on ar after January second tier ("T1er 2') est Average Salary (~S) ercent of High i~g°+ by ears of salary. The proposal would limit "sp For current participants, retirementb sed lon three lyulated ~ 2' p uld be effective for benefits on or times years of service, with HAS This change wo the limit on salary increases included in HAS• tightening • after January 1, 2009. ember 31, 2006, Tier 2 retirement benevfiots would be calculated as 2. uld be no guaranteed cost-of- For new participants hired after Dec ears of salary. In addition, there aranteed 3.5 percent percent of HAS, with HAS based on five y anticipants receive a ~ ercent for ercent of pay, compared with 8 P living increases after retiree contribultions for Tierh2 would be 7 P new members, the proposal would limit COLA. Moreover, employ a 45 and for Tier 1. Also, for current PERA members under ag PEgA's subsidy for retiree health premiums. or Paula Sandoval introduced pension reform legislation (SB 06-174) On February 6, 2006, Colorado Senat + ' 'ons. The bill has been assigned to the See aslation/20061enslatioM~~ containing many of PERA s provisi :~~~,N, co era.or cra/about/l Affairs Committee and can be found at: h selecting "Senate Bi1106-174." ministration Proposes HSA Policy Initiative in Fiscal Year 2007 Budget d a olicy initiative Bush Ads _ 006 in his budget proposal for fiscal Ye on tr0ainphealth care costs and reduce O1eri to health On February 6, 2 + as a way to c P contnbutio to expand health savings accounts (HSAs) The estimated cost of the new HSA . HSAs are designed to help individualhealthf laps (I•IDHPs) x enses using uninsured -deductible P savings accoound be $ 56 bill on over 10 years. The proposal would: incentive w ocket limit for the participants' ise the maximum annual HSA contribution to equal the out-of-p Ra this would increase the m~cimum ~0 450 t $1Ot500 for famiy ~Hp. If implemented in 2006, account from $2,700 to $5,250 for individual coverage and from $5+ eli ible for • savings a number of months the individual is g coverage; • .Prorate the maximum HSA contribution based on BHP coverage; Page 6 (~ ZU06 -Gabriel Roeder Smith ctir. Con~Pany 3/2812UU6 • Allow a refundable tax credit for a portion of after-tax contributions made to an HSA. The tax credit • would be the lesser of 15.3 percent of a taxpayer's after-tax contribution to the HSA or 15.3 percent of wages subject to employment tazirs. The purpose of the tax credit would be to offset employment taxes on the HSA contributions; • Provide a tax deduction applicable to the premium costs for the HDHP. The proposal also includes a modified tax credit for low- and moderate-income taxpayers. While a previously proposed low-income tax credit would have applied to a broader range of health insurance products, the current proposal would only apply to HSA-eligible HDHPs. The proposed maximum credit would be $1,000 for individual coverage and $3,000 for family coverage, up to 90 percent of the HDHP's premium (and further limited based on the individual's annual income). One-third of the credit could be used to fund the HSA and the rest to pay the insurance premiums. Currently, the insurance industry estimates about 3 million people are enrolled in HSA-compatible HDHPs. According to the Administration, nearly 37 percent of those were purchased by people who were previously uninsured. The Administration predicts that with the proposed policy changes, 21 million HSAs will exist by 2010, compazed with 14 million HSAs otherwise. Source: BNA Pension & Benefits Reporter, February 14, 2006. GASB Announces New Pension Research. Project In January 2006, the Governmental Accounting Standazds Board (GASB) added a new project to its research agenda. Responding to concerns about the funded status of state and local pension plans, the project is intended to open up a broad discussion regarding accounting and financial reporting for governmental • retirement benefits. Specifically, the project is designed to review GASB Statement No. 27, Accounting for Pensions, by State and Local Governmental Employers, regarding its usefulness for: Assessing the financial implications of governmental pension benefits and of managerial decisions regarding those benefits; and Making decisions about the value of benefits, proposed changes in benefits, and funding of benefits. Although not discussed in the project description, the project will. likely examine pension accounting issues currently under review by the Financial Accounting Standards Board (FASB), including: the appropriateness of asset- smoothing methods, selection of actuarial assumptions, and inclusion of the unfunded actuarial liability on the face of the financial statements. In conducting the study, the GASB will request comments from government officials, retirement system boards and staff, plan members, actuaries, auditors, bond analysts, investors, and taxpayers. The GASB expects that conclusions drawn from this project would also be applicable to other postemployment benefits. The project is described in the GASB's First-Third 2006 Technical Plan and is scheduled to continue through December 2007. The Technical Plan is available at: http•//www.gasb.org~ech/techplan.pdf • 312$/2006 ©2006 -Gabriel Roeder Smith &. Company Page 7 Research Gabriel Roeder Smith &. Company ~~ Gonsulrams 6t Aauazies Memorandum RE: Methods for Stabilizing Public Retirement Plan Contribution Rates FROM: Paul Zom and Brian Murphy DATE: March 28, 2006 A major goal in actuazially funding a retirement plan is to accumulate monies in a systematic manner so that contribution rates remain reasonably stable and the funds can earn long-term investment returns. Stable contribution rates are an important component in funding retirement plans, since they help governments budget effectively for plan contributions. BACKGROUND In the eazly yeazs of state and local retirement plan development, asset levels were very low, and investment volatility did not affect contribution rates to any great extent. During those years, it was common for plans to invest funds very conservatively, principally in government bonds or other high quality fixed income instruments. Investment return assumptions were low, perhaps in the 2% to 4% range, and contribution rates were high, but relatively stable. As time passed, asset levels grew and investment practices changed with a higher portion of assets being placed in common stocks. Accordingly, asset allocations became more aggressive and investment return assumptions rose to the 7% to 9% range. Contribution rates dropped remazkably but, as asset levels grew, the rates became more volatile. During the 1980s and 1990s, contribution rate volatility was not seen as a problem since strong investment returns meant contribution rates were falling. Serious up-side volatility in contribution rates became an issue following the poor equity returns that affected most investors from 2000 through 2002. When plan sponsors moved heavily into common stock investments and increased assumed rates of return, they were making a fundamental trade-off: low but stable investment returns were exchanged for higher but more volatile retums. Unfortunately, because the tradeoff was made gradually over time, the volatility effect was not immediately apparent. It now seems unlikely that many pension plan sponsors will want to reverse the trade by moving away from common stocks and lowering the assumed investment return rate to 4% or 5%. Doing so would help stabilize employer contribution rates, but would require a major contribution rate increase or a major decrease in retirement system benefits, or both. Moreover, it would also sacrifice some of the higher returns that are believed to be available in the equity maikets, even when measured on a risk- adjustedbasis. Given that the tradeoff is not likely to be reversed, .what can be done to stabilize contnbution rates? To mitigate the effects of short-term investment fluctuations on contribution rates, actuaries currently use a number of techniques, such as asset smoothing and amortizing unfunded actuarial gains and losses over long periods. These methods have worked well for most of the past 25 years when significant declines in investment returns have been relatively short-lived. For most of those years, investment volatility was largely on the up side, and was viewed as good news. Pension contributions could be reduced or benefits increased, or (in some cases) both.. Some employer contribution rates went to unnaturally low levels, below the plan's ~ During the 1980s and 1990s, state and local governments benefited substantialiyfrom funding their retirement plans. According to the U.S. Census Bureau, public-sector retirement plan investment earnings totaled $1.65 trillion from 1981 • to 1999, or approximately two-thirds of all plan receipts. As a result, the funded ratios of public plans grew from an average of 81% in 1990 to 104% in 2000, and employer contributions rates declined from an average of 14.4% of payroll to 10.6%, as shown in Public Pension Coordinating Council surveys. © Gabriel Roeder Smith & Company Page 1 3/28/06 al cost rate of 25% of payroll, a somewhat extreme example, m one Plan wig a norm " rate? As r contribution rate to be reduced to 2% of PaYTOll. usual event in ~l cost ecmitted the employe d an un.. °. ° °~ the funded ratio p a shock W financial markets an iOXirnately 43 / a high stocks fell apP ou h 2002 wasS• large company er the value of U. $ecause of the investment to t were built The stock market decline from 2000 ~ g cession. loses tha Over those three Yew' a Great Dep articular, asset sure U,S. history. ent laps. In P Tans that had taken contribution largest and most sustzuned decli~ea to fund rettrem p ension p e ercentage t ps a result, p with larg P employer contributi1990s evaeorated almost overnigh • to Very low levels were faced P up in the 1980s andowed the contribution rate to diOP hOUdays or had al tes. ~ o a roll now requtres contribut1On ra to of 2 /o of P y ~e~onable for increases in a contribution ra • umstances, the Pl~ mentioned earlier with 2000 through c ear. ~Iltile a 40% contribution is e t declines fromd COnrribution Under these ctr y iven. the investor ual ReQuue to er contribution rate of 40 /° per Y es eciall g all determined Ann an emp Y Tan's actuari y vestment results and the need for higher a Tarr whose normal cost is 25% of payroll ( P °or m making it difficult to P increase by a factor of 20 in the P d local governments, it is an economic forces that lead to p 2pgC). Unfortunately, the same revenues for state an pension contributions DSO tend to reduce tax methods may with the higher contributions. al smoothing come up traditional actin Tan is moving from being vestment decline occurs, acticularly if a p actuaries nificant and prolonged in When a sig overnments stabilize eth ~ uas discussed in this elves, be sufficient to stabiles o dew ooh lp gtes - stabilization m miti ate the large not, by hems to bein8 `underfunded. additional ue would be able t ~ e~ ~e GASB's related "overfunded" rofessionals are ss do Ong techniq eOUSIy and °ther retirement plan P likel that any and simul~n while tt is un y ing of this decade memorandum. ed at the begmn investment losses tha4 occurr TION METHODS stan~Tds ~~ there are several methods that can he p• STABII,IZA • accounting G CONT~BUTION UATIN es. In order to make an CRITERIA FOR EV~'I' advantages and disadvantag ,These include: are the particular methods against relevant criteria. ent contribution stabilization methods have vaz'Ying and stable from year to Differ it is imp°ctattt to comp informed decision, at are predictable ethod produce contribution rates ~ d the pcocnised Stability: Does them at are sufficient to fun • method a11o~*' for contribution rates ~ al liabilities year? a unfunded actuari Sufficiency: Does the ortize th contribution rate foamovernmenml plans? benefits? Hance: Will the resulting standards g er nor lower than • GASB COmp der the accounting • the period allowed un thod produce contribution rates that are neither hi erl ing financial within d other and Y pp~roum Rates: Dpetermep e eriod? necessary over a long' Does the method Produce contribution rates Reasonable Results: ective observers? ° es that apPeaT reasonable to obj to the measuc 'service f benefits earned by plan members as a result of members dicate plan Tan's "normal cost" is the cost o listic convenience to in tes, it is ~ A pension p ear. "underfunded" are used for sty Ve "excess em Toyer during the current y „pVe~nded" and ectively• As the recent inveosVe~naedt or tolha a er, Tan liabilities, tesp liabilities to be a ear fro ~ ~ hroughout this p P ~e terms be ~nde~nded' y m no ater than or less tlia ~I?~ assets that are greater th d d„ today may assets that are ~ plan that is "overfim could exceed the i~ccucate to consider retirem ship ddenly• p could show assets" since asset values may ortize the plan's unfunded actuariallOCerus ~uian alYrepo~ the period used to am u oses. if so, the emp Y . • and vice versa. tions, 4 In extreme situa the GASB for financial re en is financial statements. page 2 _ m~cirnum established by in ~e,goveriim ension obligation as a liability Company a net p m Gabriel Roeder Smith & 3128106 The remainder of this memorandum discusses the advan ome ar sdthe ~ ~ ~ wig the pre ousoly mentioned • otentiall help to stabtlize contribution rates. Table P P y critcria. CONTRIBUTION STABILIZATION METHODS Fixed Contribution Rates Probably the most straight-forwazd approach to stabil ed b csevetraltstate nand local retirement systems, where percent of payroll. Currently, this approach is follow y employer and (often employee) contribution rates ~ldeghtelaiazvlelac~ix~~ valuations allow the_amortization order to maintain contributions that are. suffictent to P eriod to vary, up to the maximum amortization period established by the Governmental Accounting P Standards Boazd (GASH).. The advantage of a fixed contribution rate is that it is a straight-forwazd approach that could stabilize contributions in most, but not all, circumstances. One d c d~ an ~ ~es~isk ewe o factored inl invaestment set at a level that factors to the risks of extreme market declines, like those from 2000 through 2002, could] contribupons' azeannot~adjusted tol equal~thebactuazially actuarially determined contributions. If the actua detemvned contributions, the result could be an additional accounting liability for the employer. ~~ s If Perhaps a fixed contribution rate could be a ra t a level that factors to the risk of extreme market ~ uch a to but its level might be too high to be politically sustainable so, there would be less need to change th , iven the fiscal pressures governments typically face. While there may be jurisdictions in winch s • g ht be im ossible in other jurisdictions. solution would work, it mig P Limiting Annual Changes in Contribution Rates olic Under this Another method for limiting fluctuations in ou h°thee re°uement system's funding p ~y.al change a contribution rates, either by legislation or thr g approach, state statutes (or local ordinances, plan provisions, etc.) would provide that contribution rates cou not increase by more than a specific amount (e.g., one-half of one percent) from one yeaz to the next. The advantage of this approach is that contribution disadvantageadj that th ~~te con ibutionrate canhange slowly accommodate changing circumstances. The even laz er future increases in employer could be less than the actuarially determined rate, possibly requiring 6 g contributions, and possibly producing an additional accounting liability. Funding Corridors Under this approach, employer contribution rates remain fixed while the plan's l~emdlo er contrib Lions e and change when the ratio falls outside of the range. For examp P Y established rang , could be fixed while the plan's funded ratio is between 9 rtlze tdhe underfunded (or overfunded) liabil ties ovver (or above 110%), the contribution rate is adjusted to azno a set period (e.g., 30 years). A plan could also use multiple corridors in order to amortize the liabilities over ifferent eriods. In the above example, if the plan's funded ratio fell below 80%, the unfunded actuarial d P liabilities might be amortized over 20 years. 5 An asset-liability study that forecasts the effects of prof t of nvestment volatil'ty toms on plan contributions would be • tun o lima] fixed contribution rates m hgh helpful for se g P s See footnote 4. page 3 3/2S/06 m Gabriel Roeder Smith & Company roach is that it stabilizes contribution rates while allowing adjustments that reflect e of this app and a ainst plan underfunding or overfunding. • The advantag Conse uently, it helps to gu g the plan's funded status. q ed to reflect current circumstances,,it is unlikely the rate would Moreover, since the contribution rate is Chang liabili could be created. j r too low over the long term. However, unlesseon~ a Co~°~g to is i ri ally based on w at be set too /ugh o would be required at the low end of the funding corridor, an ash ad'ustrnent when the corridor boundary is e is that the contribution rate might requtre a arp J A disadvantag low e , 70%) significant unfunded liabilities cool crossed. For example, if the lower boundary is very ('g' ded liabilities would likely result in a the sunortization of unfun build up before it is reached. Once crossed, t not be possible to achieve. sharp increase in the employer's contributions, which migh Asset Value Corridors Asset smoothing is used in the roach is used in conjunction with asset smoothing. eaz-to- ear investment Another corridor apP state and local retirement plans to reduce the effect oars and losses in the yeaz actuarial.valuations of many all investment g sins and losses gradually, typically over athree- to five-yeaz fluctuations on employer con eC u~~s t~~l g ad of recognizing they occur, asset smoothing period, thus diminishing the effect of mazket fluctuations on contribution rates. e investment has worked effectively for most of the last 25 years. However, when lazg Asset smoothing colon ed eriod, the smoothed value of assets can diverge significantly ket value. To protect against the misalignme ~ d smoothed and market asset values, an arse declines (or increases) occur over a p g P value could be prevented from going below from the mar le, the smoo value corridor may be established. For examp 90% or above 110% of the market value. this a roach is that it allows asset smoothing but maintains asset values relatively close to An advantage to PP revents the plan's funded ratio and contributionlan is exposedoamarket • market values. Consequently, it p e is that the p assets values that might be seen. as unrealistic. A disadvantag fluctuations when the boundary is crossed. Extending Asset Smoothing Periods extended successive periods of market declines also lengthens the period over which Asset smoothing dining are factored into contribution rates. While this creases Severaltgo eornmentsbhavenrecently investment losses stem also prolongs the period over which employer co le ithe California Public Employees' Retirement Sy eriods. For examp eazs to 15 years.' Moreover, it widened its extended their asset smoothing p g eriod from 3 y (CaIPERS) has lengthened its asset smoothie p 'ts for establishing the actuarial value of arse efrO ex0ectedOto reducee annuallvolat Sty in asset corridor loco 120°/a of market value. This, combined with several other Chang , employer contributions by more than 50%. airs and the smoothing period is that smaleer eo od wo ld likely x tend over at least a The advantage of extending losses are incorporated in the contribution rate. Since this long rior market upswings. The disadvantage is full economic cycle, market downswings would be mitigated by p value could become signiftcantly different fro ket valuekexceeds the smoothed value~f g that the smoothed le, when the mar conflicting signals about plan funding. For examp d history shows that pressure builds to spend valueiffe le Se~ther~be smoopthoed v a ue for an an extended perio , pressures when markets reverse. Moreover, when the mar et 2005. The other changes " March 15, "CaIPERS Advances Employer Rate Stabilization Plan, ear establishing a minimum ~ CaIpERS Press Release, ear eriod (instead of 10% per y ), include amoRiz-n8 Sams and losses over a rolling 30 y P rate for all employers equal to one-half of normal costs, and establishing "stabilization accounts" to serve • contribution reserve~funds. ~ page 4 p Gabriel Roeder Smith & Company 3/28/06 'od there may be the criticism that reality is being ignored. In this situation, establishing an tended pen , asset value corridor would help to address these issues. Asset Allocations that Minimize Investment Volatility ed at the beginning of thts Paper. This method is a partial step towazd "undoing the tradeoff' that was discuss ' investment return is a function of asset allocations et asses Although asset alocatiorthd°rnot Volattltty m ranges of returns and have different correlations with o era lan assets can be `matched guarantee returns, they can be used to diminish investment volatilityoMocantr''buttons. with plan liabilities in ways that further reduce the volatility of emp Y ossibl saving the plan Y An advantage of this approach is that it addresses investment: volatility at its source, p stment losses. A disadvantage is that asset allocations that reduce risk aze alct~ta~yll wer risks from large rove es to the allocation may return. However, if the current allocation is inefficient, c ang es on roach is taken, the investment return assumption needs to be reconsidered. while increasing returns. If thts app in the likely effects of asset allocation Chang Again, anasset-liability study would be helpful for examin S investment returns. Linking Employee Contributions to the Plan's Financial Position a wtth the to ee contribution rates are fixed by statute or l~el lan antes all of the tnvanestment risk. In most cases, emp Y Conse uently, the employer sponsonttg P plan's financial status. q to ee contribution rates to reflect investment earnings. This can be done However, some plans adjust emp y ercenta a of required contributions for the yeaz (e.g., either by requiring employee contributions to adua adjustments. more gr 40% of the normal cost), or by makutg this a roach is that it distributes the cost of ni maneas~s lowers tthe a erage costto . • An advantage of PP population, including those who dtrectly benefit from the rettrem P taxpayers (although increasing it for plan members). to ee contribution rates may result in unexpected financial One disadvantage is that large increases in emp Y increases to compensate. Moreover, if employee pressure on active employees, who may then call for salary to ment. In these circumstances, contribution rates are already high' they may act as a disincentive for emp Y the employer may have difficulty attracting and retaining qualified employees. Linking Retirement Benefits to the Plan's Financial Position the costs of investment volatility with plan members is to link retirement benefit state and local retirement plans provide cost-of-living Another method for sharing osition. Many adjustments with the plan's financial p benefits from inflation. In some adjustments (COLAs) to retirees and beneficiaries as a means of prs oicaz made on an ad hoc basis when the cases, these adjustments are linked to the plan's investment earning osition is judged sufficient to finance the COLAs. This allows a portion of the benefits to be plan s financtal p directly related to the financial health of the plan. roach might combine a relatively This could be extended further. For example, a flexible defined benefit app er ear of service) with a variable benefit based on low guaranteed benefit (e.g., 1% of final average salary p Y Y lied b some state and local erformance or other factors. This approach is currentl app Y investment p vemments that have hybrid plans or that combine defined benefit and defined contribution p ans. a shared go advanta a oflinking benefits to the plan's finanef'~Pofttma lcethin reasesS~Af disadvantageis that if the ~ g while also sharing the ben with plan participants, ine is rolonged, or comes at a time of high inflation, retirees and beneficiaries would 1 e y se • market decl P over of plan benefits. an erosion of the purchasing p page 5 ® Gabriel Roeder Smith & Company 3128106 .. b i ~. Stabilization Reserves '~ order to supplement government Some state and local governments maintain Pension stabilization reserves in times when the government's revenues exceed projections, the e contributions to the stabilization fundabt addition to those required to fun contributions in times of fiscal stress.$ During 'lization fund would be drawn down to government would mak ections, the s retirement benefits. ~eovernment's rlequired retirement plan contributions. offset some or all of the g ' lion reserves is that they allow governments to set aside funds during Good e of stabilize roach offers flexibility An advantag overninent revenues exceed expenditures. Moreover, this app and its reserves. A disadvantage is that unless the funds are held for the exclusive economic times when g other urposes. Some state laws may in establishing the fund the may be used for P purpose of stabilizing employer contributions, y them to earn rates of return that aze lower than those 'vestments. Another disadvantage is that it may be difficult to build sufficient also restrict the investment of such reserves, causing the ~~ to "better use" elsewhere. earned by the Plan s in ressure to pu stabilization reserves in the first place. There is often p CONCLUSIONS h 2002 put significant pressure on state and local lan contribution rates. This happened at a time when many The investment declines that occurred from 2000 throng While some stabilization methods were already governments to increase ~enficant additional fiscal stress additional efforts are now governments were facing g~ to er contribution rates, in place to mitigate short-term fluctuations in emp y iuiderway to address the effects of larger and longer-term market shocks• tel or in combination. All have be used sepaza Y hel will depend on the individual circumstances This memorandum addresseeSS and the extent to high they P lan's s ecific situation. • advantages and disadvantag of techniques based on the p P of the p1an• The best approach would be to use a variety there are general guidelines that will hepem Nation to reducedcontribu~ons From a larger perspective, lan. Plan sponsors and their advisors should avoid lan willhave surpluses that can be used retirement p ood. That way, when dines aze bad, the P ou s and their representatives labor gr excessively when times are g encouraging Plan sp°nSOrs to to dampen the need for increases in contribution rates. ~' aTheiocan help by a sound plan design and should understand the risks associated with pension funding. y to encourag working with their membership lied, even though it may take fund the plan appropriately and by roach should be app reasonable benefit levels. Overall, a balanced apP considerable discipline. ension trust, they tablish the reserve in a way that dedicates the asasses is ar theld w 8thcin the ptions while at the s Care should be taken to es ension trust. If the reserved ose of holding them m • same time accounts foren eon °assetse fortva cation purposes. This might undermine the pure could be considered p ~ page 6 reserve. m Gabriel Roeder Smith & Company 3!28106 • Table 1: Comparison of Contribution Rate Stabilization Methods :7 C7 3~=~, - 4= , ~ ~ s `, # ~asi3 x Optlln~i~l ~'~"'~,~+aa~~an~bt~ , ,, ~~~~~Methods=~ , ~ $ ~Stab~ilt ~ Su;fficienc ,.~ .. .~ C 'lianca~. otn ; ~ R~~~~ a ^'. ~'~ ~ J~es~i~~is ~"~ . k ~ixe~f ~ ` In extreme . + ., _ _ _. Rate could be ~f~~anttbu#~on': May not situations, too low or too Generally not eta # ~ ~ r : Stable by Incorporate risks amortization high; responsive to = ~, ~ definition. of extreme market periods may asset/liability extreme ;~ ~ ,~ ,~~ ` `` declines. exceed GASB study would be situations. x ~ fr ~~~~;N i re uirements. useful. ~a ~ ~?~~~~ ~~~.,,~k~ ,~! In extreme rnra~ ~ Change lr1 `"-~ ' Stable, with May not incorporate risks situations, amortization Allows for slow General) slow y ontribution ... _ ` measured changes of extreme market periods may adjustments in to res nd to po extreme fie ~_ ` ~ `' . declines. exceed GASB rates. situations. ~~=.~ r ' requirements. * undfn~ ! tcl' ~ d All Can be set to Rate could be Sudden orr nrtt atr x~ _ ~seY~llalue Stable until ows for contribution rate ensure compliance with too low or too adjustment when corridor a arricioPs, ,~ ~`, condor boundary adjustment when GASB hi h; g boundary is ¢~~ ' ~ x ~ is reached. boundary is amortization asseUliability study would be reached may .F , r _ ~ „ _.: reached. period useful generate ~ . re uirements. . concern. ~tiiding Rates vary from ~w ws ~ .~ ~ ~Assef ~ ~ year to year but Contribution rates Compliance with Possible ~mor~nir>g = ; ° impact of would reflect GASB Contribution misalignment of `*~~" investment benefit amortization rates would vary smoothed and ~, ,~F volatility requirements. period as necessary. market asset ~ k dam ned. requirements. values. *Asset~ ~ ~~ ~ If equity Effort to Allocation `~ May help to stabilize Shift from equities This approach investment dampen volatility .. contributions by to fixed income investments would would not affect return is greater than risk addresses ~~ '" dampening inv t t likely increase GASB , contnbutions fundamental _ es men volatility contributions. compliance. would be higher cause of ~, ,,~,._'_ . than necessary. contribution flu t ti c ons. ua ilnkin;g Volatility shared 'Employee with plan Contribution rates This approach Extreme Contributlon5 = members; may would reflect would not affect Contribution situations may reduce upward - benefit GASB rates would vary require large pressure on requirements. compliance. as necessary. contributions ,. ' ~ benefits. from members. Linking Retirement Rate increases Contribution rates This approach C t ib ti Extreme i i B nefit mitigated through would reflect would not affect on r u on s tuat ons may e s partially variable benefit GASB rates would vary result in benefits. requirements. compliance. as necessary. significant benefit loss. Stabilization. ' If reserves are Reserves held in the - Stability would Sufficiency would pension trust they Funds held Political support - depend on depend on , could be outside the required to accumulated accumulated considered plan pension trust maintain ' reserves. reserves. assets for might earn lower sufficient valuation returns. reserves. ur oses. 3/28/06 m Gabriel Roeder Smith & Company Page 7