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“History, Issues and Trends of Defined Benefit and Defined Contribution Plans and

How to Combat the Effort to Change From DB to DC”. 10/2009- Hole

History of pension plans-

The first US government pension plan was started by the militia. The first private

defined benefit corporate pension plan in the U.S. was started by American Express in

1875. In 1911 Massachusetts formed the first state pension plan. In 1948, unions won

the legal right to include pensions on the collective bargaining agenda and tried to force

company’s to set aside money to fund future obligations. The number of DB plans grew.

At that time, pension funds were invested mostly in bonds. In 1950, US Steel was one of

the first plan sponsors to utilize equities to fund pension promises. In the late 1960’s and

early 1970’s, trust banks lost control of conservative investing to pension funds and

money managers who now had the academic theories of the Markowitz and Sharpe

Modern Portfolio Theory and federal legislation. A portion of the 1970’s was a time of

low or negative returns due to high inflations. People began to move from job to job.

In 1974 the Employee Retirement Income Security Act (ERISA) was passed, largely in

part because of the collapse of Studebaker. This act set standards to protect members of

private DB plans. This first comprehensive pension reform law passed during a large-

capitalization bear market, thus further helping money managers. ERISA required

companies to fund ongoing pension costs and close unfunded liabilities; established a

tough fiduciary standard; directed plans to diversify their portfolios, and allowed pension

trustees to delegate fiduciary responsibility to money managers that registered with the

Securities and Exchange Commission (SEC). Laws were passed which reduced or

eliminated incentives and made it more expensive for the private sector to offer DB

plans.

In the 1980’s, corporate profits were down and the high interest rates reduced the present

value of pension obligations, creating surpluses that companies could use for

restructuring or acquisitions simply by shutting down the pension plans and paying out

the benefits. Corporate raiders used over funded plan surpluses to pay off debt associated

with their leveraged buyouts. In 1990 Congress ended this practice by imposing a 50

percent excise tax on reclaimed surpluses.

DB plans took another hit in the 1980’s, the recognizing of the defined contribution or

401(k) plan by the Internal Revenue Service. Union membership numbers were

decreasing, and workers were moving in mass from job to job. The DC plan filled the

needs. Companies had to think about costs as health insurance was becoming more

costly, and global competition was cutting into profits. The new DC concept seemed

cheaper to administer, but the bulk of the financing and the liability of investment risk

now fell on the uneducated worker.

In addition, the bull market began to rage in the 1980’s, and mutual funds became more

attractive. From 1985-2000, the number of corporate defined benefit plans fell from

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170,000 to 49,000. In that same time period, the number of 401(k) plans jumped from

30,000 to 348,000. The bull market continued until 1996. DC folks were happy.

High assumed rates of returns were assigned. Many times, employers were not

contributing as they should have (contribution holidays). Corporations usually made the

minimum contributions. Multi-employers usually funded higher amounts due to contract

obligations. This not only stabilized funding and minimized volatility of employer

contributions, plans were able to increase benefits. Corporations on the other hand would

make benefit adjustments annually.

In 2000-2002 the US stock market tanked. Not only did the stock prices plunge, the

Federal Reserve Board deeply cut interest rates. As a result, pension liabilities soared

and many corporations had to pump in large amounts of cash to fund their pension plans.

In 2002 and 2003 the amounts went as high as three times the annual average contributed

over the previous 20-year average.

Plans went from being well funded to being under funded. Companies went from not

needing to make a contribution for many years to having to make a balloon payment, as

they had not continuously contributed. Employers saw a way to cut costs and liabilities

or obligations. Many small corporations and some governments changed from DB to DC

plans. Some corporations closed or froze their pension plans because it seemed like

everyone else was doing it.

In 2006, good market returns and a rise in interest rates improved the financial health of

many corporate DB plans. Plans were again fully funded, but plan freezing continued.

20-25% of the nations 2.3 trillion dollars in corporate DB plans had been frozen by the

end of 2006. In years past this was only done in troubled businesses, but now it came

from financially stable companies.

Part of the cause was due to the reform of the Pension Protection Act of 2006, a law that

was intended to strengthen DB plans. Tighter funding rules required sponsors to value

their pension assets and liability more frequently, beginning in 2008. Full funding had to

be phased in over the next seven years.

The 2006 the Pension Protection Act called for the valuing of assets and liabilities more

frequently, and said they must be funded. Corporate benefits were discounted using

corporate bond interest, which therefore increased corporate liability. Soothing was

tightened and therefore more conservative investing took place producing lower

returns. On the other hand, multi-employer benefits were discounted using interest

assumption on expected returns, and they had to go to a 15-year amortization period

instead of 30 years. Funding status zones were created.

As a result of the passage of the PPA of 2006 and FASB guidelines, many companies

shut down their plans rather than face new funding requirements, additional costs and

risks. Within a year of passage of the PPA, the Pension Benefit Guarantee Corporation,

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which is the government entity established by ERISA to take over pension plans from

troubled companies, had 5,000 pension plan terminations. As a result, the PPA required

companies to pay a higher premium to the PBGC to assist with the bailouts.

The Financial Accounting Standards Board (FASB), has passed new rules that added

pressure such as no longer allowing the net funded status on their balance-sheet

footnotes, and no longer allowing smoothing values and liabilities over a variable period

of 10-15 years, but rather 24 months. Now current market values of assets and liabilities

had to be used and must be posted on the balance sheet. This could reduce the

company’s net worth considerably. In the following three years, FASB (if they are still

around due to lack of funding) was expected to extend the mark-to-market pension

accounting to the income statement, resulting in even more volatile earnings. This “FAS

Phase Two” initiative spiked the number of plans being frozen in the UK.

These and other measures, both accounting and political, forced more conversions from

DB plans to DC plans.

The real estate market bubble burst in 2007 and the financial world unraveled in 2008.

The trouble is that…

States and local governments have 14 million employees, 10% of the US workforce.

In 2000, 90% of those folks had a DB plan. One forth of those folks are not in Social

Security.

The number of government and private DB plans is falling rapidly. 437,000 individual

401 plans account for 65 million participants and 3 trillion dollars.

If you take away the DB benefits, some still have Social Security benefits to supplement

their retirement (Nebraska, District of Columbia, Michigan, and West Virginia

teachers), but how about those not under Social Security like Alaska? Other

states that are not under Social Security are: Louisiana, Colorado, Maine,

Massachusetts, Nevada and Ohio.

Some states like Florida, South Carolina, Colorado, North Dakota, Vermont, Washington,

and some plans in Ohio and Montana, a DC plan is optional.

Some states went from DB to DC and back to DB (West Virginia, and plans in

Nebraska).

Some states went to hybrids (Indiana, Washington, Nebraska, Oregon, and some plans in

Texas and Ohio).

Retirees are living longer, therefore the need for retirement funds is increasing. In 80

years, a three year “down market” has only occurred once. Are employers using the

economic downturn just to strip benefits from plans that may not have been funded

properly during the “good years”?

DC participant issues and concerns: What they should be asking themselves.

1) Have members had to buy disability insurance or life insurance (side accounts)

because of lack of disability and survivor benefits that a DB plan has? (Disability

risk, survivor risk and mortality risk). If the DC plan does offer these benefits, they

are usually based on the account employee must pay for coverage.

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2) Have members had to change their future plans such as buying long term care

insurance, because they can’t afford it now?

3) Shared longevity risk pooling of a large DB group lowers overall risk and cost due to

investment returns and mortality. (Demographic risk transfer/insurance principal).

This is not the case with individual DC plans. Do the members who switched from

a DB to a DC plan realize that they therefore must contribute a higher amount to

compensate for additional risks? DB plans which pay over the average life

expectance, not the maximum life expectancy; having a non-aging diversified

professionally managed balanced portfolio, produces higher returns at lower fees.

4) Are members lobbying to reduce the high investment costs that come out of their

assets? DB, 31 basis points (31 cents/$100 assets) as opposed to DC, 96-175 basis

points). These fees should be transparent. Administrative, investment, sales and

other fees and expenses may be on top of mutual fund retail fees. Compound this

fee difference over a 35 year career and it could be 25% a differential. Employers

make money even if the worker does not. Rebates and even revenue sharing gives

providers get a cut of the expense ratio on 401 funds to cover day to day

administrative costs. Even though costs stay the same, the fees are a percentage of

your assets and therefore, their fee dollars increase. Administrative fees are

expenses which include accounting, legal fees. These are charged to DC members

either by pro rata (proportionately based on individual account balance), or per

capita (flat fee). Investment fees may include a percentage for transaction costs

such as sales loads, sales charges, sales commissions, deferred sales charges,

redemption fees, surrender charges, exchange fees, account fees, purchase fees,

mortality and expense fees, and management fees such as advisory fees, or account

maintenance fees. The referenced pertains to actively manages funds, annuities,

collective investment funds, and mutual funds. In addition, there may be individual

service fees to cover any optional features. When do your monies go to work for

you? Is it the earliest date of contribution or deduction, or 1.5 months later? Are

the amounts being properly allocated to you? DB plans offer clout in negotiating

fees because of economy of scale. Commingled, bundled and pooled investments

offer negotiated group pricing and therefore lower expenses than DC plans.

5) Should more products or investment vehicles be offered to enhance diversification?

This includes manager selection, style (growth and income), and alternatives. The

more choices, the more risk. What is the default investment choice? What if the

sponsor changes their mind? (Freeze, conversion, buy-back, irrevocable)

6) Have target date/life cycle funds been improved? People need to consider how much

income they will need, not how much the final amount will be. The standard 401

model began to fail when, in the last thirty years, it shifted from an adequate and

secure retirement to wealth accumulation and maximum returns. Individuals have

shorter time horizons than do DB plans and therefore those plans can be more

aggressive.

7) Have retirees out lived the unpredictable DC benefit? (Annuitization rate

risk/savings shortfall risk/income stability risk). Retirees with big lump sum checks

sometimes spend big amounts of money.

8) Have active members dipped into their accounts for emergencies or living expenses?

(Life event risk/leakage risk). Pension leakage could be caused by termination,

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unemployment, part time or temporary work, disability, pre-retirement death, or

long term care. Once borrowed, it is seldom returned. There is no chance for

compound interest on those investments cashes.

9) Have members gone from job to job and cashed out their balances? (80-90%)

10) Why is vesting still from 6 months to 3 years in a DC plan? (PPA).

11) Is there an age requirement to join? Best practice implication is that there is not.

12) Why does it take up to five years to be 100% eligible? Is your time cliff or graded?

13) Have members found they have to work longer because of declining account

balances Early retirement risk), or figured that they may out live their benefit,

especially as people are living longer? (Longevity risk). Members have seen a

recent decline in net worth due to a decline in real estate equity and the capital

markets.

14) How many members don’t contribute to their DC plan? (Savings risk).

It is not mandatory forced savings like a DB plan. Are DC members lobbying to

make it automatic enrollment? (Pension Protection Act).

15) How many members don’t contribute the max. to their DC plan? What if they do not

contribute enough? (Contribution risk). Are members lobbying to increase the

maximum amounts or have escalating contributions? From 1950-1986 we saved

8% of income per year. Until recently that has dwindled down to 2% of income,

and then it was for a vacation, not retirement. Until recently, the average 401 had a

balance of $35,000, the average balance for a 55-64 year old was $60,000. How

many years could you live on that? What if that balance went down 40% this year?

Guidelines suggest that total annual contribution should be 12%-14% of pay if you

are under Social Security, and 18%-20% of pay if you are not under Social

Security.

16) Usually people want to lower their investment risk in later years by shifting from

stocks to bonds, which usually lowers their returns. Will they be able to afford to

do that? (Investment risk). Do they know the value of diversification?

17) Do participants know they have to contribute more because they won’t get the

COLA that a DB plan may have given? (Inflation risk). Will inflation erode your

savings?

18) If a participant had a DB plan and now has a DC plan, have they figured out that their

returns will probably be lower (due to higher fees and non-expert management),

and therefore they need to invest more? A retiree may need to under consume or

change their standard of living out of fear or necessity. (Replacement ratio). Will

the retiree be too thrifty for fear of running out of money? Will there be a over

savings dilemma as the employee must plan and save for maximum life expectancy

and therefore have to self insure by over saving about 25% more than a DB plan

costs for the same benefit?

19) Are participants concerned that if they have Social Security, there may be pension

offsets or windfall provisions that may effect their benefits? What if Social

Security or other government programs are reduced?

20) How many participants vote proxies in hopes of getting better boardroom governance

and therefore higher stock prices?

21) How many participants file anti trust/SEC litigation claim forms in hopes of getting a

settlement?

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22) One of the arguments as to why a DC was needed was to protect health insurance.

Have participants seen their health insurance change, i.e. co pays, caps, or

deductibles?

23) Have women complained that the DC plan is discriminatory? Women usually take

time off from work to have babies and maybe even raise the family. A DB plan

may have allowed this. Perhaps even credits could be purchased. In a DC plan, if

she does not work, she does not contribute. The sad part is that women need more

money then men because they usually live longer. If the partner dies, one may

still need 80% of the marriages financial needs. In addition, women are paid less

than men, therefore able to invest less.

24) What if the government “takes over” or negatively changes the 401 rules?

25) If the employee leaves the employer, how much will they be charged to keep their

money in the old plan?

26) If the employee cashes out their 401, does that mean creditors can lay claim for child

support or alimony?

27) Is there an early 10% withdrawal penalty if the employee is younger than 59 ½? (IRS

72T).

28) Is there an option to purchase an annuity with joint and survivor benefits (life

income) to manage longevity risk? Few DC plans offer annuities, fewer

participants opt for them.

29) Can the employee manage inflation risk with a variable or inflation protection

annuity?

30) Does the employee have the knowledge to make the proper asset allocation, do the

proper research, select the best investment options, monitor the performance and

make periodic changes including rebalancing? Is the employee able to handle the

record keeping and education needed?

31) Does the employer offer enough investment advice in the accumulation stage and

through retirement? Is it personalized one-on-one or web based? Is there a

single point of contact and a single record keeper?

32) If the company closes, how much will the Pension Benefit Guaranty Corporation

(PBGC), if applicable, pay for the DB benefit, that is if they are still around?

DC plans have no requirement to insure benefits. (Company solvency risk).

33) Has the employer given the time and resources to plan and run my retirement

program as promised? Were the employees given a choice between a DB or DC

plan? Did the employees understand the differences? What was the default

choice?

34) Sometimes employees invest not as planned. (Financial planning risk). How can

they manage money to meet their objectives, especially when an individual can

not do anything about changes in: demographics, legal or political issues, or

economical issues such as Social Security, economic growth and stability,

Medicare, healthcare, the financial markets and inflation?

35) Will their job be effected if the employer expands pension plan eligibility to part

time employees? Would a temporary or part-time employee have a 401?

(Contribution risk).

36) If the employee is a low income worker, and could get a DB benefit, they would be

less likely to need government assistance.

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Employer pension issues and concerns: What they should be asking themselves.

1) Are employers concerned that with DC plans, there will be a lower demand for

goods and services as participants and retirees can’t afford to buy? State and local

economies will be effected. (Multiplier effect). DB assets promote national

savings, economic efficiency, and create markets. They promote corporate

governance thereby making more efficient markets. They promote investment in

hard to value, less liquid assets such as real estate. DC investments conflict with

these ideals. Without the stable long term DB additions to our economy, interest

rates could be higher, the cost of capital could be higher, and investment returns

could be lower.

2) Are governments concerned that if people outlive their DC benefit, the governments

will be burdened, as the governments and social services will be the payers of last

resort? Low income workers will be hit the hardest. DB plans reduce the poverty

level for the elderly, as joint and survivor benefits give a level income for life.

3) Are employers concerned that if a DC member has to work longer because of the low

account balance, he/she may have low productivity “retire in place”? Many retire

when markets do well, and few retire when markets do poorly. Do employers really

want old men doing the young mans job of police officer or fire fighter?

4) Did employers loose effective workforce management that the DB plan offered i.e.

ability to facilitate an orderly and timely movement of employees out of the

workforce? DB’s offer flexibility in plan design in such things as investments,

contributions, and retirement windows, which can target groups of workers.

(Demographic risk). How important is the freedom to be able to allow early or late

retirement benefits that a DB plan allows? DB benefits can be increased in a tight

labor market. Ad hoc COLA’s can be given in times of high inflation or good

investment return. In private DB plans, employer contributions are flexible, they

can contribute more in good years and less in bad years. This has no direct impact

on employee benefits. In a DC plan, the employer may be required to match a

portion of the employees contribution. If the employer plans to reduce the amount

of match contribution, it must be announced prior to the benefit year. This has a

direct impact on the employees benefits. A DB plan has no such restriction.

5) Are employers having trouble attracting and retaining qualified employees because

the DB benefit is not there?

6) Are employers finding out that turnover and training costs are higher because the DC

benefit is offered? In a DC plan, there is no loyalty or tenure equity, no reward for

career employees or “get ahead” employees. This is because when salary increases

in a DB plan, it effects future benefits, but in a DC plan, in only effects

contributions.

7) Are employers finding out that their DC administrative costs are higher than a DB

plan? How can I address the big cost of service fees on low balance accounts,

especially in times of lay offs, when terminated employees keep their money in my

plan?

8) Why are open market fixed annuities so expensive? Is it fair they have liquidity

restrains and little fee transparency?

9) Do employers realize that they still have accrued DB costs, even if the new employee

has a DC plan? Current employee and retiree benefits must still be paid for. If

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assets are less than the accrued liability, unfunded liabilities remain. The employer

contribution rate may go up because fewer active members are putting in less

money. In addition, assets may have to be sold to pay benefits, and this may result

in investing in short term securities with less return. This too would increase the

employer contribution rate. The perceived advantages of changing to a DC plan are

not there. Even though this is a way to cut my costs and liabilities, savings may not

be realized for many years. Employers find they may have a misconception of what

unfunded liability really is and its cost.

10) Will employers be sued because of failure to educate the worker on asset allocation,

and the financial liabilities of investment/market risk, or fee structure, or even

failure to give information to all members, even inactive members, especially in

these times of poor performance? (2008 LaRue).

11) Do employers realize that with a DB plan, employees will retire with regularity, thus

enabling promotion of younger workers.

12) Will employers reach a point where my employer contributions will stop, either

because they need the money or tax provisions are no longer favorable?

13) Knowing the shortcomings of a DC plan, should employers, increase their

contribution?

14) Is it fair to pass too much risk and responsibility for funding and managing retirement

and health care costs to my employees? (Medical cost risk). Is this degree of

decision making something that too many employees will be ill-equipped to take?

15) As a corporate/municipal leader, are employers concerned that it may be poor public

policy to shirk the responsibility of insuring that my retirees have sufficient pension

income?

16) Do employers want to retire older workers with dignity by giving them a stable and

secure income, not one effected by a drop in market value, jumps in inflation, poor

returns, leakage etc?

17) Are employers concerned about all the rules they must comply with if thinking about

eliminating their DB plan, as the government is concerned about the company going

“belly-up” and being a drain on the Pension Benefit Guaranty Corporation?

18) Do employers realize that they may see increased productivity by employees in a DB

plan as their moral is higher and they have reduced fears about retirement, as

compared to a DC plan.

There are DB\DC issues the Federal government should be concerned about:

In 2027 Social Security expenses will exceed revenue and interest. In 2041 the SS

coffers will be depleted. Eligibility age increases and benefits are reduced. As many as

eight states are not covered by Social Security. Many government workers do not

contribute to SS or face pension offsets and windfall provisions. If you take away the DB

plan of those workers, who will bare their financial burden? Government and social

services will become payor’s of last resort.

People are not saving for their future. The median balance for 401(k)’s is $35,000. For

ages 55-64 the average is $60,000. How long can one live on $60,000? One could easily

outlive their DC pension monies. The DC final benefit is determined by the market when

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cashed out. What if one retires in a down market and loose 40% of their retirement

monies just before they are to collect?

Contributing to a 401(k) is not mandatory, they are discretionary plans. Yes, it is

portable, but a large part of the participants do not take them to the 8-10 jobs they hold

over their careers. Many have cashed them out or have borrowed against them.

Most government DB plans are well funded, as they are forced savings, managed by

trained trustees and professional money managers. Employers should be forced to make

necessary contributions and not be allowed to borrow from the pension plans.

Governments/sponsors should not restrict investments because of genocide, terrorists or

the likes. (ESG- environment, societies, and governance). Governments should not

require social or geographic investing. (ETI- economically targeted investing).

Governments should allow pension plans to invest in non-traditional asset classes, both

alternative and international up to 40% including hedge funds, real estate, private equity,

and infrastructure.

Trends in the pension world Pension plan trends: (DB unless otherwise stated)

Under funding

Change in investment policy/allocation

Increase in fixed income, international and hedge funds, hi-yield, infrastructure, and

indexing, and other alternatives

Decrease in US equities and real estate

Lower returns due to less aggressive investments

Change in consultant and/or manager

More DC loans and withdrawals

Reviewing risk tolerance

Change IRR

More due diligence

Longer smoothing

Better administration, cut down on expenses

More manager flexibility, not static and hold

Faster to react to issues

Rebalancing (consider risk, cost and volatility), and increase ranges

Reduce manager fee structure

More governance policies include errors and omissions insurance

More interaction with press and public

Reduction of COLA’s

More disability applications

More asset and liability studies

Change to Liability Driven Investing

Longer amortization period

More in-house education

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Capital and liquidity issues due to lock-ups (hedge and index funds) and funds with

capital needs (real estate and hedge), redemption gating or side pockets

Divestiture requirements

Voting proxies in hopes of corporate governance

Becoming more involved legislatively

Cash flow concerns (for DROP, early retirements or incentives)

Employer trends: (public and corporate)

Reduced/eliminated health care benefits to active and retirees

Increased health care premiums/out of pocket, active and retired

Hiring freezes

Salary cuts including executive compensation packages

Layoffs, or accept lower paying job

Furlough days

Phased retirement: reduced work schedule, or rehiring retirees on part time or temporary

basis.

Buy-outs

Reduction/elimination of “er” contributions to DC plans

Change DC offerings to value, money market or treasury

Elimination of DB plans to new or all “ee”s, 2nd

tier

Reduce DB benefits to new or all “ee”s, include caps

Increase “ee” contributions to DB plans

Lowering of DB multiplier percentage

Increasing of minimum retirement age

More communication to “ee”s reference economy and pensions

More governance policies (proactive not reactionary risk management, oversight and

enforcement, enhanced accounting standards, executive compensation tied to

shareholder interest, more disclosure and transparency)

More due diligence

Less leverage investing

Extending minimum benefit eligibility

More negative press comments: rich pension gifts will bankrupt employers. Employers

must realize that pensions are compensation traded for work.

To freeze or terminate-

Some companies have chosen to freeze their plans and wait until interest rates rise further

and the value of their liabilities declines before terminating and annuitizing benefits.

Freezes come in two varieties, “soft” or “hard”. A soft freeze is less of an impact on

employees and their morale. Benefit accruals are ended for a segment of the workforce,

typically new hires and those with little seniority. A hard freeze stops the benefit

accruals for all employees. Liabilities are reduced but not stopped, as future obligations

are based on actuarial assumptions, which are subject to change.

Fidelity has recently decided to terminate their plans. This is an expensive option as

accrued benefits must be paid out to employees, so plans must be fully funded or have the

cash on hand to pay the difference between assets and liabilities. Typically benefits are

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distributed in the form of a single- annuity for vested employees. Insurers can charge

high fees, sometimes up to 10-25% of the plan’s fully funded value.

Corporate greed allows for the freezing or closing of pension plans. The effort should

first be made to fund the pension every year, and reduce or eliminate a COLA, increase

the minimum retirement age, reduce early retirement incentives, and increase the

employee contributions

Employee trends:

Decreased job security

Delayed retirement

Less savings

Reduced contributions to DC plans

Government actions:

Suggested mandatory DC pension contribution

Funding level requirements (Fed. Pension Protection Act, and State of Mass and Penn.)

Sudan Accountability and Divestment Act of 2007 (spread to state and local level)

IRS surveys of governmental DB plans

Increase of trustee terms

Federal reform (regulatory and judicial overhaul including SEC, hedge funds, rating

agencies, banking, Fannie Mae and Freddie Mac, and naked short selling)

SEC and Congress making proposals to give shareholders more boardroom clout

(executive pay and board elections). Recently limited brokers proxy voting if

shareholders are not voting (Broker vote rule helpful as 75% of all US company shares

are held in street name and managed by brokers). Introduced shareholders say on pay

policies

Budget cuts due to GASB 45, taxpayers, credit rating agencies and plan participants my

demand prefunding. Do you continue to pay-as-you-go, issue obligation bonds,

increase “ee” and/or “er” contributions, or contain costs?

Revival of proposed legislation to repeal the WEP (Windfall Elimination Provision) and

GPO (Government Pension Offset of the Social Security Act)

Miscellaneous actions: More SEC and anti-trust litigation (less SEC settlements but larger dollar amounts, and

more subprime lawsuits)

Court rulings: Citigroup and AIG in Delaware Chancery Ct. made it harder for investors

to hold directors liable for fiduciary breaches related to their oversight duties. Half of

the publicly traded US companies are incorporated in the state of Delaware

TARP (Troubled Asset Relief Program) said no unreasonable or excessive executive

compensation packages

Some managers taking more risk. Larger tracking errors between portfolio and index.

More counter party risk wherein broker fails to deliver or take delivery of security.

More organizational changes in financial companies

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How a DB trustee/employee group can fight against going to a DC plan:

Educate yourself/trustee, plan members, tax payers, the media and the elected officials.

As a trustee understand the relationship of risk and asset allocation. Consider

aggressive transition management.

Go after those who violate anti trust or SEC regulations in hopes of recouping monies.

Direct how proxies are to be voted.

Don’t bow under pressure to chase trends. Review assumption rates. Check your

managers and consultant for conflicts of interest.

Separate the question of generosity from retirement system efficiency. Know your plan

benefits and how they are funded and measured.

Know the differences in the public DB and private DB plans such as: private DB liability

valuation risk is based on interest rates, whereas public DB plans use long term rate of

return assumptions. Private DB plans use “mark to market” rather than smoothing

gains and losses. Both issues result in greater volatility in private DB employer

contributions. The Pension Protection Act requires corporate DB plans to have higher

funding targets and use more conservative investment strategies. Public pension

funding levels exceed those in the private sector. Sources of public pension revenue:

12% employee contributions, 24% employer contributions, and 64% from investment

earnings. (In Florida, the constitution protects government pensions. Cities cannot go

bankrupt. The State would step in and run the plan, and the employer must still

contribute to the plan).

Don’t buy benefits because a plan is over funded.

Insure the employer makes the timely required contributions.

Don’t allow the employer to borrow from the plan assets.

The COLA may have to be eliminated. (Regressive bargaining).

May have to eliminate any early retirement incentive, or increase minimum retirement

age.

May have to increase the employee contributions due to lower investment returns,

increased life expectancies, and increased benefits.

May have to create new employee benefit tiers, perhaps with lower multiplier percentage.

May have to look at a hybrid plan such as a cash balance plan, which combines length of

service and investment return. Another hybrid alternative uses two plans, one using a

lower DB multiplier, and the other is the DC portion.

Don’t let the employer/yourself be more concerned about foreign policy and social

behavior than returns. (Divesture) Includes ESG (Environment, societies, and

governance) and ETI (Economically targeted investments).

Push for higher limits of alternative/International investing.

Campaign if needed (New Hampshire Retirement Security Coalition). Beware of pension

envy. Challenges may come from the uneducated, or partisan political groups or from

ideological interest groups, not necessarily from public discontent wanting wholesale

changes.

Show the costs. Less benefits do cost less. The cost of a DB plan is almost half the cost

of a DC plan when one figures the cost of lower DC plan return, higher fees and need to

invest for the maximum life expectancy. A higher DB plan return equates to a savings

of 26%, DB plan non-aging diversification equates to a 5% savings, and longevity risk

pooling (over saving) equates to a 15% savings. In other words, more money has to be

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invested in a DC plan and a DB plan, to achieve the same benefit level.

Again, do not forget about the liability costs of those who may have been in the DB plan.

Those who have been in a DB plan for years and now have a frozen plan will loose the

forthcoming years of “highest” salary, and will have only a few years of market

downturn or gain with their DC investments.

State that DB plans are a source of stable long term patient capital that plans invest into

publicly traded companies that benefit our US economy. If this DB money was not

infused into our economy there may be diminished economic growth.

The DC retiree savings pool is not stable. The IRA asset pool is larger than either the DC

or DB asset pools. This is because many older conservative workers rolled their 401’s

into IRA’s. Sadly, untimely deductions from IRA’s come with a penalty. In addition,

they usually have lower returns.

In closing, preach that pensions are not gifts, they are compensation traded for work.

401’s are not retirement plans but are optional savings plans that, unless changed, may

turn out to be only a supplement to Social Security.

DC plans intensify future problems rather than provide solutions.

A special note for police officers and fire fighters: Police officers and fire firefighters

should realize that if budgeted positions are cut to pay for their DB plans, they will face

increased job risks. Police officers and fire fighters do not judge personal risk, they put

their personal safety aside to protect the public. A DB disability does help take care of

the officer if needed. No affordable DC disability insurance could do the same. If

retired, and need to go back to work, who will hire a part-time police officer or fire

fighter? In what other jobs can they use their unique skills? If they wish to start a

second related career, there may not be that many positions available in the job market.