Hybrid Retirement Plans

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Hybrid Retirement Plans. University of Illinois September 14, 2005. Introductions. Julie Durkin julie.durkin@watsonwyatt.com Michelle Rorvick michelle.rorvick@watsonwyatt.com Watson Wyatt Worldwide 6,000 associates 90 offices in 32 countries. - PowerPoint PPT Presentation

Transcript of Hybrid Retirement Plans

Whipsaw Effect: Change from 2002 OIG Report on ConversionsW W W . W A T S O N W Y A T T . C O M
Hybrid Retirement Plans
University of Illinois
September 14, 2005
lf:\J:\act\00022\recruiting\UofI-Champaign\2004-2005\Finance Class\finance360Pres.ppt
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What does Watson Wyatt do?
Consult with employers to design, finance and administer benefit plans to attract and retain employees
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Benefits consulting
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Characteristics
Defined benefit plans that are made to look and act like defined contribution plans, or
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Cash balance plan
Defined benefit plan that expresses a participant’s benefit with a hypothetical account balance
Defined lump sum/Pension equity plan
Lump sum at retirement based on pay credits (age and/or service)
Age/Service based profit sharing plans
Annual employer contributions (% of pay)
Contribution % based on age and/or service
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What is a Cash Balance Plan?
Pension plans that define a participant’s benefit as a hypothetical account balance
Combines strengths of Defined Benefit and Defined Contribution Plans
Account grows with annual pay-related credits and interest credits
Employees receive lump sum or annuity at retirement/termination
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Account is established for each employee (hypothetically, no actual asset allocated in the trust)
Each year the account is credited with a deposit equal to 6% of the employee’s pay
Each year the account is credited with interest
equal to a public index (5.5%)
Example
What is a Cash Balance Plan?
Contribution is based on 6% of pay; Salary increases are 4% per year;
Interest credits are based on the published rate of 5.5% per year
Example
Year
Pay
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Improve employee understanding and appreciation
Easier to communicate
Complement 401(k) plans
Potential Savings
Does not meet the company’s business strategy
Uncertainty regarding the future of these plans
Negative press
Transition issues
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Each receives a contribution credit equal to $1,000
Plan provides interest credits at the rate of 6% per year
Age Discrimination claim because 55-year old
receives a smaller retirement benefit at age 65
Whipsaw issue if the age 65 account balance is discounted back to current age at a lower rate than 6%
Cash Balance Plans
10,286
1,791
11,286
2,791
Hybrid Pension Plan legislation would:
Retroactively clarify the legal status of hybrid plans for plans that are not currently subject to litigation;
Establish retroactive conversion requirements; and
Establish additional requirements for future conversions.
Issues with hybrid proposals:
Many employers would not satisfy the provisions
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Why: Ensure benefits programs meet business and HR goals
Employee View
What: Consider employee expectations and perceptions by distinct segments of your workforce
Why: Perception is stronger than reality…how your programs are perceived is how they ARE
Competitive View
Why: Ensure that market positioning reflects strategic intent
Workforce View
What: Demographic analysis & forecasting to customize recommendations to the unique make-up of your workforce
Why: Averages are misleading; we need to dig into details to know where risks are hidden - where you may have challenges recruiting and retaining over time
Financial View
What: Assess financial impact and return on investment of current and alternative designs
Why: Understand costs and cost drivers before recommending changes
Environmental View
and less costly - than changes in design
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An employer is considering a pension plan redesign.
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Reduced volatility
Enhanced employee understanding
Reaction will depend on management’s relationship with employees
Employees will want to understand the reason for the change
Reactions will vary dramatically depending on employees’:
Individual situation
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Does the proposed plan provide competitive benefits?
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Mature population in decentralized locations
Employer has maintained an extremely paternalistic culture to date
Current Business Situation
Mostly rural locations where company is major employer in town
Publicly traded company with mandate to reduce costs
Company has grown through acquisitions
Current Business Situation
Facilitate integration of acquired companies
Share responsibility between employer and employee
Provide minimum floor of protection
Improve perceived value of program
Provide competitive program
Improve employee understanding
Provide a program that does not encourage retirement at a certain date
Maintain a cost neutral program
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Pension Plan:
Unreduced benefits payable at age 60
Subsidized early retirement provided at age 55 with ten years of service.
Eligibility is after 1 year of service
Vesting is 100% after 5 years.
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Present value of pension benefits for active participants
$1,200 M
Matching contribution
$10 M
Given this situation, what would your proposed plan design be?
How would your proposed design satisfy the objectives?
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Case Study B
Two liked size companies merge and a year later merged company acquires three smaller businesses
Logistics company
Low margin business
Current Business Situation
401(k) pre-tax contributions with discretionary matching contribution
a retiree medical and life program
Company B Program
No pension plan
Smaller acquired businesses
No pension plan
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Reduce costs of programs
Promote joint responsibility for retirement
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Given this situation, what would your proposed plan design be?
How would your proposed design satisfy the objectives?
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Discussion
Discussion
Employer sponsored plans
Determine cash flow for plans
Contributions satisfying ERISA requirements
Benefit Payments
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Benefits calculated as of Age 65
Completed Years of Service
Age at Termination or Retirement
Benefit Accrual
Employee age 35 with 0 years service. Base Pay of 50000 and Total Pay of 50000. Salary increase 4%.
1% Final Avg Pay
6% Cash Balance Plan