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Cypen & Cypen
NEWSLETTER
for
JANUARY 31, 2008

Stephen H. Cypen, Esq., Editor

1. WHY HAVE SOME STATES INTRODUCED DEFINED CONTRIBUTION PLANS?:

That is the question posed in a recent Issue Brief, co-published by Center for Retirement Research of Boston College and Center for State & Local Government Excellence. Although defined benefit plans dominate the state and local sector, in the last decade twelve states have introduced some form of defined contribution plan. The degree of compulsion varies among these states from mandatory participation in a defined contribution plan for new employees, to mandatory participation in both a defined benefit and defined contribution plan, to having the defined contribution plan only as an option. The brief describes the flurry of defined contribution activity, presents data on participation and assets to put the flurry into perspective and identifies the factors that led to the changes occurring in the states where they did. The most important explanation turns out to be political rather than economic. States where the same political party controlled the legislature and the governorship and that party was Republican were the most likely to introduce a defined contribution plan. The results also suggest that plans with a high percentage of union members and those with sizeable employee contributions are less likely to add a defined contribution plan component. Interestingly, states without Social Security coverage, which provides a basic level of defined benefit protection, are not deterred from shifting to a mandatory defined contribution plan. For any given level of benefits, defined contribution plans cost more than defined benefit plans for state retirement systems. Even so, sometimes debates about introducing a defined contribution plan suggest the state can save money. Other arguments for defined contribution plans have rested more on the ability of people to control their investments and take their accumulations with them when they move from job to job -- aspects that might appeal to younger workers. Of course, moving away from defined benefit plans means that individuals must face the risk of poor investment returns, the risk that they might outlive their assets and the risk that inflation will erode the value of their income in retirement. Our view: no retiree should have to run those risks, particularly when world markets are in chaos and there is nothing an individual investor can do about it.

2. GROWING FISCAL CHALLENGES FOR STATE AND LOCAL GOVERNMENTS WILL EMERGE DURING THE NEXT TEN YEARS :

The United States Government Accountability Office has issued a report to Congressional Committees dealing with the growing fiscal challenges that state and local governments will face during the next decade. By way of background, the state and local government sector consists of fifty state governments and 87,525 local governments. These local governments include 3,034 county governments, 19,429 municipal governments, 16,504 townships, 13,506 school districts and 35,052 special districts. State and local governments provide vital services to citizens, such as law enforcement, public education and sewage treatment. Local governments derive their authority from the states, and the powers and responsibilities granted to local governments vary considerably. For example, while states generally provide authority to local governments to tax real property, local governments vary in their authority to levy other types of taxes, such as personal income or sales taxes. State and local governments collect receipts and receive federal funds to provide services to their constituents. In 2006, state and local governments received $1.9 Trillion in total receipts. Taxes, such as property taxes, sales/excise taxes, personal income tax and corporate income taxes make up a large component of these receipts -- fully $1.2 Trillion. In addition, the federal government provided over $400 Billion to state and local governments in the form of various grants (including Medicaid), loans and loan guarantees. These federal funds accounted for approximately 22% of state and local government total receipts. The model in GAO’s report shows that in less than a decade the state and local government sector will begin to face growing fiscal challenges. Both fiscal balance measures (net lending or borrowing and the operating balance) are likely to remain within the historical range in the next few years, but both begin to decline thereafter and fall below historical ranges within a decade. In other words, absent policy changes, state and local governments will face an increasing gap between receipts and expenditures in the coming years. Since a majority of state and local governments actually face requirements that their operating budgets be balanced or nearly balanced in most years, the declining fiscal conditions GAO’s simulations suggest are really just a foreshadowing of the extent to which these governments will need to make substantial policy changes to avoid these potential growing fiscal imbalances. Since 1992, GAO has produced long-term simulations of what might happen to federal deficits and debt under various policy scenarios. GAO’s most recent long-term federal simulations show even larger deficits resulting in a very large and growing federal debt burden over time. In that work, GAO found that federal fiscal difficulties stem primarily from an expected explosion of health-related expenditures. The findings thus show that the state and local sector will provide an additional drag on an already-declining federal government fiscal outlook, and that the critical problem of escalating costs of health care is an economywide problem that will need to be addressed by all levels of government. GAO-08-317 (January 2008)

3. ABSTRACT OF 2005 FORM 5500 ANNUAL REPORTS:

The U.S. Department of Labor Employee Benefits Security Administration has published its Private Pension Plan Bulletin, which is an abstract of 2005 Form 5500 Annual Reports filed by private pension plans. Over the past thirty years, as the private pension system has shifted from defined benefit plans to 401(k)-type defined contribution plans, the financing of benefits has shifted from employer to participants. In 1978, when legislation was enacted authorizing 401(k)-type plans that allow employees to contribute on a pre-tax basis, 29% of contributions to DC plans, and only 11% of total contributions to all DB and DC pension plans were contributed by participants. The percent of contributions made by employees to DC plans has doubled since then, but has remained steady at 60% for the last seven years. Here are some other highlights:

  • The total number of pension plans fell for the fifth year in a row, by .6% in 2005, to 679,000 plans. DB plans increased by .2%, while DC plans fell by .6%.
  • In 2005, the total active participant count increased to 82.7 million. However, most of the increase between 2004 and 2005 is due to a change in definition of active and total participants used for the 2005 report. The number of active participants in DB plans decreased to 20.3 million while the number of active participants in DC plans increased to 62.4 million.
  • Pension plan assets increased for a third year in 2005. Total pension plan assets reached $5.1 Trillion, exceeding the previous high of $4.7 Trillion in 2004. DB plan assets grew by 7% to $2.3 Trillion and DC plan assets increased by 8.5% to $2.8 Trillion.
  • DC plan contributions grew by 8.8%, to $248.8 Billion. DB plan contributions decreased by 1.9% to $92.7 Billion, a smaller decline than was observed in 2004. Overall, contributions to pension plans increased by 5.7% in 2005 to $341.5 Billion.
  • In 2005, pension plans disbursed $354.5 Billion for payment of benefits, with $136.6 Billion being disbursed in DB plans and $218 Billion from DC plans. These payments were made either directly to retirees, beneficiaries and terminating employees or to insurance carriers for payment of benefits. These amounts reflect a decrease from 2004 of 2.8% in defined benefit plans and an increase of 13% in defined contribution plans.
  • Overall, pensions disbursed $13.1 Billion, or 3.8%, more than they received in contributions. DB plans disbursed $43.9 Billion more than they collected in contributions, while DC plans disbursed $30.8 Billion less than they received in contributions.

The bulletin supplies lots of good information, even if a bit tedious.

4. WINE WHINE:

Proceedings of the National Academy of Sciences of the United States of America (who?) has found in a study that marketing conditions can modulate neural representations of experienced pleasantness (what?). Despite the importance and pervasiveness of marketing, almost nothing is known about the neural mechanisms through which it affects decisions made by individuals. PNAS (yes, that’s the acronym) proposes that marketing actions, such as changes in price of a product, can affect neural representations of experienced pleasantness. PNAS tested the hypothesis by scanning human subjects using functional MRI while they tasted wines that, contrary to reality, they believed to be different and sold at different prices. Results show that increasing price of a wine increases objective reports of flavor pleasantness, as well as blood-oxygen-level-dependent activity in medial orbitofrontal cortex, an area that is widely thought to encode for experienced pleasantness during experimental tasks. The paper from PNAS provides evidence for the ability of marketing actions to modulate neural correlates of experienced pleasantness and for mechanisms through which the effect operates. So, what the heck does all of this mumbo jumbo mean? Well, it means that there are wine snobs. Now, here’s what to do: buy one very expensive bottle of wine; carefully remove the price sticker, and secure it to another bottle of Two-Buck Chuck; make sure the price remains visible at all times; chuckle while your fancy friends swoon over your fabulous vino.

5. DAFFY-NITIONS:

Conference: The confusion of one man multiplied by the number present.

6. QUOTE OF THE WEEK:

“The man who says he is willing to meet you half way is usually a poor judge of distance.” Lawrence Peter


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Items in this Newsletter may be excerpts or summaries of original or secondary source material, and may have been reorganized for clarity and brevity. This Newsletter is general in nature and is not intended to provide specific legal or other advice.


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