Cypen & Cypen
January 15, 2015
Stephen H. Cypen, Esq., Editor
1. CHALLENGES FOR REFORMING GOVERNMENT PENSIONS:The Urban Institute has released a research report entitled “Reforming Government Pensions to Better Distribute Benefits.” Efforts to reform the retirement plans provided to state and local government employees are gaining momentum across the country. From 2009 to 2011, 43 states significantly revised their state retirement plans. Ten states made major structural changes to their plans in 2012. More recent reforms have passed in such states as Kentucky, Tennessee and Illinois. These initiatives have been driven primarily by financial concerns. The 2007 financial crisis depleted much of the reserves held by many state and local plans. By their own accounting, plans had set aside enough funds in 2012 to cover only about three-quarters of their future obligations. Absent any reforms, this funding gap may force state and local governments to increase their payment to pension funds, raising pressure on government budgets and threatening to crowd out other public services or lead to tax hikes. This report highlights promising reform options that could more fairly distribute retirement benefits across the public sector workforce, and help governments recruit and retain productive employees. The report begins by describing how traditional plans work and how they distribute benefits across the workforce. The author then identifies various reform options -- such as extending Social Security to all government employees (many of whom are currently uncovered), changing the benefit formula in traditional retirement plans and pursuing alternative plan designs -- that could improve the fair distribution of benefits. The final section discusses various challenges to pension reform:
States and localities can take a number of steps to improve the distribution of retirement benefits offered to public-sector employees, make retirement plans more appealing to young workers, and create better retention incentives. However, they face several obstacles. The most promising pension reforms would not improve benefits for every public-sector employee. Rather, certain government workers, especially very long-term employees and employees who begin public service relatively late in their lives, would experience benefit cuts. These groups would likely oppose such reforms. Any proposed changes to pension benefits are sometimes viewed as a subterfuge for cutting benefits, even if average benefits remain unchanged, generating further political opposition. Some reforms we have outlined would require governments to fully fund state and local retirement plans. But state and local governments may prefer the option they currently hold to defer pension funding when budgets are tight. Additionally, pension reform is complicated and does not directly affect the lives of most taxpayers. Thus, it is often difficult to galvanize public opinion around the issue and force change.
A key question for reform involves how incumbent employees would be treated. Most reforms have grandfathered existing workers, leaving their benefits unchanged and changing plan provisions only for new hires. As a result, most reforms do not have much immediate impact on plan finances. More importantly, shielding incumbent workers from any reforms creates different classes of employees, which violates norms of basic fairness and may create morale problems.
2. SOCIAL SECURITY ADMINISTRATION COULD IMPROVE OVERSIGHT OF REPRESENTATIVES PROVIDING DISABILITY ADVOCACY SERVICES: The United States Government Accountability Office, in GAO 15-62 (December 2014), found that little is known about the extent to which states are contracting with private organizations to help individuals who receive state or county assistance apply for federal disability programs. Representatives from these private organizations help individuals apply for Supplemental Security Income and Disability Insurance from the Social Security Administration. Available evidence suggests that this practice, known as SSI/DI advocacy, accounts for a small proportion of federal disability claims. Using a variety of methods, including interviewing stakeholders, GAO identified 16 states with some type of SSI/DI advocacy contract in 2014. In addition, GAO analyzed a sample of 2010 claims nationwide, and estimated that such contracts accounted for about 5% of initial disability claims with non-attorney representatives, or about 1% of all initial disability claims. Representatives working under contract to other third parties, such as private insurers and hospitals, accounted for an estimated 30%of initial disability claims with non-attorney representatives. There were different approaches to SSI/DI advocacy, but there was also much similarity. For example, Minnesota contracted with 55 nonprofit and for-profit organizations, while Hawaii and Westchester County, New York, each had a single contractor: a legal aid organization, and a for-profit company, respectively. At the same time, all three sites targeted recipients of similar state and county programs, such as General Assistance, and generally paid contractors only for approved disability claims, among other similarities. Social Security Administration has controls to ensure representatives follow program rules and regulations, but these controls are not specific to those working under contract to states or other third parties, and may not be sufficient to assess risks and prevent overpayments -- known by Social Security Administration as fee violations:
- Despite the growing involvement of different types of representatives in the initial disability determination process, Social Security Administration does not have readily available data on representatives, particularly those it does not pay directly. This situation hinders Social Security Administration’s ability to identify trends and assess risks, a key internal control. Social Security Administration’s existing data are limited and are not used to provide staff with routine information, such as the number of claims associated with a given representative. Social Security Administration has plans to combine data on representatives across systems, but these plans are still in development.
- Social Security Administration does not coordinate its direct payments to representatives with states or other third parties that might also pay representatives, a risk GAO identified in 2007. In cases involving SSI/DI advocacy contracts, a representative may be able to collect payments from both the state and from Social Security Administration, potentially resulting in an overpayment, which is a violation of Social Security Administration’s regulations.
For its part, Social Security Administration partially agreed with the recommendations, and noted that it may consider additional actions related to representatives.
3. NEW MARYLAND GOVERNOR SNUBS RETIREMENT PANEL: It may not be the most pressing concern facing Governor-elect Larry Hogan, but, the Baltimore Sun says it was disappointing to learn that he is pulling the plug on the state task force pondering how to get middle-class Marylanders to save more for retirement. Whether the incoming governor likes it or not, the loss of defined benefit pension plans in the private sector and the failure of workers to invest sufficiently in alternative defined contribution savings plans -- if they are even made available by their employers -- is a serious concern. What makes Mr. Hogan's decision notable is that the 14-member task force created by Governor Martin O'Malley less than one year ago only began what was supposed to be a two-year study this past summer. It has met only three times and has yet to issue any findings. In other words, it was just getting warmed up but will expire in mid-February under terms of the executive order unless renewed by Mr. Hogan, which he says he will not do. It is not hard to guess why. One of the key proposals being explored by the group and its chair, former Lt. Governor Kathleen Kennedy Townsend, is requiring businesses to offer a retirement savings plan or, as an alternative, enroll employees in a state-managed savings plan. There has also been discussion of making such a program an "opt out" for employees, meaning that workers would automatically be enrolled in the retirement savings plan through a deduction in their paychecks unless they took steps to remove themselves from participation. That mirrors policy discussions that have been going on across the country in recent years as governments ponder the impact of the loss of pension plans in the private sector. As a growing number of people reach their retirement years without sufficient financial resources, the strain on government to provide such basic benefits as housing, food or health care is likely to grow. Only about half of private sector workers currently participate in a retirement plan of any kind, according to the U.S. Bureau of Labor Statistics. Tens of millions of Americans are expected to outlive whatever savings they have accumulated. But some in the business community bristle at the notion that government might mandate a retirement benefit (even if it carries no fiduciary obligation to the employer), and Mr. Hogan, who spoke often during the campaign for governor about the need to lift government mandates, may be especially sensitive to that criticism. Meanwhile, refusing to maintain the task force does not come with much political cost to someone who never signed the executive order creating it in the first place. Still, that does not make the problem go away. Employees of all ages can be educated about the need to save more for retirement, but that is of limited help if their employers does not have any kind of retirement plan -- as more than one-third nationwide currently do not. And retiring the retirement task force will not keep lawmakers from taking up the issue. The will just have to do it without benefit of the extensive fact-finding and hearings by a task force that is expected to issue a report in February anyway. We are not certain that mandates are necessarily the best way for the state to proceed, but we cannot object to a conversation about them. Two years ago, California began moving in this direction, and states from Arizona to Connecticut are similarly exploring ways to provide state-based retirement plans for the benefit of private sector workers. It is difficult to see the harm in better understanding the nature of the problem and the potential remedies. Perhaps Mr. Hogan would be interested in setting up his own task force on the retirement savings shortfall (one not chaired by a high-profile member of an iconic Democratic family), but somehow we doubt it. The incoming governor made a lot of promises about reducing taxes on those who have retirement income, but the topic of those who do not never made it into his stump speech.
4. HOW MUCH CAN I AFFORD TO SPEND IN RETIREMENT?: Ken Steiner, retired Fellow of the Society of Actuaries, has established a site to help those retired individuals who decided not to annuitize all of their accumulated retirement savings to develop a spend-down strategy for their self-managed assets as part of an overall process of developing an annual spending budget in retirement. It’s that time of year again to sit down to determine your spending budget for the upcoming year. The rest of this post will illustrate the Actuarial Approach for Richard Retiree, the hypothetical retiree we last looked in our post of December 27, 2013 when we developed a spending budget for him for 2014. Richard retired on December 31, 2012 at age 65. His spending budget for 2014 from accumulated savings and his annuity totaled $45,766 ($30,766 plus $15,000). To this amount, he added his Social Security benefit of $20,000 (new information) to get a total spending budget for 2014 of $65,766. His accumulated savings (not counting home equity of about $200,000) as of the beginning of 2014 was $884,909 with about half of this amount to be invested in equities and about half in fixed income securities. In addition to receiving $20,000 of Social Security benefits and $15,000 of annuity payments during 2014, Richard’s accumulated savings earned $61,944. He spent $60,000 during 2014 ($5,766 less than his budget), so his total accumulated savings at the end of 2014 are $921,853 ($884,909 + $20,000 +$15,000 + $61,944 - $60,000). He is now age 67. Richard’s Social Security benefit for 2015 will increase by 1.7% to $20,340. He decides to apply the same percentage increase to his 2014 spending budget to determine his preliminary 2015 spending budget from accumulated savings and annuity. This amount is $46,544 (1.017 X 45,766). He then goes to the Excluding Social Security V 2.0 spreadsheet in this website and enters his beginning of 2015 accumulated asset amount of $921,853 and the number of years until age 95 (28). All other input items are unchanged from the 2014 calculation. The resulting spendable amount based on this calculation is $52,790. Ninety percent of this amount is $47,511. If Richard wanted to follow the recommended smoothing algorithm, his budget for 2015 would be the sum of this 90% corridor amount of $47,511 plus his new Social Security amount for 2015 of $20,340, or $67,851. But Richard has been reading articles that have convinced him that he should be more conservative in his retirement budgeting, so he decides that he will segregate $100,000 of his accumulated savings into an “Emergency Use” fund that he will not consider as assets for normal spending purposes. Therefore, he reruns the spreadsheet with assets of $821,853 and the preliminary spending amount for 2015 (the 2014 amount increased by inflation is now within 10% of the revised spreadsheet amount of $48,215. Therefore, Richard decides to stay with $46,544 as his spending budget attributable to accumulated savings and annuity, to which he adds his Social Security benefit of $20,340 to obtain a total spending budget for 2015 of $66,884. Richard is also concerned about investing 50% of his accumulated savings in equities. While investment in equities during the last two years has resulted in significant gains to him, he worries that he might not be able to cover his essential expenses if the markets suffer significant losses. He has determined that his essential expenses total about $55,000 per year (or about $34,660 from accumulated savings and annuity income). Using the Excluding Social Security V 2.0, he determines that he will need accumulated savings of about $550,000 to meet his essential expenses. Therefore, he decides that he will change his asset investment mix of the $821,853 of accumulated savings not earmarked for emergency purposes to 33% equities and 67% fixed income securities. He understands that he also has his home equity in reserve in addition to his emergency fund if he should need to pay for long-term care or other healthcare emergencies. He is comfortable with a budget for 2015 that is almost 11% higher than the amount he actually spent for 2014.
5. “TOP TEN” LIST FOR FIDUCIARIES: Brian Cave presents its Top Ten New Year’s Countdown. But, the list is set to Pop Culture themes that dominated 2014:
- It is all About The Fees, about the Fees. No trouble. Another year, another reminder that fees should be closely scrutinized by plan fiduciaries. Participant fee disclosures are not the new kid on the block anymore; however, fiduciaries should still ensure that all required fee disclosures are complete, accurate and made timely. Plan fiduciaries should also periodically monitor all fees charged against the plan’s assets to ensure reasonableness.
- The DOL Ice Bucket Challenge -- I challenge you, within 24 hours -- to get your payroll remittances in. DOL has not receded from its firm position that employee deferrals segregated from corporate assets should be paid into the plan, as “soon as reasonably practicable.” So, now is as good a time as any to visit with payroll or HR to make sure an air tight process is in place for timely transmitting employee contributions and loan repayments to the plan. Sure, 24 hours may not be a feasible deadline, but remember that the 15th business day of the following month is not a safe harbor for transmissions.
- “Game of Thrones” is our new “Sopranos”, “Orange Is the New Black” and “IPS is the new Plan Document.” With heightened scrutiny of plan fiduciaries flowing in part from the so-called 401(k) fee litigation, retirement plan fiduciaries should pay particular attention to the contents of the plan’s investment policy statement (IPS) – or adopt one if it is missing. The review should be focused on ensuring that the IPS is consistent with the fiduciaries’ intent, the other governing plan documents and actual practice (e.g., do we actually use a watch list for 1-year before removing an underperforming manager?).
- Cause the players gonna play, play, play, play, play; And the haters gonna hate, hate, hate, hate, hate; Baby, I am just gonna delegate, gate, gate gate. Delegate it all. It all?? Being an ERISA fiduciary is hard and delegating certain responsibilities may seem attractive. Retirement plan fiduciaries are well-served to consider retaining professionals and service providers to help perform certain fiduciary tasks. Keep in mind, however, that the act of delegating is a fiduciary act – and even after delegating responsibilities, fiduciaries still have a duty to monitor plan service providers. Also, delegation needs to be permitted by the governing plan documents.
- Justin Bieber went to jail again, but this does not have to happen to you. Get fiduciary liability insurance. Okay, so ERISA fiduciary jail is unlikely, but personal liability for restoring to the plan amounts lost due to a breach of ERISA’s complex rules is a real possibility. Remember, that ERISA fiduciary liability insurance serves as a first line of defense for potential breach of fiduciary duties. These policies often come as riders to D&O coverage; consider getting your company’s risk manager or counsel engaged to review the scope and amount of the coverage to assess its appropriateness. Remember that a fiduciary liability insurance is not the same as a fidelity bond. As discussed here, a fidelity bond is separate and distinct from fiduciary liability insurance – and bond coverage is specifically required by law.
- It is not just for Actors at the Oscars, Take a “Group Selfie” when your committee next meets (Yes, that’s a thing now – and a real word according to the Oxford Dictionary). Sure, it may not be as exciting as the red carpet or post-Academy Awards parties, but holding regular plan fiduciary/committee meetings can be a grand ole’ time. Plan fiduciaries should meet periodically (we generally recommend at least quarterly) to consider information regarding performance, selection, and oversight of plan investments, investment managers, service providers, and other plan administrative matters. Minutes of the meetings should be kept to help demonstrate that the fiduciaries have engaged in a prudent process of analyzing and assessing relevant issues.
- Avoid “Scandals” and Having to Call Olivia Pope’s Crisis Management Firm. Provide fiduciary education and training to plan fiduciaries. It is another one of our favorite taglines – the simple act of providing fiduciary training to your organization’s ERISA fiduciaries is a major step in minimizing fiduciary liability. Training will educate fiduciaries as to their responsibilities and help establish a record of procedural prudence. There are some really nifty fiduciary training programs which can be easily customized for any group of plan fiduciaries.
- I am so fancy, You already know… I have reviewed my plan docs, and I am good to go. Since fiduciaries should make decisions by following the applicable plan documents (e.g., plan, summary plan description, IPS, trust, committee charters, delegations, etc.), fiduciaries should make sure plan documents are consistent with intended plan design, with one another and with actual practice. This can be an arduous undertaking, but can pay huge dividends down the road in the event of litigation or an in-depth plan audit by the IRS or DOL.
- “How I Met Your Mother” ends, but fee litigation continues.The list of 401(k) fee cases left on the docket is dwindling, but the Supreme Court has agreed to weigh in on a standard of review issue in the Tibble case. Moral of the story??? Stay tuned, pay close attention to the items above, pay really close attention to item 10 below and, when in doubt, get the help of retirement plan experts.
- Let it Go, Let it Go, Cannot Let ERISA Concerns Hold you Back anymore. If we have said it once, we’ve said it a thousand times -- being a good fiduciary is all about having a procedurally prudent process. For each fiduciary decision you should: inquire; analyze; consider alternatives; get help and advice if needed; and document the process, actions and basis for the decision. Completing these tasks will help establish and demonstrate procedural prudence, and ERISA stress will melt away. Pop the bubbly once more!
6. DILLERISMS: I want my children to have all the things I could not afford. Then I want to move in with them. - Phyllis Diller
7. STUFF YOU DID NOT KNOW: Intelligent people have more zinc and copper in their hair.
8. TODAY IN HISTORY: In 1943, World’s largest office building, Pentagon, completed.
9. KEEP THOSE CARDS AND LETTERS COMING: Several readers regularly supply us with suggestions or tips for newsletter items. Please feel free to send us or point us to matters you think would be of interest to our readers. Subject to editorial discretion, we may print them. Rest assured that we will not publish any names as referring sources.
10. PLEASE SHARE OUR NEWSLETTER: Our newsletter readership is not limited to the number of people who choose to enter a free subscription. Many pension board administrators provide hard copies in their meeting agenda. Other administrators forward the newsletter electronically to trustees. In any event, please tell those you feel may be interested that they can subscribe to their own free copy of the newsletter at http://www.cypen.com/subscribe.htm.
11. REMEMBER, YOU CAN NEVER OUTLIVE YOUR DEFINED RETIREMENT BENEFIT.
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