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Cypen & Cypen
NEWSLETTER
for
MARCH 30, 2006

Stephen H. Cypen, Esq., Editor

Never Forget - September 11, 2001

1. METHODS FOR STABILIZING PUBLIC RETIREMENT PLAN CONTRIBUTION RATES:

A research memorandum from Paul Zorn and Brian Murphy of Gabriel Roeder Smith & Company recognizes that a major role in actuarially 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 contributions rates are an important component in funding retirement plans, since they help governments budget effectively for plan contributions. In the early years 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, 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 remarkably, but as asset levels grew, the rates became more volatile. 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 returns. Given that the tradeoff is not likely to be reversed, what can be done to stabilize contribution rates? The memorandum addresses several methods that may be used separately or in combination: fixed contribution rates; limiting annual changes in contribution rates; funding corridors; asset value corridors; extending asset smoothing periods; asset allocations that minimize investment volatility; linking employee contributions to the plan’s financial position; linking retirement benefits to the plan’s financial position; and stabilization reserves. All have advantages and disadvantages, and the extent to which they help will depend on the individual circumstances of the plan. The best approach would be to use a variety of techniques based on the plan’s specific situation.

2. IRS ESTABLISHES E-MAIL BOX FOR TAXPAYERS TO REPORT PHONY E-MAILS:

The Internal Revenue Service announced March 27, 2006 (IR-2006-049) that it has established an electronic mailbox for taxpayers to send information about suspicious e-mails they receive, which claim to come from IRS. Taxpayers should send the information to phishing@irs.gov. (Who said IRS wasn’t hip?) The new IRS mailbox allows taxpayers to send copies of possibly fraudulent e-mails involving misuse of the IRS name and logo to IRS for investigation. Instructions on how properly to submit one of these communications to IRS may be found on the IRS website at www.irs.gov. Due to volume expected at the new mailbox, IRS will not be able to acknowledge receipt or reply to taxpayers who submit bogus e-mails. The mailbox is only for suspicious e-mails and not for general taxpayer contact or inquiries.

3. GASB WHITE PAPER ON WHY GOVERNMENTAL ACCOUNTING AND FINANCIAL REPORTING IS -- AND SHOULD BE -- DIFFERENT:

Governmental Accounting Standards Board has issued a white paper asserting that governments are fundamentally different from for-profit business enterprises in several important ways. They have different purposes, processes of generating revenues, stakeholders, budgetary obligations and propensity for longevity. These differences required separate accounting and financial reporting standards in order to provide information to meet the needs of stakeholders to assess government accountability and to make political, social and economic decisions. Although state and local governments in the United States have had separate standards for over 100 years, occasionally the question is raised: why can’t general purpose governments (cities and counties, for example) simply apply the standards established for business enterprises? The following questions and answers briefly address that issue:

Why are separate accounting and financial reporting standards essential for governments? Separate accounting and financial reporting standards are essential because the needs of users of financial reports of governments and business enterprises differ. Due to their unique operating environment, governments have a responsibility to be accountable for the use of resources that is significantly different from business enterprises. Although businesses receive revenues from a voluntary exchange between a willing buyer and seller, governments obtain resources primarily from the involuntary payment of taxes. Taxes paid by an individual taxpayer often bear little direct relationship to the services received by that taxpayer. The longevity of government and its role to maintain and enhance the well-being of citizens through the provision of public services also result in information demands that differ from those of business enterprises. For example, governments do not operate in a competitive marketplace, face virtually no threat of liquidation and do not have equity owners.

How do existing account and financial reporting standards reflect the different needs of stakeholders? The needs of the users of governmental financial reports are reflected in differences in the components of the conceptual framework for accounting standards and in individual accounting standards. Some of the most significant GASB standards that address differences in governmental and business financial reporting include (1) the measurement and recognition of certain types of revenues (for example, taxes and grants), (2) the view that capital assets provide services to citizens rather than contribute to future cash flows, (3) the use of fund accounting and budgetary reporting to meet public accountability needs, (4) the use of accountability principles rather than equity control to define financial reporting entity and (5) the treatment of pensions and other postemployment benefits to allocate cost of services equitably to applicable periods.

Why is there an ongoing need to set additional governmental accounting standards? Since its inception in 1984, GASB has strived to meet the needs of users of governmental financial reports by issuing a number of important standards. Although GASB has made progress, the need to develop and improve accounting standards for governments still exists. For example, additional components of the conceptual framework, which enhances consistency in setting government standards, is still being addressed. In addition, there are many important types of transactions, such as though associated with derivatives and intangible assets, for which there are no existing standards or for which existing standards are not comprehensive.

Ah -- now we see it clearly...not.

4. WHY ARE HEALTHY EMPLOYERS FREEZING THEIR PENSION PLANS?:

An Issue in Brief from Center for Retirement Research at Boston College asks that provocative question. Financially healthy companies are freezing their defined benefit pension plans and replacing them with 401(k)s. This change has an immediate adverse effect on mid-career workers, and, even though younger workers do not recognize it, the shift will probably mean that many young workers will end up with an inadequate retirement income. For, while 401(k) plans are fine in theory and could even be superior for the mobile employee, they transfer too much of the responsibility to individuals. Individuals make mistakes at every step along the way. Median 401(k)/IRA balances in 2004 were only $35,000. There are more than enough explanations for the new trend. And desire to control compensation costs, the pressures of rising health care outlays, the confluence of economic, demographic and regulatory risks, and the emergence of a two-tier pension system all make the sponsorship of defined benefit pension plans relatively unattractive. Moreover, the genie is out of the bottle. Given that the employer-sponsored pension system is a voluntary arrangement, nothing is likely to stop other healthy companies from following suit in closing down their defined benefit plans. Just what we wanted to hear.

5. DOW TRIVIA:

On March 29, 1999, the Dow Jones Industrial Average closed above 10,000 for the first time. And although we all know what happened to the Dow in the next several years, as of this writing it remains above the 10,000 mark.

6. QUOTE OF THE WEEK:

From Edgar Watson Howe, “A good scare is worth more than good advice.” (Especially when you are investing.)

Copyright, 1996-2006, all rights reserved.

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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