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Cypen & Cypen
MAY 12, 2005

Stephen H. Cypen, Esq., Editor

Never Forget - September 11, 2001


Mercer Human Resource Consulting announces the release of its Manager Search Trends Report 2004. The report provides valuable insights into institutions’ investment manager hiring patterns and trends around the world. United States Equity was the most popular single product category, with 90 searches accounting for $6 Billion of assets placed. Second was Global Equity, which had been the most popular category in 2003 and in 2002, with 85 searches and $9 Billion worth of assets placed during 2004. Currency Overlay attracted the greatest increase in interest, with 28 searches and $10 Billion worth of assets placed -- a dramatic increase from 2003 when there were only 8 Currency Overlay searches. If you are really interested in more details, the report costs a cool grand.


Mercer has also issued a prospective on retirement, entitled “Defined Benefit Plans: Still a good solution?” Defined benefit plans face severe challenges. Contribution requirements are escalating sharply. Accounting costs suddenly are high and volatile, while looming accounting changes threaten greater volatility. Executives question plans with unfunded liabilities and poorly defined risks. Many employees do not understand DB plans and seem to appreciate 401(k) plans more. Has the time for pension plans come and gone? Are pension plans still a good solution? Well, despite serious challenges, a properly-designed and communicated DB plan actually creates substantial value for both employer and employee, and can be a source of competitive advantage for the employer. The following represent some critics’ objections and the responses:


  • Volatile Contribution Requirements --volatility results from employers making just the minimum required contribution and investing in equities. But plan sponsors can help stabilize contributions by either (a) making higher contributions to create a cushion for contribution requirements or (b) investing primarily in fixed income securities. (For years, we have been suggesting that cities contribute more than the minimum required contribution, set by the actuarial valuation.)
  • Volatile Expense Levels -- current accounting methods include many techniques for smoothing volatile expenses.
  • Unfunded Liabilities -- such liabilities can be minimized by better funding policies, plan design and investment policies. (Why are employers that fund the absolute minimum surprised when unfunded liabilities develop?)
  • Pension Plans Cost Too Much -- after years of funding-holidays, many came to think that there was no cost to a DB plan. Of course, we know better today. But, as demonstrated in the report, the cost can be up to 50% less in a DB plan. Those who believe that DC plans cost less may fail to recognize they also deliver much less retirement income.
  • Lack of Portability -- complete portability implies that people are indifferent to whether they stay with an employer or leave. Employers who want a lower turnover should view the lesser portability of a DB plan as an advantage.
  • No Early Access to Funds -- less than 40% of early distributions from qualified plans are rolled over to other retirement vehicles. DB plans that retain funds until retirement are accomplishing their goal much better than plans with early distributions.
  • Complex Administration -- some plans are difficult to administer, but this is often a result of complex design chosen by the plan sponsor. Straightforward plan design can simplify administration and enhance employee appreciation.


The Florida Division of Retirement refused to pay benefits to Lavondra Steadman’s ward, claiming that she had failed timely to produce the documentation requested by the Division, namely, guardianship papers and an order determining heirs. On appeal, the appellate court concluded that the circuit court order obtained by Steadman and submitted to the Division -- an order determining beneficiaries -- satisfied the Division’s documentation requirement, and the Division’s refusal to consider her application was frivolous. Apparently the Division and the administrative law judge had not stayed current with changes in the law, by demanding an order determining “heirs,” which no longer exists and which was replaced by an order determining “beneficiaries.” Because Steadman should have never been required to file the appeal, pursuant to Section 120.595(5), Florida Statutes, the appellate court granted her motion for attorney’s fees in the amount of $7,500.00, as requested by her attorney. That section authorizes a court to award attorney’s fees to a prevailing party if it finds that an appeal was frivolous, meritless, an abuse of the appellate process or if agency action that precipitated the appeal was a gross abuse of the agency’s discretion. Steadman v. Department of Management Services, 30 Fla. L. Weekly D1043 (Fla. 5th
DCA, April 22, 2005).


Victor Raynor was ordered to undergo a “fitness-for-duty” evaluation. Believing he was required to do so to comply with the order that he undergo the evaluation, Raynor signed an authorization for release of the results of the evaluation. In the course of the psychological examination, which took place at the offices of a private practitioner who was not a city employee, Raynor disclosed a personal incident involving a bar fight he was in 23 years earlier. Eventually, the doctor reported that Raynor was fully fit for duty. Apparently, the city wanted to inquire into details of the almost-quarter-century-old incident, so Raynor and the Fraternal Order of Police sought a temporary injunction. Among other things, they claimed a violation of the Law Enforcement Officers’ Bill of Rights, Section 112.532-534, Florida Statutes, in that the interview did not take place at the office of the local precinct and was not recorded. However, the court found LEOBR only applied when interrogation is by members of the law enforcement officer’s agency. However, the court did find that disclosure of the details of the interview would violate Raynor’s privacy under Article I, Section 23, of the Florida Constitution. Any waiver of Raynor’s state constitutional right of privacy under threat of being terminated would be invalid. Besides, Raynor only authorized release of the results of his examination. Thus, finding present all four conditions for entry of a temporary injunction, the court enjoined and restrained the city from requiring the appearance or questioning of Raynor regarding any matters disclosed in the doctor’s report or using the information derived therefrom in any manner adverse to him. Florida State Lodge, Fraternal Order of Police v. Atlantic Beach Police Department, City of Atlantic Beach, Florida, 12 Fla. L. Weekly Supp. 456 (Fla. 4th Cir., February 28, 2005).


A recent issue of The Inside Edition is entitled “Understanding Behavioral Finance -- How to Minimize Plan Participant Investing Errors.” Until recently, the field of finance ignored human irrationality. Economic theory presumed that individuals had unbiased expectations and acted rationally to maximize their future wealth. But researchers who study financial decision-making have discovered a number of consistent errors in the way people make investment choices. Unbiased, rational wealth-maximizers seem to exist largely in economists’ imaginations. Briefly, behavioral finance combines economics with psychological insights about how people make decisions, in order to shed light on market behavior. When investors do not behave as economic theory would predict, the fault lies in “bounded rationality,” which has two components: (1) constraints on time and information and (2) limits to the ability to handle complexity. People often resort to rules of thumb and other mental shortcuts that can lead to sub optimal outcomes. Plan participants generally do not act to maximize their financial self-interest when it comes to saving for retirement. The primary errors in judgment are

Inadequate Saving -- people often exhibit a lack of self-control when attempting to forego present enjoyment for future gratification. Further, humans are prone to what is known as “hyperbolic discounting,” which means that the overemphasize immediate desires and rewards at the expense of long-term needs.

Naive Diversification -- a common error is to use simple allocation strategies that do not take risk/return preferences into account.

Loss Aversion -- people tend to accord losses about twice as much weight as gains; that is, losses hurt substantially more than the pleasure that is obtained from a comparable gain. As a result, people tend to invest using strategies that minimize loss rather than maximize wealth.

Status Quo Bias -- a recent study shows that nearly half of plan participants surveyed never changed their allocation during a ten-year period! Why? One theory is fear of regret. Better not to make a decision than to make an incorrect one.

The Disposition Effect -- investors are more likely to sell funds that have increased in value than they are likely to sell funds that have decreased in value.

So, what to do? A behavioral finance approach generally emphasizes automatic and default features that work to circumvent the inadequate saving tendencies of many plan participants. Recommended features include automatic enrollment, automatic rebalancing, default investment options and automatic increases in deferral rates. For anyone who cares about the future financial health of defined contribution plan participants, common behavioral errors should influence how they think about plan design and oversight. Automation and standardization of the investment process should be the watchwords for plan design. As much as possible, participants should be provided with effective guidelines to help remove emotion from decision making. Hey, wait a second: doesn’t the defined benefit structure take care of all these matters for plan participants? Duh.


Citizens Budget Commission is a “nonpartisan civic organization devoted to influencing constructive change in the finances and services of New York State and New York City.” On April 29, 2005 CBC issued “The Case for Redesigning Retirement Benefits for New York’s Public Employees.” The three major findings are (1) retirement benefits are a large and rapidly growing expense for the city and the state; (2) benefits provided by the city and state are more generous than those provided by large private employers, the federal government and most other states and localities; (3) generous pension benefits for city and state workers can no longer be justified on the ground that these workers’ wages are lower than in the private sector, because for most occupations wages in the public sector are higher than the private sector. Thus, CBC makes two general recommendations: require retirees to pay 50% of the premium for health insurance and switch to defined contribution plans for new employees (Sound familiar?). And if conversion of new workers to DC plans cannot be authorized in the near future, the following steps should be taken to alter the existing DB system:

  • Increase required employee contributions.
  • Raise the minimum age requirement for retirement.
  • Base pension benefits on the more standard definition of final average salary (five years).
  • Define work-related disabilities more rigorously.
  • Eliminate valuable supplements available to some retired New York City uniformed workers.

The foreword acknowledges input from several members of pension staff, but concedes their participation does not necessarily indicate that they agree with the recommendations. No kidding.


Hercules Incorporated amended its defined benefit plan in 2001. The amendment to the plan’s lump-sum payment option replaced the interest rate assumption that had previously been used to calculate present value of a participant’s accrued benefit with the annual interest rate on 30-year Treasury securities. The change was effective with respect to payments made on and after January 1, 2002. Hercules requested a determination from IRS that the amended plan met all of the qualification of requirements under the Internal Revenue Code. An interested party asserted that the amendment violated IRC’s anti-cutback rule. Nevertheless, IRS issued a favorable determination letter to Hercules. The interested party then filed a petition for declaratory judgment, challenging IRS’s determination. The United States Tax Court ruled that the IRS was correct in determining that the amendment to the plan’s lump-sum payment option did not violate the anti-cutback rule of IRC Section 411(d)(6). Stepnowski v. Commissioner of Internal Revenue, 124 T.C. No. 12; No. 8383-03R.

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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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