Cypen & Cypen
AUGUST 21, 2008
Stephen H. Cypen, Esq., Editor
The National Institute on Retirement Security has published A Better Bang for the Buck: The Economic Efficiencies of Defined Benefit Pension Plans. Worries about retirement security abound. Families fear they will not have enough to support an adequate retirement income as home values and financial markets plummet. Dwindling profit margins have employers looking to cut costs. And governments are concerned about delivering on promises they have made to the citizens and to their employees, as tax revenues shrink amid a weakening economy. in this environment, some have proposed replacing traditional defined benefit plans with 401(k)-type defined contribution retirement savings plans, in an effort to save money. But decision makers would be wise to look before they leap. To deliver the same level of retirement benefits, a DB plan can do the job at almost half the cost of a DC plan. Hence, DB plans should remain an integral part of retirement income security in an increasingly uncertain world because they offer employers and employees a better bang for the buck. The value of traditional DB pensions to employees is generally recognized: they provide a secure, predictable retirement income that cannot be outlived. The less well known is the value of a DB pension to an employer. Due to their group nature, DB plans possess “built-in” savings, which make them highly efficient retirement income vehicles, capable of delivering retirement benefits at a low cost to the employer and employee. These savings derive from three principal sources. First, DB plans better manage longevity risk, or the chance of running out of money in retirement. By pooling longevity risk of large numbers of individuals, DB plans avoid the “over-saving” dilemma -- that is, saving more than people need on average to avoid running out of cash -- that is inherent in DC plans. Consequently, DB plans are able to do more with less. Second, because DB plans, unlike the individuals in them, do not age, they are able to take advantage of the enhanced investment returns that come from a balanced portfolio throughout an individual’s lifetime. Third, DB plans, which are professionally managed, achieve greater investment returns as compared with DC plans that are made up of individual accounts. A retirement system that achieves higher investment returns can deliver any given level of benefit at a lower cost. Because of these three factors, NIRS finds that a DB pension plan can offer the same retirement benefits at close to half the cost of a DC retirement savings plan. Specifically, the analysis indicates that the cost to deliver the same level of retirement income to a group of employees is 46% lower in a DB plan than it is in a DC plan! This finding is an important factor for policy makers to consider, especially with respect to public sector work forces, where tax dollars are an important source of funds for retirement benefits. DB plans are a more efficient use of taxpayer funds when offering retirement benefits to state and local government employees. Here are a couple of details, which when compared with a typical DC plan:
All in all, this piece may be the definitive one in providing “ammunition” against
the scourge of DC plans in this country. Go to
The United States Court of Appeals for the Seventh Circuit has rendered a decision implying that institutional investors have a duty to monitor potential securities class action claims. The case involves Colorado Public Employees’ Retirement Association, which appealed from a district judge’s refusal to allow it to intervene as a plaintiff in a pending class action for purpose of appealing a three-and-a-half-year-old order granting summary judgment against original representatives of the class. The issue was whether CoPERA was entitled to wait so long before trying to become a party. The appellate court affirmed. CoPERA almost certainly either knew -- and if it did not know it was negligent in failing to learn -- back in 2004 that summary judgment had been entered dismissing certain claims on the merits. (All doubts would have been dispelled had the district court certified a certain class before granting summary judgment, as he should have done anyway.) It is possible that a large, sophisticated investor (with a $6 Million claim) would not know that it was a member of a class in a class action suit, but is exceedingly unlikely. CoPERA is not some hapless individual who might be a member of a class in a class action suit without knowing it because the class had not been certified and class members therefore formally notified. Large pension funds have securities lawyers on retainer, and their lawyers would have known about and monitored the progress of the class action whether or not the fund’s trustees did. (CoPERA is the 23rd largest pension fund in the United States, with $38 Billion in assets.) A district judge has discretion in deciding whether a motion to intervene is timely, and he did not abuse that discretion in this case when he refused to allow belated intervention by a sophisticated litigant with a large stake, which had no good excuse for failing to seek intervention (or bringing its own suit) years ago. Note, the appellate court assumed, without presenting any empirical evidence, that large pension funds have securities lawyers on retainer to monitor progress of class actions. Also, the court did not define “large” pension funds. If “large” is a relative term, it could very well be that most, if not all, public plans are “large.” Larson v. JPMorgan Chase & Co., Case Nos. 08-1045, 08-1064 and 08-1170 (U.S. 7th Cir., June 23, 2008).
In an attempt to fill deficits in retirement plans, public pension funds in the United States are increasing bets on high-risk hedge funds and real estate, Bloomberg News reports. New York’s Comptroller is asking lawmakers to increase a cap limiting the amount of so-called alternative investments in the state’s Common Retirement Fund, third-largest U.S. public pension fund, at $154 Billion. South Carolina’s retirement system adopted a plan in February to invest as much as 45% of its $29 Billion in hedge funds, private equity, real estate and other alternatives -- from zero 18 months ago! Our take? Hold on to your athletic supporter.
For the first time since March 2003, the one-year performance of institutional portfolios was negative across the board, with the -6.01% rate of return for Taft-Hartley plans having assets greater than $1 Billion the worst performance for the period ending June 30, 2008, according to the Wilshire Trust Universe Comparison Service. Wilshire TUCS includes nearly 1,300 plans representing $3.04 Trillion in assets. The median performance of all master trusts for the year ended June 30, 2008 was -4.49%, with a quarterly return of -0.74%. The median performance of corporate pension plans was -5.20% for the year and -0.87% for the quarter, while public pension funds median performance was -4.51% for the year and -.93% for the last quarter. Even larger plans with a greater allocation to alternatives were not immune from the impact of worldwide market volatility during the past year. The performance of all sizes and types of plans faltered last year, with asset allocation unable to mitigate overall performance.
The Department of Labor’s regional office in Boston is investigating how corporation pension plan fiduciaries value their alternative investments. According to pionline.com, the result could be a huge increase in expense and work for plan fiduciaries. Pension plans often rely on financial statements of general partners to report value of those investments. But in at least one letter to an unidentified pension plan, the director of DoL’s Boston regional office contends that plan fiduciaries need to have a process in place independently to value the alternative assets. The letter says the plan’s failure to have an established process by which the fair-market of alternative investments can be determined violates the Employer Retirement Income Security Act. A process which merely uses the general partner’s established value for all funds without additional analysis may not insure that alternative investments are valued at fair market value. Investment consultants says changes in asset valuation suggested by DoL’s letter could create an enormous new work load and expense for plan executives and staffs. While most pension plans do rely on financial statements of general partners in their investment partnerships, those financial statements are usually audited. Besides, custodian banks that hold investments for plans could also question valuations that do not make sense. The new “process” could require plans to hire appraisal firms, investment banks or new in-house staffers with appraisal expertise. Requiring plans to do their own valuations may very well discourage plan investments in alternatives. (No kidding.) Note to Florida plans: be cognizant of Section 112.661(17), Florida Statutes. That section requires the board’s investment policy to provide for valuation of illiquid investments for which a generally recognized market is not available or for which there is no consistent or generally accepted pricing mechanism. The investment policy must also require that, for each actuarial valuation, the board verify the determination of fair market value for those investments and ascertain that the determination complies with all applicable state and federal requirements. That section also requires that if such investments are utilized, the investment policy include the criteria set forth in Section 215.47(6), Florida Statutes. The latter section contains detailed requirements for nontraditional assets and requires “assurances that sufficient investment expertise is available to the board to properly evaluate and manage such activity.” Now, more than ever, it’s a jungle out there.
Do you realize in about 40 years we'll have millions of old ladies running around with tattoos? (And rap music will be the Golden Oldies!)
“A foolish consistency is the hobgoblin of little minds, adored by little statesmen and philosophers and divines.” Ralph Waldo Emerson
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