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Cypen & Cypen
OCTOBER 12, 2005

Stephen H. Cypen, Esq., Editor

Never Forget - September 11, 2001


On October 5, 2005 Wilshire Associates Incorporated issued its 2005 report on City & County Retirement Systems: Funding Levels and Asset Allocation. The study includes 104 city and county retirement systems. Of the 104 retirement systems, 60 reported actuarial values on or after June 30, 2004 and 44 reported before then. For the 60 city and county retirement systems that provided actuarial data on or after June 30, 2004, pension assets and liabilities were, respectively, $170.1 Billion and $192.7 Billion. The funding ratio (assets-to-liabilities) for all 60 was 88% in 2004, up markedly from 83% for the same 60 plans in 2003. For the 60 city and county retirement systems that provided actuarial data on or after June 30, 2004, pension assets grew 13%, or $20 Billion, from $150.1 Billion in 2003 to $170.1 Billion in 2004, while liabilities grew 7%, or $12.8 Billion, from $179.9 Billion to $192.7 Billion. With asset value growth outpacing growth in liabilities, the 60 city and county pension plans went from a $29.8 Billion shortfall to a $22.6 Billion shortfall. For the 96 systems that provided actuarial data on or after June 30, 2003, pension assets and liabilities were, respectively, $236.6 Billion and $293.3 Billion. Funding ratio for the 96 plans was 81% in 2003. Of the 60 systems that provided actuarial data for 2004, 75% have market value of assets less than pension liabilities; that is, they are underfunded. The average underfunded plan has a ratio of assets-to-liabilities equal to 82%. City and county portfolios average a 66% allocation to equities, including real estate and private equity, and 34% to fixed income. The 66% equity allocation is slightly higher than last year’s 65%. Nine of the 104 retirement systems have allocations to equity that equal or exceed 75%, and three have equity allocations below 50%. The 25th and 75th percentile range for equity allocation is 62% to 70%. The median actuarial interest rate assumption is 8% (.8% less than Wilshire’s forecast of 7.2%). As in the past, we expect the National Association of State Retirement Administrators swiftly to advise Wilshire of its recurring concerns about the report, particularly the meaning and consequences of the term “underfunding.”


According to the latest data in The Conference Board’s Institutional Investment Report, U.S. institutional investor ownership of the U.S. equity market rose to 59.2%, or $7.9 Trillion, of outstanding U.S. equities in 2003, up from 51.8%, or $6.6 Trillion, in 1999. Institutional investors gained even greater control of the largest 1,000 corporations: at 2004 year-end, they owned 69.4% of the equity of these largest companies, up from 61.4% in 2000. Pension funds owned 40.7% of total U.S. equity assets in 2003, insurance companies 23.3%, investment companies 22%, bank and trust companies 11.7% and foundations 2.4%. Since 1980, investment companies and mutual funds have grown the fastest (to 22% of assets in 2003 from 2.6% in 1980), followed by pension funds (to 40.7% from 32.6%). In the same period, bank and trust companies declined substantially (to 11.7% from 38.8% of total assets in 1980). U.S. institutional investors controlled $19.634 Trillion in assets in 2003, nearly matching their peak of $19.664 Trillion in 1999. The Conference Board report was summarized in P&I Daily.


The Committee on Investment of Employee Benefit Assets asked its members -- chief investment officers of many of the nations’ largest corporate pension plans -- to respond to a survey on the impact of proposed changes to rules governing defined benefit pension plans and how these changes could affect pension plans and the workers and retirees in those plans. The survey requested information on the ways plans might change in response to particular policy initiatives. The survey covers some of the changes proposed by the Administration in its pension reform plan and one accounting proposal that continues to be discussed. Forty-seven senior corporate investment officers responded to the survey. Respondents manage $418 Billion in defined benefit plan assets in behalf of 5 million plan participants and beneficiaries. Without reporting here the specific survey inquiries, CIEBA came to the following conclusions. Defined benefit plans continue to be an important part of the nation’s retirement system, covering more than 35 million Americans and their families. Private sector defined benefit plans generally provide universal coverage to workgroups and do not require employees to contribute in order to participate. DB plans are designed to insulate participants from both investment and longevity risks. DB plans can provide substantially more benefits per dollar than other savings vehicles, such as defined contribution plans. DB plan assets are invested more efficiently and are more diversified, disciplined and stable than assets invested by individuals. DB plans are long-term in nature. Many of the proposals now pending in Congress are short-term oriented. These proposals would have long-term consequences for current and future workers, with potential to damage the retirement security of millions of Americans. Plan asset allocation decisions have an important impact on pension plan participants. Shifting plan assets away from equities raises the long-term cost to employers sponsoring DB plans. As the survey demonstrates, such a shift would accelerate the trend to “soft” freezes -- closing plans to new entrants -- and “hard” freezes -- freezing benefit accruals for existing participants. Soft freezes are especially difficult on younger workers who may never have the opportunity to participate in a retirement plan where they have significant protection from a variety of risks. Hard freezes are especially damaging to mid-career and older workers, who are not able to earn benefits during their prime earning years. Several of the pending proposals individually could have a negative impact on the future of DB plans. But the collective impact of two or more of the proposals would be worse. Policy makers need to recognize that in their rush to address today’s issues, they may be undermining retirement security for future retirees. Very well said.


On March 30, 2005, a United States District Judge permanently enjoined EEOC from publishing or otherwise implementing a “Proposed Rulemaking” that would exempt from the prohibitions of the Age Discrimination in Employment Act “the practice of altering, reducing, or eliminating employer-sponsored retiree health benefits when retirees become eligible for Medicare or a State-sponsored retiree health benefits program.” (See C&C Newsletter for April 14, 2005, Item 1.) Applying a 1984 U.S. Supreme Court test, the trial judge held that the challenged regulation was contrary to law and Congressional intent under ADEA and its amendments. In so holding, the court expressly noted that it was bound by the Third Circuit’s 2000 decision in Erie County, and that Erie County required a conclusion that the regulation failed the 1984 U.S. Supreme Court test when the regulation was challenged. While the matter was pending in the Third Circuit on EEOC’s appeal, the U.S. Supreme Court decided National Cable and Telecommunications Association v. Brand X Internet Services, U.S. , 125 S. Ct. 2688 (2005), which dramatically altered the respective roles of courts and agencies. Brand X held that a court’s interpretation of a statute only bars an agency from interpreting that statute differently from the court if the court has determined the only permissible meaning of the statute. Because the Third Circuit’s Erie County decision did not determine the only permissible meaning of the relevant provisions of the ADEA, under Brand X, the court is not bound by Erie County in reviewing EEOC’s regulation. Thus, on EEOC’s motion for relief from judgment, the trial judge granted the motion. However, because the parties had already indicated their intention to appeal, the judge stayed the portion of the order vacating the permanent injunction, so that the injunction will remain in effect pending appeal. AARP v. Equal Employment Opportunity Commission, Case No. 05-CV-509 (E.D. Pa., September 27, 2005).


The cover story in October 2005's Benefits & Compensation Digest is entitled “Fiscally Fit Public Sector Pension Plans: Take Steps With Next-Generation Analytical Tools.” The article, co-authored by the legendary Cathie Eitelberg, says that most public sector plans still have a long way to go before becoming fiscally fit. In fact, some are actually losing ground, which can put benefits at risk. Monitoring a plan’s fiscal health, testing “what-if” scenarios to assess emerging trends, making timely and planned course corrections and developing a balanced strategy for making up any lost funding can help public sector plans find their way back to fiscal fitness and ensure promised benefits will be delivered. In the final analysis, the most important question for plan sponsors is whether promised benefits remain supportable over time. One way to find out is to take the following steps: (1) establish the desired timing to return to actuarial balance (for example, 10 years), (2) do a cash-flow study to understand the projected, annual liquidity needs of the plan over the next 10 years and (3) utilize asset-liability modeling to discover the annual necessary rates of investment return required to bring the plan into actuarial balance by the end of the desired period. Balancing security and funding stability is a delicate task, but financial engineering -- diligence in monitoring a plan’s fiscal health and making course corrections in a timely and planned manner -- can help to make it a reality.


The October 2005 Benefits & Compensation Digest has another excellent article, entitled “Alleviating Funding Pressures in Defined Benefit Retirement Plans.” Pension underfunding is a problem for all types of pension plans. Using a case study of a defined benefit plan, the article identifies funding problems and their causes, such as plan performance, plan design and actuarial cost methods. Tough decision making about funding and benefits should be made with assistance of plan professionals. Decisions will involve studies by the actuary as to alternative changes in contributions or benefits; discussions with investment consultants; advice from the plan attorney with respect to permissible reductions in benefits; and input from the administrator with respect to complications and administrative burdens. As difficult as the process may be, it is important to contributing employers, unions, membership, as well as to the professionals, that plan funding be strengthened so the plan can continue to be able to provide benefits in a predictable and reliable manner. Some pretty hard medicine.

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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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