Cypen & Cypen
DECEMBER 8, 2005
Stephen H. Cypen, Esq., Editor
Beginning January 1, 2006, the deductible rate that workers can claim for using personal cars on business will be 44.5 cents a mile, down 4 cents a mile from the increase announced in September, 2005 (see C&C Newsletter for September 22, 2005, Item 2). In addition, the deductible rate for medical and moving expenses will be 18 cents a mile, a decrease of 4 cents from the current rate but still 3 cents higher than for the first 8 months of 2005. http://www.irs.gov/pub/irs-drop/rp-05-78.pdf.
After the United States Supreme Court ruled that the term “workweek” in the Fair Labor Standards Act of 1938 included the time employees spent walking from time clocks near a factory entrance to their workstations, Congress passed the Portal-to-Portal Act of 1947, which, among other things, excepted from FLSA coverage walking on an employer’s premises to and from the location of the employee’s “principal activity or activities,” and activities that are “preliminary or postliminary” to “principal activity or activities.” The Act did not otherwise change the Court’s descriptions of “work” and “workweek” or define “workday.” Regulations promulgated by the Secretary of Labor shortly thereafter concluded that the Act did not affect the computation of hours within a “workday,” which includes “the period between the commencement and completion” of the “principal activity or activities.” Eight years after enactment of the Portal-to-Portal Act and the interpretive regulations, the Supreme Court explained that the “term ‘principal activity or activities’... embraces all activities which are ‘an integral and indispensable part of the principal activities,’” including the donning and doffing of specialized protective gear “before or after regular workshift, on or off the production line.” In consolidated cases from the United States Courts of Appeals for the First Circuit and the Ninth Circuit, the U.S. Supreme Court unanimously held that because donning and doffing gear that is “integral and indispensable” to employees’ work is a “principal activity” under the statute, the continuous workday rule mandates that the time the employees spend walking to and from the production floor after donning and before doffing, as well as time spent waiting to doff, are not affected by the Portal-to-Portal Act, and are instead covered by FLSA. Although the cases involved poultry and meat processing operations, the Supreme Court’s expansion of the compensable workday will now open to challenge the timekeeping practices of a broad range of public and private employers. Donning and doffing activities that have previously been thought to be de minimis will need to be reevaluated in light of the Court’s mandate that associated walking time is also compensable. IBP, Inc. v. Alvarez, Case Nos. 03-1238 and 04-66 (U.S., November 8, 2005).
Pension Benefit Guaranty Corporation released two final rules on November 29, 2005. The first deals with the maximum guaranteed pension benefit for 2006. With respect to a plan participant in a single employer pension plan that terminates in 2006, the new maximum monthly benefit guaranteed by PBGC is $3,971.59, beginning at age 65 ($47,659.08 annually). The foregoing amount represents an increase from $3,801.41 in 2005 ($45,616.92). The second rule amends PBGC’s benefit valuation regulations by adopting more current mortality assumptions. Mortality assumptions prescribed under PBGC’s regulations to be used to value benefits for healthier participants were taken from the 1983 Group Annuity Mortality (GAM-83) tables. The rule updates those assumptions by replacing a version of the GAM-83 tables with a version of the GAM-94 tables. The updated mortality assumptions will better conform to those used by private-sector insurers and pricing group annuities.
It may be that the only thing worse than doing nothing about public pension plans is doing something about them, says Joe Mysak in bloomberg.com. The latest “something,” according to rating company Standard & Poor’s, is switching from defined benefit to defined contribution systems. Remember how this defined contribution business swept through the private sector over two decades ago? We’re doing away with the stodgy old DB pension plan, the companies told us. We’re going to replace it with the regular contribution of a percentage of your salary. You do the same and it all goes into a private investment account that will just grow and grow and grow until you retire. When you’re 65 you’ll be a millionaire! This approach somehow never caught on with states and municipalities, most of which still run their own public pension plans on the DB system. Only four states -- Alaska, Florida (optional), Michigan and Ohio -- have DC plans. Many states and localities are thinking about such plans now, though, as costs of retirement systems increase. States and municipalities couldn’t just dump their existing plans, of course; they would begin DC plans for new employees. So are they all going to take this route? Not so fast, says S&P: the switch to DC in effect transfers complete investment risk from employer to employee. And while some public employees might succeed in building a nice nest egg that will carry them through their retirement years, many will not. Here’s where it gets interesting, from a credit perspective, according to S&P. If investment performance flags, then the retiree could be looking at a lower-than-expected standard of living, which is not a happy prospect. And if the shortfall in savings is large enough, S&P says, the retiree may need public assistance. Governments, unlike corporations, cannot easily write off the needs of their retired employees if projections fail to come to fruition. Which means what? These unanticipated increased employer costs to make up for below-average retiree wealth could offset, partially or totally, the earlier direct benefits from lower, more predictable contribution rates gained through a direct contribution conversion. Expecting everyone to save the perfect amount for their own retirement is unrealistic. Wishing that everyone would behave responsibly, on the one hand, and that the investments they choose appreciate sufficiently so that their savings last a lifetime, on the other, won’t make it so. There are going to be casualties. The one thing predictable about the future of public pensions in the United States is that there is going to be more hysteria about the subject, more headlines and more frantic searching for magic answers. There is no such thing as public pension perfection, and there is no secret formula for achieving it. States and municipalities have to guard against giving away the store in terms of benefits. They have to be sure to make annual contributions to their pension plans. They have to avoid using gimmicks to attain short-term budget relief in exchange for long-term headaches. They should stop playing games with their pension plans.
In another opinion piece from bloomberg.com, John Wasik starts with the assumption that Congress can cut through a political briar patch and pass a law that forces full disclosure of pension debts. The consequences might be stunning. Companies with poorly-funded pension plans might have to contribute billions of dollars more to their retirement plans and touch off worker demands that employers pony up even more money for their retirement security. Just as surely, investors would punish companies with the highest retirement debt. Financial analysts estimate that total shareholder equity for companies in the S&P 500 would drop by $255 Billion, or 7%. The 18 most underfunded companies would fare worse, suffering a 25% reduction in shareholder equity. In fact, the shareholder equity would be wiped out at the seven S&P 500 companies with the biggest funding gaps in their pension plans. Because pension assets and liabilities are treated as “off-balance sheet” items, how much a company really earns and holds in corporate assets is distorted. Roughly 20% of the $1.3 Trillion in S&P 500 pension fund assets is currently reported on balance sheets. Full disclosure usually illuminates boardroom secrets and might lead to changes. Companies that conclude their defined benefit plans are too expensive might trigger freezes or shutdowns. Pension fund managers may even sell stocks to reduce the overall risk profile of their portfolios, and buy bonds or other securities. Once market gyrations subside, the outcome for future retirees will be even more challenging. Ultimately, knowing how pensions are funded will force investors large and small to educate themselves. They will need to focus more on lowering risk and expenses to achieve their retirement goals. No matter what the political or economic climate, that’s a sound practice.
A recent piece from watsonwyatt.com addresses the media frenzy that has surrounded the pension woes of several airlines and the resultant potential financial hit on the Pension Benefit Guaranty Corporation. An increasing number of large defined benefit pension sponsors have either frozen or closed their pension plans to new hires, leading many analysts to conclude that the traditional DB pension system is in a tailspin. But to paraphrase Mark Twain, the rumors of DBs’ death may be greatly exaggerated. After taking a second look at the cost and benefits of DB plans, some employers have decided they are worth keeping. While some sponsors are turning away from DB offerings, many are discovering good reasons to keep their DB plans. Watson Wyatt surveyed more than 500 companies with DB plans and found that over a six-year period between 2000 and 2005, two-thirds did not change the basic DB/DC structure of their retirement plans for new hires. A significant number of companies (17%) froze or closed their DB plans and adopted a DC-only package. However many companies (about 9%) actually added DB plans, increased benefit accruals or expanded DB coverage. Four percent converted their traditional plans to a hybrid design between 2000 and 2005 -- a period that coincides with many of the significant regulatory and market challenges to the DB system. Interviews at a number of companies that decided to stay with their expanded DB programs revealed several recurring themes:
DB plans that were designed to encourage older workers to retire in years past are now being turned around to encourage older workers to keep working, through design features like increasing accruals. The financial market fluctuations of recent years have been a trial by fire for most DB sponsors, forcing them to come to grips with the risk in their pension portfolios. While some have responded by getting rid of their DB plans, others -- recognizing the benefits of these plans -- have turned to emerging tools for managing portfolio risk through asset/liability matching and hedging strategies.
A new Issue in Brief from Center for Retirement Research at Boston College asks that very question. Employer plans are a critical component of the United States retirement income system. Existence of these plans, especially the increasingly-dominant 401(k)s, seems highly dependent on their favorable tax treatment. It is less clear, however, whether the employee contributions that fund these plans are a response to the favorable tax provisions or to the “Christmas Club” nature of pensions that make saving automatic. This issue has become increasingly important, because reduction in taxation of equities to date, and near elimination of equity taxation recommended by the President’s Advisory Panel on Federal Tax Reform, dramatically reduce tax advantages of employer plans. Will employer plans survive in the absence of any tax advantage to saving within a plan as opposed to a fully taxable account? And if employer-sponsored pensions do not survive, will saving -- and retirement saving in particular -- increase or decrease? One could argue that making favorable tax provisions available to all forms of saving could encourage people to save more. Or one could argue that the “Christmas Club” nature of pensions is key, in which case a substantial retrenchment of employer-sponsored plans could dramatically reduce saving. The implications of any such a decline should be part of any debate about tax reform.
An article in CFO.com predicts that the other shoe has yet to drop on pension consultants’ possible conflicts of interest, but companies cannot afford to wait. In a piece written before revelation of the investigation referred to in the next item, the author makes reference to the report by the Securities and Exchange Commission Office of Compliance Inspections and Examinations dated May 16, 2005 (see C&C Newsletter for May 19, 2005, Item 1) and the Department of Labor and SEC Guidance issued June 1, 2005 (see C&C Newsletter for June 2, 2005, Item 1). The author says the SEC has yet to take official action against any pension consultants, but its commission enforcement division is thought to be looking into the matter. In a postscript, the author talks about the thoughts of a former SEC Chairman, who advises not to wait for the governmental inquiry. Make sure the people who are serving your employees understand that neither the employees nor the employer have any tolerance for conflicts of interest and any practices that are followed must be consistent with the interests of plan beneficiary. The former Chairman says the allegations that pension consultants could be offering advice to retirement plans based on anything other than what is best for the plan and its participants is “extraordinarily serious.”
According to several press sources, Merrill Lynch has received a subpoena from the Securities and Exchange Commission as part of an investigation into conflicts of interest among advisers to pension funds. SEC’s interest in the Merrill Lynch Jacksonville, Florida, operation appears to grow out of its study of the pension consulting industry, in which it found conflicts at more than half the consultants it examined (see C&C Newsletter for May 19, 2005, Item 1). In a letter to its clients, Merrill Lynch was quick to point out that the investigation is a non-public, fact-finding inquiry; that the investigation and the subpoena do not mean that SEC staff has concluded that anyone has broken the law; and that the investigation does not mean SEC has a negative opinion of any person, entity or security. Stay tuned for more developments.
Two seats on the New York Stock Exchange have just sold for $4 Million each. We suspect our recent report of a sale for $3.025 Million should have been $3.25 Million (see C&C Newsletter for November 17, 2005, Item 10).
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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.