Fixing Retirement Inequality

Just last week, I suggested that retirement inequality is nearing an apocalypse. It's an awfully strong statement to make as both the US and the world have plenty of problems to deal with. Since this one is US-centric (I have nowhere near sufficient expertise nor do I have the requisite data to offer an informed opinion outside the US), I thought I would step up and make some suggestions.

First, the problem: according to the most optimistic data points I have seen, somewhere between 60 and 70 percent of working Americans are "on track" to retire. And, these studies, when they are nice enough to disclose their assumptions use pretty aggressive assumptions, e.g., 7 to 8 percent annual returns on assets (the same people who tout that these are achievable condemn pension plans that make the same assumptions) as well as no leakage (the adverse effects of job loss, plan loans, hardship withdrawals, and deferral or match reductions). The optimists don't make it easy for you by telling you that even their optimistic studies result in 30 to 40 percent of working Americans not being on track to retire (a horrible result). They also tend to pick and choose data to suit their arguments using means when they are advantageous, but medians when they are more so.

Yes, we do have a retirement crisis and as the Economic Policy Institute (EPI) study was good enough to make clear, it is severely biased against the average worker.

The EPI study presented data on account balances and similar issues. It did not get into interviewing actual workers (if it did, I missed that part and apologize to EPI). But, I did. I surveyed 25 people at random in the airline club at the largest hub airport of a major US-based airline. People who wait in those clubs at rush hour are not your typical American worker; they tend to be far better off. I asked them two questions (the second only if they answered yes to the first):

• Are you worried about being able to retire some day? 19 answered yes.
• Would you be more productive at work if you felt that you could retire comfortably? All 19 who answered yes to the first question answered yes to the second as well.

While I didn't ask further questions, many groused about fear of outliving their wealth. Some talked about issues that fall under leakage. A few, completely unprompted remarked that if they only had a pension ...

For at least the last 13 years and probably more than that, retirement policy inside the Beltway has been focused on improving 401(k) plans with the thought that pensions are or should be dead. Even the Pension Protection Act of 2006 (PPA) was more about making 401(k)s more attractive than about protecting pensions. Yet, 13 years later with an entire decade of booming equity markets, even the optimists say that one-third of American workers are not on track to retire.

We've given every break that Congress can come up with to make 401(k)s the be all and end all of US retirement policy. They've not succeeded. 

Think back though to when the cornerstone of the US retirement system was the pension plan. The people who had them are often the ones who are on track to retire. 

Yes, I know all the arguments against them and here are a few:

• Workers don't spend their careers at one company, so they need something account-based and or portable.
• Companies can't stand volatility in accounting charges and in cash contribution requirements.
• Nobody understands them.
• They are difficult to administer.

PPA took a step toward solving all of those problems, but by the time we had regulations to interpret those changes, the "Great Recession" had happened and the world had already changed. Despite now having new pension designs available that address not just one, but all four of the bullet points above, companies have been slow to adopt these solutions. To do so, they need perhaps as many as three pushes:

• A cry from employees that they want a modern pension in order to provide them with usable lifetime income solutions.
• A recognition from Congress and from the regulating agencies that such plans will be inherently appropriately funded and therefore (so long as companies do make required contributions on a timely basis) do not pose undue risk to companies, to the government, to employees, or to the Pension Benefit Guaranty Corporation (PBGC) (the governmental corporation that insures corporate pensions) and therefore should be encouraged not discouraged.
• Recognition from the accounting profession in the form of the Financial Accounting Standards Board (FASB) that plans that have an appropriate match between benefit obligations and plan assets do not need to be subjected to volatile swings in profit and loss.

Give us those three things and the pensions sanctioned by the Pension Protection Act can fix retirement for the future. As the EPI study points out, we'll make a huge dent in the retirement crisis and we'll do in a way that makes the problem far less unequal.

It's the right thing to do. It's right for all working Americans.

If Income Inequality is a Crisis, Retirement Inequality is Nearing an Apocalypse

I've likely inflamed just with my title. So be it.

The Economic Policy Institute (EPI) earlier this week released an article by Monique Morrissey on the State of American Retirement Savings. It's subtitle is "How the shift to 401(k)s has increased gaps in retirement preparedness based on income, race, ethnicity, education, and marital status." It is stunning.

I've been saying for at least this decade that we have a retirement crisis. Despite protestations from those who favor self-sufficiency over employer and government-provided programs, the crisis looms larger. I wrote about this summer. But, as a full-time consultant working with clients who require that I place their needs first, I simply don't have time to do the research that the think tanks do. So, I often rely on the work that they have done. Regardless of the source, my considered opinion is that all of the data are sound whether the think tanks are right-leaning, left-leaning, or centrist. 

What I quibble with are the conclusions. 

More than half of Americans being on track to retire is not a favorable prognosis. It's especially not favorable when the modeling underlying that statement assumes constant, and perhaps unachievable, returns on investments and constant rates of deferral to 401(k) plans. We're asking a populace that is largely under-educated about financial and investment matters to instantly become great investors. We're also asking them to save for their retirement (including retiree health and long-term care) above all else -- no blips allowed. You lose your job? Keep saving. You pay for a child's wedding? Keep saving. You pay for an unexpected medical expense? Keep saving.

Is that practical? Of course it's not.

The EPI study has presented us with 20 charts. Each has a headline which, in my opinion (understanding that yours may be different) fairly depicts the data it shows. Here are a few of the more eye-catching ones (indented notes after the headlines are mine and should not be attributed to or blamed on EPI)::

• Retirement plan participation declined even as baby boomers approached retirement
• A smaller percentage of workers are now participating in employer-sponsored retirement plans than were 10 years ago. With the rise of the gig economy, this rates to get worse.
• The share of families with retirement savings grew in the 1990s but declined after the Great Recession
• Fewer than 60% have retirement savings. Period. How are the rest to ever retire?
• Retirement savings have stagnated in the new millennium
• Despite that savings of those above the age of 55 have increased fairly dramatically, those for the entire working population have barely moved suggesting that the runup in equity markets over the last decade has done little for most of America.
• Most families—even those approaching retirement—have little or no retirement savings
• This is frightening. In any age range, median (meaning half are better off and half are worse off) retirement savings are well beneath $50,000 ... in total.
• More people have 401(k)s, but participation in traditional pensions is more equal
• We'll return to this later, but this suggests that poorer people and minorities are less likely to make use of 401(k)s. Identifying the root cause is a highly charged issue and cannot be done with certainty, but identifying this as a sign of a problem is clear.
• High-income families are seven times as likely to have retirement account savings as low-income families
• Most black and Hispanic families have no retirement account savings
• Single people have less, but retirement savings are too low across the board
• The data show that single women, in particular, lack retirement savings. But, even among married couples, levels of retirement savings are abysmal.
• 401(k)s magnify inequality
• Those out of the top 20% when stratified by income represent a disproportionately low level of savings account balances.

I said I would return to the statement that participation in traditional pensions is more equal. It seems clear that this is because in most cases, an employee becomes a participant in a pension not through an affirmative decision to do so, but as part of his or her employment. It doesn't require an income disruption. It's not more difficult to participate when you have an unexpected expense.It's not easier for the wealthy to participate, nor for men nor ethnic or racial majorities. 

Yes, pensions have a horrible stigma attached to them right now. Many public pensions are horrifically underfunded and potentially place their sponsors (cities, states, etc.) in grave financial danger. The same could be said about some of what are known as multiemployer plans (that's a story for another day) except that their sponsors are, generally speaking, employers that employ very specific types of employees. 

For the rest of the populace and potential plan sponsors (employers), sponsorship of traditional pensions has waned considerably. About 18 months ago, I explained why. 

Before we write them off completely, however, let's look at what pensions do. According to the EPI study, participation is somewhat equal. They provide lifetime income protection, the single greatest fear of people nearing retirement. They can be part of the employment covenant.

And, thanks to the Pension Protection Act of 2006, they need not bring with them the cost volatility that has maddened CFOs across the country.

The data in the EPI study and not simply their interpretations absolutely scream that more than income inequality, retirement inequality is the looming personal financial crisis. Congress will bat this around and try to make it a partisan issue. But, it shouldn't be. It's a people crisis. It's a dire crisis. It needs a fix and the fix is available, but it needs to get started.

When Your Deal Involves a Pension

Corporate deals abound perhaps like never before. Mergers, acquisitions, consolidations -- call them what you will. They're still deals and they involve pensions, sometimes frozen, more often than you think. If you are the acquirer in any of these transactions, it would not be at all surprising to find that your team is giving these pensions were getting shorter shrift than they deserve.

Why?

More than most other elements of a corporate transaction, the costs of sponsoring a pension plan (single-employer) or being a participating employer in one (multiemployer) are both volatile and perhaps a bit out of your control. On the surface, that's bad. And, a significant problem is that traditional due diligence does not address this.

What do I mean by that? There are plenty of firms out there that perform due diligence in deals. On the financial side of this, the work is typically done by large accounting firms and their consulting arms or by the larger, traditional, multi-service consulting firms. What I have seen, and I have by no means seen everything, tends to be a fairly standard report with numbers filled in. It often relies a lot on the past and tends to assume that the past will be reflective of the future. For many of those future costs, that's probably not a horrible assumption. For pensions, unfortunately, it often is.

You see, whether you are focused on cash or on financial accounting, the amount of your future costs is dependent on rules. The rules are complex and they do not lend themselves to cost stability. Today, estimating what those costs will be is not easy. Doing so under a variety of economic scenarios is more complex and likely more expensive. Developing strategies to control those future costs adds even more difficulty and even more cost. It also takes a long time. And, of course, you are never able to work with current or perfect data. In the future, it will be much simpler. At least that sounds nice, but our predictions about the future are often wrong.

The future is here. It's here today.

Everything I said above that was difficult and expensive and more difficult and more expensive and takes a long time -- it doesn't have to.

We don't need great data. We don't need to bother your staff. We can move at the speed of deals. And it won't break the bank.

That future you were hoping for -- it's here now.

Hospitals and a Sky is Falling Economic Prediction

The headline from today's CFO Journal published by the Wall Street Journal was stark: "Sour Economic Outlook Weighs on CFO Spending, Expansion Plans. Let's leave off the lack of expansion plans, but focus on spending.

Consider a low-margin industry that employs highly-skilled workers in short supply -- hospitals -- in particular. Talk to heads of HR in the hospital sector. Most have nearly identical top concerns: how do I attract and retain skilled professionals? What they are obviously referring to are physicians, nurse practitioners, nurses, technologists, and technicians. These are all careers that require very specific, often extensive, education. They are all in short supply and feeling burnout. What is there to keep them around?

Direct cash is not a good option. First, as the WSJ piece suggests, CFOs just won't part with the levels of cash necessary to attract and retain. Second, and while data demonstrating this phenomenon are difficult to find, people live to their levels of income. In other words, if you have a doctor earning $200,000 per year with annual savings in his 401(k) only, if you give him a $50,000 pay increase, his savings in many cases will remain 401(k) only.

This is not good. Some day that physician is going to burn out. He may tire of a profession that has changed from being highly personal to largely impersonal. He may tire of insurers telling him how to practice medicine. He may tire of government intervention.

In any event, if he tires, he is going to do so without being prepared for retirement.

Therein may lie the key.

Prepare your skilled staff for retirement. Do it not by increasing your costs, but by reallocating your labor costs.

Most people live to (or above regardless of pay or nearly to) their paychecks. And, they want pensions.

Give them what they want. Give them a pension that checks all the boxes:

• Secure
• Lifetime Income Options Without Subsidizing the Profits of Large Insurers
• Portability
• Easy to Understand
• Professionally Managed Investments
• Stable, Predictable, and Manageable Costs

The time is now. Act while the economy is still strong and prepare yourselves and your employees for when it's not.

Surprise -- Employees Want Pensions

I read an article yesterday highlighting, as the author pointed out, that employees value benefits more than a raise. Some of the findings were predictable -- the two most important were health insurance and a 401(k) match and they were followed by paid time off. But, just barely trailing those were pension benefits with flexible work hours and the ability to work remotely far behind.

Let's put some numbers behind the ordering:

• Health insurance -- 56%
• 401(k) match -- 56%
• Paid time off -- 33%
• Pension -- 31%
• Flexible work hours -- 21%
• Working remotely -- 15%

What I found remarkable about this is that five of those six get constant attention. In today's workplace, however, as compared to one generation ago, pensions get little, if any, attention yet nearly one-third of workers would rather have pensions than a raise.

Why is this the case? Neither the survey nor the article got into any analysis as to the reasons, so I get to way in here entirely unencumbered by nasty things like facts. I get to express my opinions.

Ask a worker what they fear. I think they will tell you that two of their biggest fears are losing their health and outliving their savings. The second, of course, can be mitigated by guaranteed lifetime income.

Workers are beginning to realize that 401(k) plans are exactly what Congress intended them to be -- supplemental tax-favored savings plans. In fact, generating lifetime income from those 401(k)s is beyond what a typical worker is able to do. Their options for doing so, generally speaking, are to self-annuitize (when you run out of money, however, the guarantee goes away) or to purchase an annuity in the free market. 

That, too, comes with a problem. While that purchase is easy to do and does come with a lifetime income guarantee, it also comes with overhead costs (insurance company risk mitigation and profits plus the earnings of a broker). Roughly speaking, a retiree may be paying 20% of their savings to others in order to annuitize. That's a high price. Is it worth it? Is that why workers want pensions despite often not really knowing what they are?

Pensions are not for everybody; they're also not for every company. But, this survey strongly suggests that companies that provide pensions may become employers of choice. In the battle for talent, that's really important.

Many companies exited the pension world because the rules made those pensions too cumbersome. But, the rules have gotten better. They've put in writing the legality of plans that many employers wanted to adopt 15 to 20 years ago, but feared doing something largely untried. And, there is bipartisan language floating around in Congress that would make such plans more accessible for more employers.

Designed properly, those plans will check all the boxes for both the employer and the employees. It seems time to take another look.

Compensating Executives Under the New 162(m)

Except for those who are either executives or people involved in determining the ways that executives are compensated, one of the changes to the Internal Revenue Code last fall seemed like a little throw-in designed to appease a small constituency, but that few would really care about. That small group that does understand the change, however, knows it is a pretty big deal.

Let's recap so that we can all be on the same page. Prior to the Tax Cut and Jobs Act (TCJA), and oversimplifying somewhat, public companies were entitled to deductions for executive compensation so long as such compensation did not exceed $1 million per year for a covered employee. Performance-based compensation was not to be counted against that limit and covered employees were the CEO plus the four other highest compensated employees.

Since the passage of the TCJA, there have been several key changes to Section 162(m):

• Once you become a covered employee of a company (beginning in 2017), you remain a covered employee of that company, essentially forever;
• The CEO plus four other highest paid has been changed to CEO plus CFO plus three other highest paid;
• Companies no longer get an exemption for performance-based compensation; and
• Some grandfathering exists for certain agreements that existed in writing.

That does not leave a whole lot of wiggle room for companies. And, for companies that have provided large amounts of performance-based compensation to their executive group, meaningful deductions may be gone.

I'm not about to suggest that I can fix this new problem. But, you should note that amounts that have been deductible under Section 404 are unaffected by these changes. Section 404 of the Internal Revenue Code relates to qualified pension plans. What this means is that to the extent that parts of an executive's compensation which would be subject to Section 162(m) are somehow moved into a qualified pension plan, the funding of that plan will, subject to the rules of Section 404, generally qualify for a corporate tax deduction.

Of course, there are a myriad of rules around what it takes to keep such a pension qualified including the nondiscrimination rules of Section 401(a)(4). But, for most companies that still maintain ongoing pensions, the ability to transfer some otherwise nondeductible compensation to such a pension plan may still exist. It's one of the tools in the tool box that companies should look into.

Focusing on the Pension Part of the Deal

Let's suppose you're on the finance side of a business. That business is buying a company and you learn that the company that you are acquiring has one or more defined benefit (including cash balance) pension plans. What do you do now?

Pension plans and the finances associated with them are among the most confusing and misunderstood elements of a deal like this.The rules are unnecessarily complex and are often misunderstood even by people that you might be inclined to engage as experts. Cash flow requirements do not align well with financial accounting charges and not knowing the right questions to ask could seriously impede your ability to get the answers that you need.

So, how can I help?

Among the really nice things about pension plans is the amount of information that is publicly available on each of them. You see, in its infinite wisdom, Congress and the agencies that Congress has entrusted to regulate pensions have deemed that a myriad of such information has to be disclosed every year for each plan. In unknowing hands, that information is just that -- information. In the right hands, however, it's a veritable goldmine.

As a senior finance person, what do you need to do?

1. Identify all of the plans that you might be (will be) acquiring.
2. Identify what measures are important to you (e.g., cash flow, financial accounting expense, government disclosures, volatility, loan covenants).
3. Identify your constraints (e.g., available cash to use for pensions, funded status triggers to loan covenants).
4. Identify your goals with regard to the plans.

Notice that I didn't mention plan documents, participant census data, plan asset statements, or anything else that you thought you needed to provide. This is where that goldmine comes in.

I call your attention to a recent situation where we had just the information in 1. through 4. above. The goals were fairly simple and included roughly these:

• Help us to understand the amount of cash necessary to pay for the plan(s),
• Tell us what is not being done optimally, and 
• Help us to find ways to optimize these plans on a path to termination.

Our client now has a 10-year forecast of cash flow requirements under multiple scenarios. They understand what has not been done optimally over the last 10 years or so. And, they now have a strategy all set to go so that when they do pull the trigger and finish their deal, they'll be putting their pension dollars to optimal use.

This is a place where off-the-shelf, cookie-cutter solutions don't work. Every plan is different. Every plan has different thresholds. Every company is different. Every company has different resources.

But what makes every company the same is that every company needs a solution that is customized to their situation.

Preparing for Pay Ratio

Could the politically charged pay ratio calculation and disclosure of Dodd-Frank Section 953(b) go away with this year under this Republican Congress? Of course it could. Since companies generally will not be doing this disclosure until early 2018, does that mean they should hope that it goes away and not plan for it? No. The process will be long and data collection will be arduous for many companies. You don't want to get caught unprepared.

For those of you not familiar, I have written on this extensively. And, despite the fact that I think it will be a huge expenditure of effort by issuers of proxies and that I think it will provide little value to shareholders and the public generally, it's still the law and it becomes a requirement in the upcoming proxy season.

In a nutshell, determination of the pay ratio will follow this process:

• Identify the CEO (that should be easy)
• Identify the employee in the controlled group globally whose annual total compensation (a term of art including almost all forms of current and deferred compensation) when ranked sequentially among all employees falls right in the middle of that ranking
• Determine the annual total compensation for the CEO (you're doing this for the proxy already)
• Determine the annual total compensation for the median compensated employee
• Determine the ratio of the two

You may be wondering at this point where the complexities may lie; that is, in what situations are you more likely to want to consider outsourcing this determination than doing it yourself. Consider these as complicating factors:

• You operate in multiple countries
• You sponsor multiple pension plans perhaps in multiple countries
• You provide equity compensation broadly
• You provide other unusual forms of compensation
• You are afraid for whatever reason that your pay ratio will be high enough to garner unwanted negative publicity and you'd like guidance on managing the message

If you do have any of those situations, I'd suggest you consider seeking outside help. After all, this sort of data manipulation and these sorts of calculations are likely not in your core competencies. And, if they're not, I'd love to find a way to make your determination of the pay ratio less painful for you.

Doing Your Due Diligence on Advisers and Actuaries

I read an interesting article this morning. In it, I read about a company that had used the same retirement plan adviser for quite a long time and developed a good relationship with them. After 13 years of this adviser assisting them with investment monitory, a fiduciary policy, and an investment policy, as well as manager searches, the company in question decided that just as part of due diligence, even though they figured there would only be about a 10% of chance of changing advisers to go through that due diligence process and bid those services out as well.

What the company, Dot Foods, found was that it was being charged perhaps more than a market competitive price and getting less than market competitive level of service. It was time for a change.

We could draw an analogy to lots of different kinds of services, but as consultants like to say, I'm going to drill down a little bit (I can't believe I used that term as hearing it always makes me hear a dentist's drill).

Let's put this in the context of a decent-sized, but not enormous defined benefit pension plan. To give some context, let's say that the plan has between $50 million and $1 billion in plan assets and let's assume that the plan is frozen (this is not an uncommon situation).

Now consider your plan advisers, particularly your actuary. Ask yourself these questions:

• How long have you been working with your current actuarial firm?
• Over that time, how many fresh ideas or analyses have they brought you with respect to your plan? When was the last time they brought you one that they didn't charge you for?
• Reflecting the fact that your plan was frozen and that some of the work behind the actuarial valuation would be much simpler, did they voluntarily reduce your actuarial fees the year after you froze your plan?
• Do you get as much attention from them as you did before your plan was frozen?
• Have they given you a strategic plan to get to termination of your plan? Or, have they just told you that interest rates are too low now and you'll have to wait it out?
• If they have given you a plan, was it provided in the context of your business or was it just their standard template?

You can pretty easily tell what the so-called best practice answers to all of these questions are. And, for your sake, I hope that after reflecting on your answers that you are able to tell yourself and your colleagues that most or all of those answers are what you would like them to be.

Suppose they're not. 

I know. You have a frozen plan and you think you are in set it and forget it mode. You don't really want to spend time both in the due diligence or RFP process to do this check and you certainly don't want to invest the time and effort that you think will be necessary during transition. 

Consider this scenario. You are able through that process to identify enough hard savings and soft savings that hiring a contractor or temporary employee to help with the transition would be a drop in the bucket in terms of cost compared to what you will be saving. During the RFP process, you get a freebie of some ideas that will help you to meet your strategic objectives with a promise of more to come. You learn that your actuary had gotten lazy and was delivering sub-optimal consulting.

Hmm ... there's an interesting term. What in the world is sub-optimal consulting? 

Sub-optimal consulting is a fancy way of saying that your actuary is just going through the motions. Everything they are providing you is correct, but none of it is the best correct answer.

I'm not implying here that your actuary should be doing anything underhanded or unethical. Quite to the contrary, your actuary should be following the law and Actuarial Standards of Practice to a tee. Oftentimes, however, within those constraints, there are a range of potential answers. Some are far more conducive to your business than others.

Consider this recent real example. A company, now a client, didn't like the news it was consistently getting from its actuary. That company didn't know if that news was the only way or if there was a better way. So, they asked. 

What they learned was that if their actuary did take the time to understand the interrelationship between their plan and their business that there was better news that they could be getting. The company came back to us and asked, "Can you save us money?" The answer was that there were hard dollar savings (fees) that would be small and other savings that would be significant. 

Perhaps you are the company that is getting great service and perhaps you maintain the plan for which everything is being done properly.

Perhaps you're not.

The Recommended Pension Contribution

For years, I have seen in many pension plan actuarial reports a line item that the actuary or the actuary's firm refers to as the "recommended contribution." When reviewing these reports, that item has always been an anomaly to me.

Sometimes, what it represents is spelled out in the report; sometimes, it's not. But, when it is seemingly well-defined, where does it come from? Many times, it is equally to the minimum required contribution under ERISA. Other times, it looks like the actuary through a dart at a sequence of numbers between that minimum required amount and the maximum amount that the plan sponsor can deduct on its corporate tax return.

I'm not saying that an actuary should not recommend a particular level of contributions. But, what I am saying is that it's not so simple. It's certainly not based on the same formula for every plan. In fact, there are lots of elements that should go into that recommendation.

This is where we might see a difference between an Enrolled Actuary who happens to label himself or herself as a consultant and an excellent consultant who is also an excellent actuary. The consultant will focus on the client's business needs in working with the client to develop a recommendation. Some very key questions to which the consultant needs to understand the answers might include these:

• Where will the money come from to make any contributions? Will they come out of free cash flow? Will the sponsor need to borrow. If so, at what rate? Will that borrowing cut into the company's borrowing limits to the point that it may encumber their ability to run their business?
• Do the potential tax deductions with respect to these contributions have value to the company? Is the company paying income taxes currently? There are a variety of reasons that it may not be. The company may not currently have positive net income. It may already have sufficient deductions to offset all of its income. Does the company have what are often referred to as NOLs or Net Operating Loss carryforwards?
• Will the company be better positioned to make contributions in excess of the minimum required amount in some future year than it is this year? Perhaps this year, the cash would be better used elsewhere, but the company's forecasts indicate that it will have free cash flow to make up its funding deficit in 2016. 
• How will any of this affect the company's risk management strategy? What sorts of risks are in that strategy?
• How will various stakeholders react to a large, but not legally required contribution?
• Will the effects on financial accounting expense (ASC 715 for those who care) matter? Sometimes, the decrease or increase in pension expense attributable to making or not making additional pension contributions (actually the return on those assets) looks like a big number. However, when we look at that change divided by the number of shares of company stock outstanding, the effect does not move the needle enough to change the company's reported earnings by share by even a penny. In other words, it goes away in the rounding.
• How about loan covenants? Oh, Ms. or Mr. Actuary, do you know about those? Does the company have any? (I'm pretty sure they do.) Do any of them relate to the pension plan? Maybe they do; maybe they don't. 

And, finally, the plan sponsor needs to act in the best interests of plan participants. While it doesn't seem likely that making any contribution to the plan at least equal to the ERISA minimum required amount would fail to meet that requirement, those interests need always be top of mind for the individual or committee making such decisions.

This is by no means an exhaustive list of the issues that the plan's actuary should consider, but it's a start. When your actuary "recommends" a contribution amount, have they made sure that they understand the answers to questions like this?

If not, perhaps we need to talk. If not me, then contact one of my colleagues.

Senators Portman and Cardin Appeal to Treasury for Retirement Nondiscrimination Help

We don't see it much in Washington these days, but Senators Rob Portman (R-OH) and Ben Cardin (D-MD) are teaming up once again. That's right, senators from opposing parties are finding common ground to do something together. And, they have a worthy goal. The key question, in my mind, is whether or not they have found a good way to achieve that goal.

A little more than a week ago, the dynamic duo penned a letter to Treasury Secretary Jack Lew asking that the Treasury Department review pension nondiscrimination regulations, specifically with regard to so-called soft frozen plans. They did this under the guise of retirement security for working Americans.

I have mixed feelings about what they write and I will come back to that later. First, however, it is necessary to give some background on pension nondiscrimination and soft freezes.

ERISA, signed into law on Labor Day, 1974, generally prohibited companies from providing nondiscriminatory pension benefits. While the rules perhaps had more teeth than I am going to see, this was generally achieved by showing three things about the pension benefits that were offered:

• That they were properly integrated (with Social Security) under Revenue Ruling 71-446
• That they covered a reasonable cross-section of employees (this was difficult to not satisfy in my experience)
• That they were comparable within the meaning of Revenue Ruling 81-202

Along came the Tax Reform Act of 1986 (TRA). It added some more specific rules to the Internal Revenue Code (Code) among them sections 410(b) and 401(a)(4). Together with a few related provisions, this suite of rules became known generally as the nondiscrimination rules. Regulations were long and cumbersome. But, unlike previous rules, they prescribed objective tests to determine whether the retirement benefits offered by a company were nondiscriminatory.

Objective tests are good and they are bad. From a practitioner's standpoint, they give us a set of bright line rules to follow. Exceed the thresholds and you pass. Fall short and you fail. It's pretty simple.

These sections of the Code were regulated fairly early in my career and I became somewhat expert at dealing with them. What I learned, somewhat oversimplified, is that it is quite rare that a tester, highly knowledgeable with respect to the rules, cannot force a company's plans through the tests to prove them nondiscriminatory. In fact, I worked with some situations that on their faces were very discriminatory in favor of highly compensated employees (HCEs) and proved that they were not.

There is one situation, however, that has always proven to be troublesome -- that of soft frozen plans. Generally, a defined benefit (DB) plan is soft frozen when participation (and benefit accrual) continues for employees who were in the plan on the soft freeze date and never happens for those who were not. In a variation on the theme, future participation is sometimes limited to those who have met some age and service threshold with the company as of the soft freeze date. 

What frequently happens is that over time, the population that remains in the DB plan becomes more predominantly composed of HCEs. And, as this happens, the DB plan on its own is not nondiscriminatory. What companies would like to do is to look at the total retirement program and show that it is nondiscriminatory. But, as many of these companies have only a 401(k) plan going forward (401(k) plans cannot be aggregated with DB plans for most testing purposes), the math just doesn't work.

So, companies wind up taking the only alternative that they can see and eventually totally (hard) freeze the DB plan. When they do so, the grandfathered employees, as a group, are often just at the point in their careers that their pension accruals are largest. These are the years that were going to allow them to retire securely.

This is the problem that Portman and Cardin seek to address. They tell us that the nondiscrimination rules were meant to enhance retirement security, not to detract from it. To me, this is where the difference in views that often occurs between legislators and businesspeople comes to the fore. 

Legislators, when developing retirement rules have often preached that if we force companies to provide similar benefits to nonhighly compensated employees (NHCEs) as to HCEs that the companies would increase NHCE benefits to meet that bogey. To paraphrase President Kennedy (who used the slogan of the New England Council (Chamber of Commerce)), they assume that a rising tide will lift all boats.

Historically, it hasn't worked that way. Faced with that situation, companies have opted to provide smaller benefits across the board, thereby lessening retirement security for most, and have found other ways to provide for their key employees.

Senators Portman and Cardin have a worthy goal. They seek to find a way to allow companies to continue to provide meaningful benefits to those people who have an expectation of those benefits. But, even if they do, they cannot solve the whole problem.

For years, Congress has passed bills designed to enhance retirement security only to see that each one in turn has caused more and more companies to get out of the business of providing retirement benefits to their employees. Oftentimes, these rules, such as the Pension Protection Act of 2006, have been poorly thought through, and actually decrease retirement security for workers. In fact, during my career, each time a major piece of pension legislation has become law, a swath of companies seek ways to get out of the business of providing pensions. But, no law over that period has caused companies to start up new plans.

If we want to restore a sense of retirement security for typical working Americans, we need to start anew from the beginning, not simply apply another band-aid to the problem. That said, I applaud the senators for making far more of a constructive effort than any of their colleagues.

Pension Miseducation

Like many benefits and compensation professionals, I receive daily my fair share of e-mail blasts from consolidators -- those services that scour the web for tidbits to provide to their readers. Because they have tens of thousands of free subscribers, they are able to sell advertising. That's their business model, as I understand it.

This morning, I opened one of those e-mails and found this article that looked like it was worth a read. In fact, there was some interesting material in there. And then there was this:

That aphorism also suits one frustration of today's pension plan sponsors. Somehow, they have to attain lofty actuarial return goals of 7% to 8%, but the expected returns they have to draw from, for both equities and fixed income, are stuck at ground level.

Hold on a second. Lofty actuarial return goals, you say? This implies somehow that the actuaries set the target and that based on that, plan sponsors and their associated investment committees then struggle to meet that target.

This is backwards. The selection of actuarial assumptions is different for accounting and for funding. In either case, however, the actuary does not just willy-nilly pick a target return on assets assumption. For ERISA funding purposes, the law mandates the selection. For FASB (ASC) purposes, the plan sponsor selects the return on assets assumption with the advice of experts including the actuary and investment adviser for approval by auditors. To the extent that the actuary finds the assumption to fail to meet Actuarial Standards of Practice (ASOPs), the actuary is to disclose such and to provide calculations representing what the amounts would have been had the assumption met the ASOPs.

Those who do not seem to understand this take a different position. The typical process for those sponsors looks like this:

• Look at the expected return on assets assumption.
• Go to the investment adviser and tell them that they need an investment portfolio that will meet or exceed that expected return on assets assumption.

But, the sponsor owns that assumption (if it is for accounting purposes). If it's for government plan funding, usually (state and local laws differ) the sponsoring government has input into the assumption. 

If an actuary has some (or all) purview over the return on assets assumption and (s)he is doing his or her job properly, the actuary will look at the investment lineup together with a capital market model and develop a return on assets assumption commensurate with that lineup. It is not the other way around. If plan sponsors do not think that their investment lineup can return 7% to 8%, then they should lower their assumption for expected return on plan assets. Yes, this will increase their financial accounting costs (and their funding costs for governmental plans). Ultimately, the cost of a plan is what it is. The cost of paying $1 per month for the rest of an individual's life is the same, no matter the actuary.

In my personal experience, for years, many plan sponsors pressured their actuaries to use more aggressive actuarial assumptions in an effort to influence P&L and, back in the days when it mattered for funding costs, to keep required contributions down. Some actuaries agreed to do that, some did not. 

But, when a plan sponsor, including a state or local government, chooses a high expected return on assets assumption, usually to manage short-term costs, that they are unable to find a suite of investments to generate that expected return is not the actuary's fault. Place blame where it belongs.

Brits Love Their Pensions

In a survey by Canada Group Life Insurance, the most important employee benefit (according to employees) in the UK is a good pension. In second place is a good holiday/vacation policy. According to Canada Group,  "In a tough marketplace where employers are working hard to retain their top talent, they need to close the difference between the benefits they offer and what employees actually want."

Perhaps Americans love their pensions, too, or they would if they had them.

Our Private Retirement System is Broken

In my last post, http://johnhlowell.blogspot.com/2010/11/europeans-want-pensions-do-us-workers.html , I noted that roughly half of European workers in a survey would be willing to give up some of their pay for bigger pension benefits. Likewise, more than one-fourth would trade some pay for better health and disability benefits.

What does all this say? To me, it says that they are, perhaps subconsciously, looking for ways to manage personal risk. As life expectancies rise and retirement savings wane, American workers fear they will not be able to support themselves in their retirement years. The current retirement system is broken.

• Fewer and fewer companies sponsor defined benefit pensions, although most public sector workers still have them. Said differently, the taxes paid by corporate workers pay for the pensions of the public sector, but the private sector workers don't get their own pensions.
• 401(k) plans are not the answer. Yes, they are permanent and portable, but there are issues.
• Companies recently have shown the propensity to decrease their matching contributions with no warning.
• Plan investments have performed poorly over the past decade or so.
• Layoffs are numerous causing discontinuity in savings and forcing many unemployed workers to dip into or even eliminate their savings.
• Pay increases have not kept up with increases in employees' costs of living in recent years.

On that last bullet, did I really say that? Isn't this the country where retirees have not gotten their "automatic COLA increase" for two years running because of no increase in inflation?

Workers have other costs. How much have your contributions to your "employer-provided" health care plan increased over the same two years? How about contributions to other employee benefit plans? I'd bet that the actual benefits that you are eligible for under those plans have decreased over the same period. The cost of education, especially higher education, continues to skyrocket. So, while the Consumer Price Index (CPI) may not have changed much in the last two years, YOUR cost of living probably has.

In 1974, Congress passed a bill known as ERISA -- the Employee Retirement Income Security Act. President Ford signed it into law that year on Labor Day. Note those boldfaced words -- retirement income security. 36 years later, where are we? The private pension system has been gutted. Employer-provided profit sharing is rarely seen. Money purchase plans have largely gone the way of the dinosaur. Americans are expected to save for their own retirement, but are ill-equipped to know either how or how much. 

Unlike the poorly named Pension Protection Act of 2006 (which probably didn't protect anyone's pension outside of PBGC insurance), Small Business Jobs Protection Act which surely didn't protect any jobs, the American Jobs Creation Act of 2004 which does not appear to have created any jobs, and the American Recovery and Reinvestment Act of 2009 which seems to be failing in both of those endeavors, we need a whole new approach. Don't offer me any more band-aids. They don't seem to stick.

Whether it be through tax incentives or by dis-entangling the private sector retirement program from the Tax Code, Americans need incentives to save, mechanisms to save, the ability to save and the motivation to save.

There are lots of experts out there. Unfortunately, there don't appear to be any of them among the 535 elected officials whom taken together, we call Congress.

It's much like Congress trying to figure out how to create jobs. Too many of those in Congress have never actually created a job, just like too many of them have never had to think about a pension.

Wow, ranting does the heart good. What do you think?

Europeans Want Pensions -- Do US Workers as Well?

In a survey of more than 7500 workers across 10 of the leading economies in Europe, Aon Hewitt found that 49% of workers would give up some of their pay for a more generous pension, 35% would take greater health or disability insurance in lieu of some pay, and 26% would give up some pay to be able to deposit it in to a savings plan for some future expense such as a home.

Do American workers think the same way?

With all of the press garnered by generous public and Congressional pensions, this writer believes that most workers yearn for far more retirement security than they currently have, even if it means that they need to give up some level of current compensation. In my next post, I'll touch briefly on some of the issues that I think are at the root of this issue.

Debt Commission, Retirement Plans and Retirement Policy

This February, President Obama created National Commission on Fiscal Responsibility and Reform, sometimes referred to in the press as the Debt Commission or Debt Panel. The Commission has made the headlines recently with its draft recommendations ( http://big.assets.huffingtonpost.com/CoChairDraft.pdf ).

What does this mean for your retirement? In this article, we looked at how it might affect both Social Security and qualified (pension, 401(k), etc.) retirement plans. How will it affect your retirement?

Learn more here: http://www.aon.com/attachments/debt_comm_oct2010.pdf