Introductions. Hybrid Retirement Plans. Julie Durkin Gary Bakker Watson Wyatt Worldwide

Transcription

1 Hybrid Retirement Plans University of Illinois W W W. W A T S O N W Y A T T. C O M September 18, 2006 Introductions Julie Durkin julie.durkin@watsonwyatt.com Gary Bakker gary.bakker@watsonwyatt.com Watson Wyatt Worldwide 6,000 associates 90 offices in 32 countries 1 U:44373:\06\RET:\U of 1._ ppt

2 What does Watson Wyatt do? Consult with employers to design, finance and administer benefit plans to attract and retain employees We balance these needs with the employer s financial constraints 2 What does Watson Wyatt do? Benefits consulting Retirement Investment consulting Group & health care International Workforce planning Communication Technology solutions Human capital consulting 3

3 Agenda Hybrid Plans Cash Balance Plans Changes Due to Pension Act and Cooper Decision Case Studies Future of Retirement Plans Questions 4 Hybrid Plans What are they? Why were hybrid plans created? Why would an employer be interested in a hybrid plan? How will the new pension act affect hybrid plans? 5

4 Hybrid Plans Characteristics Defined benefit plans that are made to look and act like defined contribution plans, or Defined contribution plans that mimic accrual patterns similar to defined benefit plans 6 Hybrid Plans Examples Cash balance plan Defined benefit plan that expresses a participant s benefit with a hypothetical account balance Defined lump sum plan Lump sum at retirement based on pay credits OR fixed dollar amounts Age/Service based profit sharing plans Annual employer contributions (% of pay) Contribution % based on age and/or service 7

5 Cash Balance Plans What is a Cash Balance Plan? 8 What is a Cash Balance Plan? Pension plans that define a participant s benefit as a hypothetical account balance Combines strengths of Defined Benefit and Defined Contribution Plans Account grows with annual pay-related credits and interest credits Employees receive lump sum or annuity at retirement/termination 9

6 What is a Cash Balance Plan? Example Account is established for each employee (hypothetically, no actual asset allocated in the trust) Each year the account is credited with a deposit equal to 6% of the employee s pay Each year the account is credited with interest equal to a public index (5.5%) 10 What is a Cash Balance Plan? Example Year Pay Pay Credit Interest Credit Balance #1 $50,000 $3,000 $0 $3,000 #2 $52,000 $3,120 $165 $6,285 #10 $71,166 $4,270 $2,154 $45,580 #20 $105,342 $6,321 $7,247 $145,327 #30 $155,933 $9,356 $17,660 $348,111 Contribution is based on 6% of pay; Salary increases are 4% per year; Interest credits are based on the published rate of 5.5% per year 11

7 Comparison of Benefit Accruals Benefit Accrual 5.0 Benefit Values as a Multiple of Total Pay Age at Termination or Retirement 1% Final Avg Pay 6% Cash Balance Plan Employee age 35 with 0 years service. Base Pay of and Total Pay of Salary increase 4%. 12 Cash Balance Plans Why Have Companies Implemented Them? 13

8 Why Have Companies Implemented Cash Balance Plans? Improve employee understanding and appreciation Easier to communicate Complement 401(k) plans Attract and retain talent Provide portable retirement benefits Meets the company s business strategy Potential savings More stable costs 14 Cash Balance Plans Why Have Companies Avoided Them? 15

9 Why Have Companies Avoided Cash Balance Plans? Does not meet the company s business strategy Uncertainty regarding the future of these plans Negative press Transition issues IBM Legal issues IBM (Cooper vs. IBM age discrimination) Xerox (Berger vs. Xerox whipsaw issue) 16 What is Age Discrimination? 5% of Pay Cash Balance Plan with Interest at One-Year Treasury Rate 16% Lower court in Cooper case Time value of money is age discriminatory 16% New pension law and appellate court 30 Years of Interest to age 65 5% is 5% no matter how old you are when you earn it 5% 5% Age 35 Age 65 Age 35 Age 65 Pension law addresses future, Cooper decision addresses past 17

10 Comparisons of Plan Designs Hybrid Plan Traditional Not Age Discrimination 5% of pay 1.5% x Final Pay x Service before 1/1/2000 1% x Final Pay x Service after 1/1/2000 Is Age Discrimination 7% of pay until age 40 5% of pay thereafter 1.5% x Final Pay x Service until age 40 1% x Final Pay x Service thereafter 18 New Pension Law Covers Basic age discrimination claim Conversion rule 3 year cliff vesting requirement Variable interest crediting requirements Whipsaw calculations 19

11 Vesting and Interest Credits on Level Playing Field with DC Plan 3-year cliff vesting Interest crediting: Rate can not be greater than market rate Variable Rate Variable index Fixed rate Minimum guarantee Market index Example CPI 4% Greater of 4% or 30-year Treasury rate S&P 500 return* * However, while annual negative returns are okay, you can not reduce the principal (sum of contributions) 20 Conversion Issues: No Wearaway Must provide at least A + B Plan A: Benefit earned prior to amendment Pre-conversion 1% x Pay x Service B: Benefit earned after amendment Post-conversion 5% Cash Balance Plan A: B: Benefit earned at conversion is frozen Cash balance account Pay = $50,000 Service = 10 Years 1% x 10 x $50,000 = $5,000 payable at age 65; Including early retirement subsidies + At conversion = $0 Year 2 = $2,500 Year 3 = $5, No different than a DC conversion

12 New Hybrid Designs Viable Vesting Conversions Funding Applicable Hybrid 3-year vesting A + B Cash flexibility A + B DC Plan 3-year vesting or 6-year graded Limited cash flexibility Investments Forms of Pay Design Flexibility Flexible - generally company controlled Annuities required Significant Flexible generally employee controlled Annuities optional Limited Cash balance plans and defined contribution plans will be on equal footing; each has some advantages over the other 22 Case Studies 23

13 Given: Sample Conversion Questions An employer is considering a pension plan redesign. The plan currently provides a benefit equal to 1.5% of a participant s final average compensation multiplied by years of service. The employer is considering a cash balance plan that provides a benefit with pay credits equal to 3% of pay. 24 Why Would an Employer Consider This Change? Reduced volatility Less expensive plan on an ongoing basis Enhanced employee understanding 25

14 How Will Employees View This Change? Reaction will depend on management s relationship with employees Employees will want to understand the reason for the change Reactions will vary dramatically depending on employees : Individual situation Understanding of the current plan and the difference in these types of plans 26 Other Issues How will the costs of these programs compare? Does the proposed plan provide competitive benefits? 27

15 Case Study A Current Business Situation Large manufacturer wants to review current benefit programs Mature population in decentralized locations Employer has maintained an extremely paternalistic culture to date 28 Case Study A (cont.) Current Business Situation Mostly rural locations where company is major employer in town Publicly traded company with mandate to reduce costs Company has grown through acquisitions 29

16 Objectives for Retirement Program Case Study A Facilitate integration of acquired companies Share responsibility between employer and employee Provide minimum floor of protection Improve perceived value of program Provide competitive program Provide a program that does not encourage retirement at a certain date Maintain a cost neutral program 30 Case Study A Current Program Pension Plan: 2% of Career Average Pay payable at age 65 Unreduced benefits payable at age 60 Subsidized early retirement provided at age 55 with ten years of service. Eligibility is after 1 year of service Vesting is 100% after 5 years 31

17 Case Study A Current Program (cont.) 401(k) Plan: Pre-tax deferrals 50% match on deferrals up to 3% of pay 32 Case Study A Given this situation, what would your proposed plan design be? How would your proposed design satisfy the objectives? How do you think the employer/employees will respond to your proposal? 33

18 Employer Proposal Discussion 34 Employee Proposal Discussion 35

19 Case Study B Current Business Situation Two liked size companies merge and a year later merged company acquires three smaller businesses Logistics company Company is re-branded IPO likely in near future Low margin business Paternalistic culture at the two original companies 36 Case Study B Background 37 Company A Program 1.5% final average pay pension plan 401(k) pre-tax contributions with discretionary matching contribution A retiree medical and life program Company B Program No pension plan 100% match up to 3% of pay Smaller acquired businesses No pension plan 50% match up to 6% of pay

20 Case Study B Objectives Integration of companies Build retirement program consistent with business goals Reduce costs of programs Create a program which will attract and retain employees Promote joint responsibility for retirement 38 Case Study B Given this situation, what would your proposed plan design be? How would your proposed design satisfy the objectives? How do you think the employer/employees will respond to your proposal? 39

21 Case Study B Employer Proposal Discussion 40 Case Study B Employee Proposal Discussion 41

22 Future of Retirement Plans 42 Future of Retirement Plans Baby boomers are retiring Uncertainty regarding social security system Shift towards defined contribution plans Phased retirement Retirement age Health Life expectancy 43

23 Retirement Consulting Design retirement programs based on changing objectives Determine cash flow for plans Contributions satisfying funding requirements Benefit payments Determine impact of new legislation such as the Pension Protection Act on plan funding Calculate pension expense under FASB # 87 and 132 and IAS #19 accounting standards 44 Retirement Consulting (cont.) Calculate benefits Perform budget planning calculations Asset liability modeling Non-discrimination testing 45

24 46 Questions