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Federal Update

16th Annual Louisiana Public Retirement Seminar

by Cynthia L. Moore, Attorney at Law and Washington Counsel, National Council on Teacher Retirement

September 15, 2004

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Topics

Terrorism Investments Defined Benefit versus Defined

Contribution Plans (DB/DC Debate) Other Issues: See NCTR Report

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Focus on public fund investments in companies with activities in 7 countries (Cuba, Iran, Iraq, Libya, North Korea, Sudan, and Syria)

Report by Center for Security Policy (CSP)

Terrorism Investments

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Controversial Report

“The Terrorism Investments of the 50 States” by CSP

Finding: 87 of nation’s 100 largest public pension funds invested from 15 to 23% of total portfolios in companies with business in terrorist-sponsoring countries

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CSP

Per website, “a non-profit, non-partisan organization committed to the time-tested philosophy of promoting international peace through American strength”

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Problems with Report

Does not differentiate between companies doing business with these countries and companies actually supporting terrorist activities

Unable to trace revenues generated by publicly traded companies to sponsorship of terrorism

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Problems with Report, continued

Singles out public plans for criticism Does not attack institutional and private

investors

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NASRA, NCTR, NCPERS, and Others Critical of Report In their letter to Frank Gaffney, CSP

President, they say:– Report was based on faulty premises,

contained inflammatory title, provided distorted and misleading picture of states and their pension funds

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CSP and Conflict Securities Advisory Group (CSAG) CSAG is marketing Global Security Risk

Monitor -- a software product offered on a subscription basis for $12,500 per year

CSP and CSAG appear to share office CSP and CSAG do share a top person

-- Roger Robinson, Senior Resident Fellow at CSG, and President of CSAG

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Senator Frank Lautenberg (D-NJ) Involved He wrote to some public fund

executives asking them for:– A list and risk assessment of portfolio

investments with ties to or activities with U.S. Department of State-designated terrorist sponsoring countries

– Information on whether asset managers are assessing such business relationships

– A list of other investment restrictions

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Bottom Line

Federal government decides whether U.S. companies can do business in other countries based on national security concerns

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Joint Letter (mentioned above) NCTR and NASRA joined Economic

Terrorism Commission in 2001 Commission has been working to set up

meeting with the Office of Global Security Risk (OGSR) in the Securities and Exchange Commission (SEC)

Response by Public Fund Groups

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OGSR will focus on disclosure issues, particularly regarding the disclosure of operations of foreign and U.S. companies on U.S. exchanges that operate in terrorist-sponsoring countries

OGSR

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DB/DC Debate

Definitions Features Issues

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What is a DB plan?

Benefit based on formula:– Years of Service times– Final Average Salary times – Multiplier equals Annual Pension Benefit

Level of benefit at retirement is known Benefits are guaranteed

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How do DB plans operate?

Funded by employer contributions, employee contributions, and investment income

Overseen by board of trustees, who are subject to strict fiduciary laws

Assets managed by professionals Generally large entities, which can

operate at a low cost

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What is a DC plan?

Individual account Level of benefit at retirement unknown Benefits are not guaranteed

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How do DC plans operate?

Funded by employer contributions, employee contributions, and investment income

Individual makes investment decisions usually from a range of options

Because each account separate, cannot benefit from economies of scale, thus more expensive than DB plans

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Features of DB Plans

Beneficial to U.S. Economy Beneficial to Employers (State and

Local Governments and Taxpayers) Beneficial to Employees

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Beneficial to U.S. Economy

Fueling the economy: investment of DB plan assets and the flow of benefit payments to retirees creates a continuous, predictable, and growing source of economic stimulus

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Beneficial to U.S. Economy

Boosting economic growth: DB plans are large pools of assets, the investment of which adds billions of dollars each year to U.S. economy through higher returns than what would be earned if assets in DC plans

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Beneficial to U.S. Economy

Creating needed capital: DB plans offer a major source of entrepreneurial capital that would not be otherwise widely available

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Beneficial to Employers

Low administrative costs Reserve funding reduces costs High performance workforce Flexible design

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Secure retirement benefits Comprehensive and flexible design

Beneficial to Employees

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More than just retirement benefits– Disability Protection– Early Retirement Benefits– Early Retirement Incentive Programs– Death Benefits– Benefit Improvements– COLAs– Portability through Purchases of Service Credit

Other Features of DB Plans: Comprehensive and Flexible Design

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Private sector is moving to DC plans Portability Participant control Participant preference

Arguments of DC Plan Proponents

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Private sector is moving to DC plans? Not necessarily True for small private sector businesses

of between 2 and 9 employees False for large companies -- stable

number of DB plans at large companies between 1997 and 2002 per U.S. Pension Benefit Guaranty Corporation

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Private sector is moving to DC plans? State and local governments more like

large companies in outlook and needs than small private sector entities

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Only DC plans can provide portability? False DB plans offer:

– Purchases of service credit– Indexing future retirement benefits of

inactive retirement system members– Enhancing benefits of terminating

members

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Only DC plans can provide portability? Drawback to portability -- Leakage Two-thirds of individuals in DC plans

cashed out their assets when they changed to a new employer per Employee Benefits Research Institute (EBRI) 2002

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Does participant control translate into more retirement security? No -- Individual investors have difficulty

beating market Study by Nebraska Public Employees’

Retirement Systems (NPERS) of returns between 1983 and 1999

NPERS operates both DB and DC plans

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Does participant control translate into more retirement security? Results of study:

– DB plans -- 11% return per year– DC plan participants -- 6% return per year

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Does participant control translate into more retirement security? Median cost of a DC plan is

approximately 1.4% Median cost of a DB plan is

approximately 0.30% Higher DC cost reduces assets

available for benefits

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Do employees want DC plans?

Few employees who had the chance to transfer from DB to DC plan in Florida and Ohio have done so

Impetus for DC plans: vendors who earn higher fees from DC plans

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Case Study

Wall Street Journal 8/16/02 Two Cousins in Illinois -- Drew who

worked for Illinois Department of Revenue and Michael who worked in high tech sector

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Drew started with a $18,000 a year salary -- promoted and retired with a salary of $72,000

Michael had a 401(k) plan with a company that laid him off in 2002 and the value of his retirement savings sank by $30,000

Case Study

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Drew took an early retirement at age 51 and his pension approximated $54,000

If Michael were to retired now as Drew has done, he could take only $28,000 per year to be sure that he didn’t outlive his money

Case Study

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DB Plans  DC Plans

Benefits guaranteed Yes No

Benefits known at retirement Yes No

Assets managed by professionals Yes No

Low expenses Yes No

Economic engine for economy Yes No

Encouragement of employee longevity Yes No

Disability protection Yes No

Early retirement benefits Yes No

Early retirement incentive programs Yes No

Death benefits Yes No

Benefit improvements Yes No

COLAs Yes No

Portability

Yes, through purchases of

service credit and other mechanisms

Yes

Comparison of DB and DC Plans

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See attached NCTR Federal Update

Summary of Other Issues