hybrid retirement plans
DESCRIPTION
Hybrid Retirement Plans. University of Illinois September 14, 2005. Introductions. Julie Durkin [email protected] Michelle Rorvick [email protected] Watson Wyatt Worldwide 6,000 associates 90 offices in 32 countries. - PowerPoint PPT PresentationTRANSCRIPT
W W W . W A T S O N W Y A T T . C O M
Hybrid Retirement Plans
University of Illinois
September 14, 2005
2
Introductions
Julie [email protected]
Michelle [email protected]
Watson Wyatt Worldwide– 6,000 associates
– 90 offices in 32 countries
lf:\J:\act\00022\recruiting\UofI-Champaign\2004-2005\Finance Class\finance360Pres.ppt
3
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
4
What does Watson Wyatt do?
Benefits consulting – Retirement – Investment consulting– Group & health care– International– Workforce planning– Communication
Technology solutions
Human capital consulting
5
Agenda
Hybrid Plans
Cash balance plans
Case Studies
Future of Retirement Plans
Questions
6
Hybrid Plans
What are they?
Why were hybrid plans created?
Why would an employer be interested in a hybrid plan?
7
Hybrid Plans
Defined contribution features
Defined benefit features
8
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
9
Hybrid Plans
Examples – Cash balance plan
Defined benefit plan that expresses a participant’s benefit with a hypothetical account balance
– Defined lump sum/Pension equity planLump sum at retirement based on pay credits (age
and/or service)
– Age/Service based profit sharing plansAnnual employer contributions (% of pay)Contribution % based on age and/or service
10
Cash Balance Plans –
What is a Cash Balance Plan?
11
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
12
What is a Cash Balance Plan?
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 interestequal to a public index (5.5%)
Example
13
What is a Cash Balance Plan?
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
Example
Year PayPay
CreditInterest
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
14
Comparison of Benefit Accruals
0.0
1.0
2.0
3.0
4.0
5.0
35 40 45 50 55 60 65
Ben
efit
Val
ues
as
a M
ult
iple
of
Tota
l P
ay
Age at Termination or Retirement
Benefit Accrual
Employee age 35 with 0 years service. Base Pay of 50000 and Total Pay of 50000. Salary increase 4%.
1% Final Avg Pay6% Cash Balance Plan
15
Transition from 1% Final Avg Pay to 6% Cash Balance – Winners and Losers
Ratio of New Plan Benefits to Current Plan Benefits
Benefits calculated as of Age 65
Completed Years of Service
0-4 5-9 10-14 15-19 20-24 25-29 30-34 35+
Curren
t Age
< 25
25-29
30-34
35-39
40-44
45-49
50-54
55-59
60-64
65+
111%
111%
111%
111%
111%
111%
111%
111%
97%
97%
97%
97%
97%
97%
97%
97%
84%
84%
84%
84%
84%
84%
84%
80% 94%
71%
70% 71%
69% 70% 71%
69% 69% 70% 71%
68% 69% 69% 70% 71%
67% 68% 69% 69% 70% 71%
65% 71% 72% 72% 73% 74%
Big Loss Loss Neutral Win Big Win
0% - 79% 80% - 94% 95% - 104% 105% - 119% 120% +
16
Cash Balance Plans –
Why Do CompaniesImplement Them?
17
Why Do Companies Implement 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
18
Cash Balance Plans –
Why Do CompaniesAvoid Them?
19
Why Do Companies Avoid 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)
20
Legal Issues
Two employees, one age 25, the other age 55– Each receives a contribution credit equal to $1,000– Plan provides interest credits at the rate of 6% per year
– Age Discrimination claim because 55-year oldreceives a smaller retirement benefit at age 65
– Whipsaw issue if the age 65 account balance is discounted back to current age at a lower rate than 6%
Cash Balance Plans
25-year-old 55-year-old
A. Pay Credit 1,000 1,000
B. Interest credits to age 65 10,286 1,791
C. Account balance at age 65 11,286 2,791
21
Proposed Pension Reform Legislation
Change the funding of pension plans
Hybrid Pension Plan legislation would: – Retroactively clarify the legal status of hybrid
plans for plans that are not currently subject to litigation;
– Establish retroactive conversion requirements; and
– Establish additional requirements for future conversions.
22
Case Studies
23
Employer View• What: Assess “alignment” by clearly
defining “desired state”• Why: Ensure benefits programs
meet business and HR goals
Employee View
• What: Consider employee expectations and perceptions by distinct segments of your workforce
• Why: Perception is stronger than reality…how your programs are perceived is how they ARE
Competitive View
• What: Review position in the relevant marketplace
• Why: Ensure that market positioning reflects strategic intent
Six Views
Workforce View• What: Demographic analysis &
forecasting to customize recommendations to the unique make-up of your workforce
• Why: Averages are misleading; we need to dig into details to know where risks are hidden - where you may have challenges recruiting and retaining over time
Financial View• What: Assess financial impact
and return on investment of current and alternative designs
• Why: Understand costs and cost drivers before recommending changes
Environmental View• What: Determine which non-design
factors may affect program acceptance
• Why: Changes to environmental factors may be more powerful - and less costly - than changes in design
24
Sample Conversion Questions
Given:
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.
25
Why would an employer consider this change?
Reduced volatility
Less expensive plan on an ongoing basis
Enhanced employee understanding
26
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
27
Other Issues
How will the costs of these programs compare?
Does the proposed plan provide competitive benefits?
28
Case Study A
Large manufacturer wants to review current benefit programs
Mature population in decentralized locations
Employer has maintained an extremely paternalistic culture to date
Current Business Situation
29
Case Study A (cont.)
Mostly rural locations where company is major employer in town
Publicly traded company with mandate to reduce costs
Company has grown through acquisitions
Current Business Situation
30
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
31
Objectives for Retirement Program – Case Study A (cont.)
Improve employee understanding
Provide a program that does not encourage retirement at a certain date
Maintain a cost neutral program
32
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.
33
Case Study A – Current Program (cont.)
401(k) Plan:– pre-tax deferrals– 50% match on deferrals up to 3% of pay
34
Case Study A – Current Costs
Present value of pension benefits for active participants
– $1,200 M
Matching contribution– $10 M
Total - $1,210 M
35
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?
36
Employer Proposal
Discussion
37
Employee Proposal
Discussion
38
Case Study B
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
Current Business Situation
39
Case Study B – Background
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
40
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
41
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?
42
Case Study B – Employer Proposal
Discussion
43
Case Study B – Employee Proposal
Discussion
44
Future of Retirement Plans
45
Future of Retirement Plans
Baby boomers are retiring
Uncertainty regarding social security system
Employer sponsored plans
Phased retirement
Retirement age
Health
Life expectancy
Pension reform
46
Retirement Consulting
Design retirement programs based on changing objectives
Determine cash flow for plans– Contributions satisfying ERISA requirements– Benefit Payments
Calculate pension expense under FASB # 87 and 132 and IAS #19 accounting standards
47
Retirement Consulting (cont.)
Calculate benefits
Perform budget planning calculations
Asset liability modeling
Non-discrimination testing
48
Questions