Defined Benefit and Defined Contribution Plans Realities and Myths: An Employer

1
Defined Benefit and Defined Contribution Plans
Realities and Myths An Employers Perspective

• William H. Leighty
• Chief of Staff to Mark R. Warner
• Governor of the Commonwealth of Virginia
• Bill.Leighty_at_Governor.Virginia.Gov

2
Basic Facts We are talking BIG !

• Nationally, by state, by company by individual,
  total assets get noticed.
• The payments to pension plans are equally
  significant and always have high visibility in
  the budget process.
• Investments from public pension funds add 200
  billion to the nations economic output. (Does
  anyone really ever save anymore?)

3
Basic Facts Lets get this straight right up
front.

• Large corporations participate in Defined Benefit
  Plans.
• Defined Benefit Plans continue to be the choice
  of most public plans.
• Pension plans, public or private, are funded by a
  mix of investments, employer contributions and
  employee contributions.

4
Basic Facts Oh, by the way did I mention?

• Average expenses for Defined Benefit Plans are
  approximately 0.30 of assets.
• Expenses for Defined Contribution Plans range
  between 0.50 and 2 of assets.
• Average return on investments is higher for
  Defined Benefit Plans than for Defined
  Contribution Plans.

5
Defined Benefit Plan We take care of you (to
some degree)

• Employer pays a defined amount upon retirement
  based on length of service and final average
  compensation.
• Employer sets retirement eligibility age and
  length of service.
• Benefit is fixed and guaranteed.
• Investment risk is borne by the employer.

6
Defined Benefit Plan The fine print.

• Employee must vest in the plan.
• Most plans provide annual Cost of Living
  Adjustments (COLAs) to protect an employees
  benefit from inflation.
• Most plans also provide a survivor benefit and
  disability benefit.

7
Defined Contribution Plan You take care of
yourself (to some degree).

• Contributions are placed in an individual
  account.
• Employees are responsible for the investment of
  the assets in the employee account.
• Investment risk is borne by employee.

8
Defined Contribution Plans The fine print.

• Amount of retirement benefit is uncertain as this
  amount is based on an employees investments,
  lifespan and rate of spending in retirement.
• Benefit is guaranteed only through the purchase
  of an annuity.
• Employer accrues no unfunded liability for
  funding benefit.

9
Nature and Form of the Benefits A quick summary.

• Defined Benefit Plans (you aint gonna get rich!)
• Designed for income replacement.
• Provides retirement income
• Defined Contribution Plans (you could be a
  millionaire!
• Designed for capital accumulation.
• Provides an account balance.
• (If you are smarter than Warren Buffett)

10
What Employers Want Regardless of plan design.

• A plan design for the benefit of employees.
• A plan design that offers stability in financial
  planning.
• A plan design that keeps expenses down.
• A plan design that does not require extensive
  administrative complexity.

11
What Employers Want Benefit for employees

• Defined Benefit Plans offer a stable and reliable
  retirement benefit which is most attractive to
  employees seeking long-term careers. The promise
  of future benefits helps retain employees with
  long service.(golden handcuffs)
• Defined Contribution Plans are portable. The
  benefit is most attractive for employees who wish
  to preserve job mobility.

12
What Employers Want Stable financial planning

• Constant benefit changes and actuarial
  revaluations often contribute to volatility in
  contribution rates.
• Legislative bodies have little tolerance for
  volatility
• DC plans offer complete stability for the
  employer.

13
What Employers Want Low administrative expenses
and administrative burden

• Employers are pressured more than ever before to
  lower cost.
• Costs of complexity and cost of compliance are
  bigger for DB vrs DC

14
Current Public Plan Environment

• Alaska
• Legislature passed and Governor has approved
  legislation that provides a mandatory Defined
  Contribution Plan for new employees hired on or
  after July 1, 2006.

15
Current Public Plan Environment

• California
• Governor introduced pension initiative which
  would end the Defined Benefit Plan in 2006.
• The initiative was withdrawn from the ballot in
  April 2005.

16
Current Public Plan Environment

• Florida
• Began a Defined Contribution Plan for existing
  employees and new hires in 2002.
• Employers requested Defined Contribution Plan
  because it offered more budget certainty and
  empowerment for the employees.

17
Current Public Plan Environment

• Michigan
• A mandatory Defined Contribution Plan for new
  hires began in 1997.
• Portability was an issue addressed by this
  legislation.

18
Current Public Plan Environment

• Nebraska
• Began a Defined Contribution Plan in 1960s for
  state and county workers.
• Conducted a large scale study in 2000 which
  concluded that members of the Defined
  Contribution Plan averaged investment returns of
  6 where members of the Defined Benefit Plan had
  an average return of 11.
• Legislators closed the Defined Contribution Plan
  January 1, 2003.

19
Current Public Plan Environment

• New Mexico
• Governor has requested a feasibility study for
  changing the Defined Benefit Plan for teachers to
  a Defined Contribution Plan.

20
Current Public Plan Environment

• North Dakota
• Established a Defined Contribution Plan for
  non-classified employees in 2000.
• 250 participants in the program.

21
Current Public Plan Environment

• Ohio
• Defined Contribution Plan began in 2003.
• Provides extensive educational programs for
  participants in Defined Contribution Plan.

22
Current Public Plan Environment

• West Virginia
• Adopted a Defined Contribution Plan for teachers
  in 1999.
• Members of the Defined Contribution Plan lost
  millions of dollars.
• Legislature closed this program in 2005.

23
Politics and Public Pension Plans

• ALEC (American Legislative Exchange Council) has
  DC conversions high on their public agenda.
• This issue is being argued on political terms by
  non employers.
• DC proponents have simplicity on their side.

24
Conclusions

• DC vrs DB debate should be an employer driven
  discussion.
• It is not. It is being driven by politics.
• It is also fueled by a political environment that
  is increasingly simplistic in addressing issues.
• DC is has basic advantages that can be used by
  proponents in making their argument.
• DB Proponents need to reduce complexity and
  compliance costs.