1. DB vs. DC A False Choice in Retirement Plans
Florida Government Finance Officers Association
Nature Coast Chapter
Citrus Hills Golf & Country Club
April 16, 2014
DB vs. DC A False Choice in Retirement Plans
Presented By:
James J. Rizzo
Piotr Krekora
Gabriel, Roeder, Smith & Company

2. DB Plans and DC Plans
There had been a debate swirling around corporate and governmental employers for many decades as to which is better:
Defined benefit (DB) retirement plans, or
Defined contribution (DC) retirement plans
Let’s defined the terms first by examining their characteristics
Jim

3. DB vs. DC Debate Traditional Defined benefit (DB) plans
Benefits paid are defined by formulas and rules
Contributions by employer are actuarially determined
Pension plans usually pay monthly pensions for life
Like the pension part of FRS
Like local police and fire pension plans
Like Social Security
Traditional Defined contribution (DC) plans
Employer contributions are defined by a formula
Account balance plans that credit interest equal to the actual earnings of underlying investment assets
Like the Investment Plan part of FRS
Like 401(k) plans in the private sector
Like so-called 401(a) plans and 457 plans in the government sector
Jim

4. Distinguishing Features
Individual Account Balances
Account Interest Credited
Investment Risk*
Predictability of Contributions*
Unfunded Actuarial Accrued Liability*
Retirement Planning*
Longevity and Other Risks*
Benefit Skew*
Form of Benefit*
Portability
Vesting
Funded Status
Operational Expenses*
Education and Communication * Most important distinctions
Jim

5. DB vs. DC Comparison
Jim

6. DB vs. DC Comparison
Jim

7. Hybrid Plans
A hybrid plan is a single plan that has some features of a DB plan and some features of a DC plan
An arrangement with side-by-side DB and DC plans
Two separate plans
This arrangement is not really a hybrid plan
Although some people use the term “hybrid” when describing a side-by-side DB and DC
But consider a Toyota Prius – gasoline and electric in one car
Two broad types of hybrid plans
Cash Balance Plans
Variable Benefit or Variable Annuity
Jim

8. Hybrid Plans Cash Balance Plans
“Looks” more like a DC plan (each member has an account balance)
Implementations
Recently proposed in State Senate for FRS, but more recently amended out
At OUC and JEA (electric utilities in Orlando and Jacksonville), Cash Balance Plans in the last few years
In some other states and jurisdictions outside Florida
At many private sector employers
Employer contributes a fixed amount into each employee’s account; employee contributes as well
Interest is credited to each account
Different plan designs credit interest differently
Interest credit is not permitted to equal the rate earned by the actual underlying assets
Benefit is usually paid out in a lump sum at termination or retirement; sometimes annuitized pension is permitted
Jim

9. Hybrids Plans Variable Benefit or Variable Annuity
“Looks” a lot like a DB plan (lifetime pensions paid)
Implementations
State of Wisconsin
City of Ocala GE
Some private sector employers
Monthly benefit amount varies depending on certain trigger points built into the plan design
Investment Return Trigger - Some change the multiplier for the current year depending on investment returns for the year - higher multiplier for higher return; lower multiplier or zero for lower returns. Other plan designs pay additional “dividends” on benefits
Employer Contribution Trigger - Some change the multiplier for the current year (or all years retroactive to transition date) in order to keep the employer contribution predictably within a pre-set corridor – higher multiplier for low employer contribution; lower multiplier for high employer contribution
Jim

10. Hybrid Features
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11. Hybrid Features
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12. Hybrid Features
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13. Hybrid Features
Jim

14. Hybrids Plans Primary motivations for moving from DB to DC plans
“The corporate world has moved from DB to DC plans.”
“ We got rid of our DB plan where I work(ed).”
“I never had a DB plan; neither should they.”
“ The conservative think-tanks and legislatively active organizations say we should move to a DC plan.”
“My political party leaders say DB plans are bad.”
“DB plans are more dangerous than DC plans in the hands of politicians.”
“I don’t trust elected officials to stand firm against the unions by not refusing retroactive benefit improvements for DB members.”
“Employer contributions to our DB plans have become unbearably and unreasonably high.”
“Employer contributions need to be more predictable.”
“Employer (taxpayers) should not bear the investment risk.”
Jim

15. Case Study: City of Ocala GE
Driving principles from City Council
Roll back future benefits to bend the cost curve soon
Future benefits should resemble FRS
Share risks between employees and employer
Make employer contributions more predictable
Jim

16. Case Study Bend the expected cost curve
Changing benefits for new hires alone will take a very long time to bend the expected cost curve
So putting in a DC plan for new hires alone won’t do much
Putting in a new DB formula for new hires alone won’t do much
Must change benefits for all employees (current and new) in order to bend the expected cost curve in a reasonably short time
Either all in a DC or
All in a less generous benefit structure for future service
Not permitted to roll back benefits for current retirees or for current active employees eligible for normal retirement
Not permitted to roll back benefits retroactively, i.e., cutting accrued benefits below what active employee have earned now
Jim

17. Case Study Bending the expected cost curve
Freeze the benefits for current actives at what they earned as of the transition date; call it Part A
Start the new and less generous benefit structure for future service; call it part B
Final benefit is Part A plus Part B
Jim

18. Case Study Make the employer contribution more predictable . . .
By sharing the risk with employees
Moving to a DC plan for new hires alone will take a very long time to share the risk
Not permitted to share the risk with current retirees or with current active employees eligible for normal retirement
Not permitted to share the risk on benefits earned at transition
Part B benefit structure is the hybrid plan design
Part B monthly projected benefit can go up or down, depending on the trigger mechanism, thereby sharing the risk and reward
Part A monthly benefit is fixed and frozen at the transition date
Jim

19. Case Study
Without a VBH feature in the legacy DB plan -- It will take over 40 years to reach a risk-sharing with employees; in 20 years City/taxpayers still bear 85% of investment risk
Employees Bear 100% Risk
City/taxpayers Bear 100% Risk

20. Case Study
Part B starts out with a 1.6% multiplier, like FRS Regular Class
Multiplier can go up, but not above a cap of 2.55%
Multiplier can go down, but not below a floor of 1.0%
Depending on the level of the actuarially required contribution
As long as the actuarially determined contribution (ADC) stays within a pre-set employer contribution budget, the multiplier remains unchanged; improves predictability
Makes the employer contribution more predictable
Jim

21. Case Study If the ADC were to go above the top of the budget corridor:
The multiplier is reduced in order to keep the ADC inside the corridor
Employee bears the risk above the corridor.
If the ADC were to go below the bottom of the budget corridor:
The multiplier is increased in order to keep the ADC inside the corridor
Employee reaps the reward below the corridor
Makes the employer contribution more predictable by sharing the risk (and reward) with the employee
Jim

22. Case Study
With
a VBH
Feature:
Budget
Corridor

23. Disclaimers
Circular 230 Notice: Pursuant to regulations issued by the IRS, to the extent this presentation concerns tax matters, it is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding tax-related penalties under the Internal Revenue Code or (ii) marketing or recommending to another party any tax-related matter addressed within. Each taxpayer should seek advice based on the individual’s circumstances from an independent tax advisor.
This presentation shall not be construed to provide tax advice, legal advice or investment advice.
Readers are cautioned to examine original source materials and to consult with subject matter experts before making decisions related to the subject matter of this presentation.
This presentation does not necessarily express the views of conference sponsor, nor Gabriel, Roeder, Smith & Company, and may not even express the views of the speaker.
Jim

24. Questions and Answers ?
Jim