Chapter 29
Pension Plan Management
ANSWERS TO END-OF-CHAPTER QUESTIONS



29-1 a. Under a defined benefit plan, the employer agrees to give retirees a specifically defined benefits package. The payments could be set in final form as of retirement date, or they could be indexed to increase with the cost of living.

b. Under a defined contribution plan, companies can agree to make specific payments into a retirement fund, and then have retirees receive benefits from the plan depending on the investment success of the plan.

c. Under a profit-sharing plan, the employer makes payments into a retirement fund, but the payments vary with the level of corporate profits.

d. An employee’s pension rights are said to be vested if they provide a claim on pension fund assets, even if the employee leaves the company prior to retirement.

e. Portability refers to a pension plan that an employee can carry from one employer to another.

f. A pension plan is fully funded when the present value of expected retirement benefits is equal to the fund’s assets on hand. If assets on hand exceed the present value of expected benefits, then the plan is said to be overfunded. If present value of benefits exceeds assets, then the fund is underfunded.

g. The actuarial rate of return is the discount rate used to determine the present value of future benefits under the plan. It is also the rate of return at which the fund’s assets are assumed to be invested.

h. The Employee Retirement Income Security Act (ERISA) of 1974 is the basic federal law governing the administration and structure of corporate pension plans.

i. The Pension Benefit Guarantee Corporation (PBGC) is a government run insurance system created by the ERISA to ensure that employees of companies which go bankrupt before their plans are fully funded will receive benefits.

j. Federal Accounting Standards Board (FASB) Statement 87, “Employers Accounting for Pension Plans,” and FASB Statement 35, “Accounting and Reporting by Defined Benefit Plans,” provide firms with current guidance for reporting pension costs, assets, and liabilities. For defined contribution plans, FASB rules require the annual contribution to be shown on the income statement, with a note to the financial statements explaining the entry. Conversely, the rules for defined benefit plans require far more complex reporting procedures. In this case, the fund’s overall funding status must be reported directly on the balance sheet if the plan is underfunded, and the annual pension expense must be shown on the income statement. In addition, the firm must provide information concerning the breakdown of the fund’s annual pension expense and the composition of the fund’s assets in the notes section of the annual report.

k. Funding strategy for a pension fund involves two decisions: (1) how fast should any unfunded liability be reduced, and (2) what rate of return should be assumed in the actuarial calculations?

l. The investment strategy for a pension plan also involves two decisions: (1) what rate of return should be targeted, given investment risk considerations, and (2) how should a portfolio that minimizes the risk of not achieving that return be structured?

m. Asset allocation models are used by pension fund managers to help plan funding and investment strategies. These models examine the risk/return relationships of portfolios with various mixes of assets under different economic scenarios.

n. The Jensen alpha is a numerical measure of a portfolio’s performance as compared to a “market” portfolio, such as the S&P 500. The alpha measures the vertical distance of a portfolio’s return above or below the Security Market Line. It represents the extra return (positive or negative) after adjustment for the portfolio’s market risk.

o. Tapping fund assets refers to usage of pension fund assets for a corporation’s own benefit. Given that corporate sponsors administer defined benefit plans which have assets running into the hundreds of billions of dollars, to what extent should a corporation be able to tap its pension fund? Should companies be able to use funds to fight off takeovers? There are no easy answers to these questions.

p. Health care benefits are offered by most companies as part of their retirement packages, usually until the retirees reach age 65 and become eligible for Medicare. With the population aging and Health care costs surging, the present liability of estimated future costs of retiree health care represents a large portion of many companies’ net worth. Also, a 1990 FASB rule requires companies to accrue, or set up a reserve for, future medical benefits of retirees. These factors have resulted in many companies either scrapping or significantly reducing coverage of their retiree health benefits.

29-2 Ideally, the employee will choose the plan that provides the incremental cash flows (both costs and benefits) that maximize the employee’s expected utility of consumption. However, there are many economic variables involved which have profound effects on the expected value of the plans. These include employee’s expected work life, potential number of employers, vesting provisions of funds, risks of adequate funding of pension funds, expected inflation, and the likelihood of unexpected inflation. Because these factors can vary so much between individual employees and employers, no meaningful generalizations about these variables’ specific effects on pension funds can be made.

29-3 From an employer’s standpoint, the defined benefits plan’s major advantage is promotion of low employee turnover. The economic consequences of job-changing are not desirable under a defined benefits plan, since benefits are frozen at the time of separation, instead of adjusted for inflation over time. Thus, defined benefit plans provide incentive to stay with the firm for a long period.
However, there are several disadvantages associated with defined benefit plans. First, the plan puts greater risk on employers, since it guarantees to pay employees a fixed retirement benefit regardless of the firm’s ability to fully fund the plan. Second, the employer’s future cash contributions to the plan are uncertain, thus hampering financial planning efforts. This is particularly true if retirement benefits are based on final years’ salaries, which can grow at different rates than inflation and other assumed levels. Finally, because of FASB Statement 87, there are greater financial reporting requirements associated with defined benefits plan.
Defined contribution plans avoid many of the problems of the defined benefits plan, since future payments are based on the rate of return on the pension plan’s portfolio. Furthermore, since employee retirement benefits are not fixed, defined contribution plans are exempt from the reporting requirement of FASB Statement 87. However, since retirement benefits are based on the portfolio’s return, the defined contribution plan provides no strong incentives for employees to remain with the firm, as do defined benefit plans.
The greater risks involved with a defined benefits plan are a major reason why in general only large corporations, such as IBM and GM, can afford to offer them to employees.

29-4 Pension fund data are found in the annual report section entitled “Notes to Consolidated Financial Statements.” For example, the 1991 IBM Annual Report indicated a present value of pension benefits of $16.2 billion for its U.S. plan and a plan asset value of $25.2 billion. IBM’s pension fund information covers about 1.5 pages in its report, because its defined benefits plan requires more disclosure than a company having a defined contribution plan like Rubbermaid, with a few paragraphs in its 1991 Annual Report devoted to pension plans and other employee benefits. In accordance with FASB Statement 87, firms with underfunded or overfunded plans must incorporate the shortage or excess directly into the firm’s balance sheet. Thus, firm’s having underfunded plans with large liabilities and significant current contributions will report lower profits and a weaker financial condition than firms that have their plans fully or overfunded.

29-5 If the returns on these assets are less than perfectly positively correlated with the fund’s other assets, then the addition of such investments as foreign stocks and precious metals would lower the overall riskiness of the portfolio. In other words, if these assets have a lower beta than the fund’s portfolio, then adding them will lower the beta of the fund. However, the returns on foreign stocks and precious metals are typically quite volatile, and such assets are generally not suitable for meeting current payment obligations.

29-6 a. Defined benefit plans carry with them economic incentive to discriminate against older workers in hiring, while defined contribution plans are neutral in this regard.

b. There is an economic incentive for employers to discriminate against women in their hiring practices if they use defined benefit plans, since women tend to live longer than men.

c. Defined benefit plans contribute to lower employee turnover which would reduce training costs.

d. The pension benefits of a defined contribution plan are highly sensitive to changes in the actuarial rate of return on the pension fund’s investments. Union leaders may be more flexible with this plan.

29-7 Most economists would argue that insurance premiums of any type should reflect the relative risk to the insurer. Thus, corporate liability insurance is higher for drug manufacturers than for greeting card makers, and life insurance is higher for smokers than for nonsmokers. Following this line of reasoning, PBGC insurance premiums should be higher for those firms whose pension plans are more likely to require a PBGC bailout.
SOLUTIONS TO END-OF-CHAPTER PROBLEMS



29-1 a. His wage in the final year of working is $179,700:

$20,000(1.05)45 = $20,000(8.9850) = $179,700.

Thus, his annual retirement benefit is $80,865:

$179,700(0.01)(45) = $80,865.

b. Assuming an actuarial rate of 10 percent, CC must accumulate $615,066 by the time of Mr. Jones’s retirement:

PV = $80,865(PVIFA10%,15) = $615,066.

CC must contribute $856 per year over Mr. Jones’ 45-year working life to accumulate $615,066.

$615,066 = PMT(FVIFA10%,45)
PMT = $856.

c. Final year wage = $20,000(1.05)20 = $53,066.

Annual retirement benefit = $53,066(0.01)(20) = $10,613.

Lump sum required = $10,613(PVIFA10%,15) = $80,723.

Annual contribution = $1,409:
$80,723 = PMT(FVIFA10%,20)
PMT = $1,409.

We see that the older worker requires $1,409 - $856 = $553 more in annual pension fund contributions. Thus, from a pension funding standpoint alone, CC would favor a younger worker.

d. Ms. Brown would receive the same retirement benefit as computed for Mr. Smith in Part a, $80,865 per year. However, Ms. Brown would receive the benefit for 25 rather than 15 years. Thus, her annual pension cost would be $1,021:

PV = $80,865(PVIFA10%,25) = $734,015.

$734,015 = PMT(FVIFA10%,45)
PMT = $1,021.

Thus, the company is actually “paying” Ms. Brown more than they are paying Mr. Smith. Whether this is equitable or not is a matter of debate.


29-2 a. Required return = k = kRF + (kM - kRF)b = 10% + (6%)1.2 = 17.2%.
Realized return = = 18.0%.
Alpha = - k = 18.0% - 17.2% = 0.8 percentage points.

b. If the portfolio return was net of all transaction costs and management fees, then the portfolio manager “outperformed the market” on a risk-adjusted basis. This may be due to his extraordinary ability to identify undervalued stocks or, more commonly, shear luck.

c. Thus, it would be impossible to predict next year’s performance based on one year’s historical performance.


29-3 a. Find the present value (today’s value) of the firm’s obligations.

To simplify calculations, find the value of each 5-year period’s payment as of the beginning of the period. For example, the value at Time 10 of the payments for Years 11-15 is:

10 11 12 13 14 15
| | | | | |
2,500,000 2,500,000 2,500,000 2,500,000 2,500,000

N = 5, I = 10, PMT = -2500000, FV = 0, PV = $9,476,967 = Value at
Year 10.

0 10 15 20 25 30
| | | | | |
9,476,967 7,581,574 5,686,180 3,790,787 1,895,393
3,653,781
1,814,969
845,214
349,874
108,622
6,772,460

b. Since the assets are less than the PV of benefits, the plan is underfunded.

Funding ratio = = = 0.89.


MINI CASE

SOUTHEAST TILE DISTRIBUTORS INC. IS A BUILDING TILE WHOLESALER THAT ORIGINATED IN ATLANTA BUT IS NOW CONSIDERING EXPANSION THROUGHOUT THE REGION TO TAKE ADVANTAGE OF CONTINUED STRONG POPULATION GROWTH. THE COMPANY HAS BEEN A “MOM AND POP” OPERATION SUPPLEMENTED BY PART-TIME WORKERS, SO IT CURRENTLY HAS NO CORPORATE RETIREMENT PLAN. HOWEVER, THE FIRM’S OWNER, ANDY JOHNSON, BELIEVES THAT IT WILL BE NECESSARY TO START A CORPORATE PENSION PLAN TO ATTRACT THE QUALITY EMPLOYEES NEEDED TO MAKE THE EXPANSION SUCCEED. ANDY HAS ASKED YOU, A RECENT BUSINESS SCHOOL GRADUATE WHO HAS JUST JOINED THE FIRM, TO LEARN ALL THAT YOU CAN ABOUT PENSION FUNDS, AND THEN PREPARE A BRIEFING PAPER ON THE SUBJECT. TO HELP YOU GET STARTED, HE SKETCHED OUT THE FOLLOWING QUESTIONS:

A. HOW IMPORTANT ARE PENSION FUNDS TO THE U.S. ECONOMY?


ANSWER: PENSION FUNDS CONSTITUTE THE LARGEST AND FASTEST GROWING MAJOR CLASS OF INVESTORS. IN 1995, THESE FUNDS HAD ASSETS OF OVER $4.0 TRILLION; THEY OWNED ABOUT ONE-THIRD OF ALL THE STOCK OF U. S. CORPORATIONS; THEY ACCOUNTED FOR ABOUT HALF OF ALL STOCK TRADES; AND THEY OWNED ABOUT HALF OF ALL OUTSTANDING CORPORATE BONDS. THUS, PENSION FUNDS ARE A MAJOR FORCE IN THE FINANCIAL MARKETS.


B. DEFINE THE FOLLOWING PENSION FUND TERMS: (1) DEFINED BENEFIT PLAN;
(2) DEFINED CONTRIBUTION PLAN; (3) PROFIT SHARING PLAN; (4) VESTING; (5) PORTABILITY; (6) FULLY FUNDED, OVERFUNDED, UNDERFUNDED;
(7) ACTUARIAL RATE OF RETURN; (8) EMPLOYEE RETIREMENT INCOME SECURITY ACT (ERISA); (9) PENSION BENEFIT GUARANTEE CORPORATION.

ANSWER: 1. UNDER A DEFINED BENEFIT PLAN, THE EMPLOYER AGREES TO GIVE RETIREES A SPECIFIC DEFINED BENEFIT, SUCH AS $500 PER MONTH, 80 PERCENT OF HIS OR HER AVERAGE SALARY OVER THE 5 YEARS PRECEDING RETIREMENT, OR 2.5 PERCENT OF HIS OR HER HIGHEST SALARY FOR EACH YEAR OF EMPLOYMENT.

2. IN A DEFINED CONTRIBUTION PLAN, COMPANIES AGREE TO MAKE SPECIFIC PAYMENTS INTO A RETIREMENT FUND, AND THEN THE RETIREES RECEIVE BENEFITS FROM THE PLAN DEPENDING ON THE INVESTMENT SUCCESS OF THE PLAN.

3. UNDER A PROFIT SHARING PLAN, THE EMPLOYER MAKES PAYMENTS INTO THE RETIREMENT FUND THAT VARY WITH THE LEVEL OF CORPORATE PROFITS.

4. AN EMPLOYEE IS VESTED IF HE OR SHE HAS THE RIGHT TO RECEIVE PENSION BENEFITS EVEN IF THEY LEAVE THE COMPANY PRIOR TO RETIREMENT. IF THE EMPLOYEE LOSES HIS OR HER PENSION RIGHTS UPON LEAVING THE COMPANY PRIOR TO RETIREMENT, THE RIGHTS ARE SAID TO BE NONVESTED. MOST PLANS TODAY HAVE DEFERRED VESTING, IN WHICH PENSION RIGHTS ARE NONVESTED FOR THE FIRST FEW YEARS, SAY 5, AND THEN BECOME FULLY VESTED AT THAT POINT.

5. A PORTABLE PENSION PLAN IS ONE THAT AN EMPLOYEE CAN CARRY FROM ONE EMPLOYER TO ANOTHER. PORTABILITY IS ESPECIALLY IMPORTANT IN INDUSTRIES WHERE JOB CHANGES ARE FREQUENT--AS IN TRUCKING AND CONSTRUCTION--AND UNION-ADMINISTERED PLANS ARE TYPICALLY USED TO MAKE PORTABILITY POSSIBLE.

6. IF THE PRESENT VALUE OF EXPECTED RETIREMENT BENEFITS IS EQUAL TO PLAN ASSETS ON HAND, THE PLAN IS SAID TO BE FULLY FUNDED. IF ASSETS EXCEED THE PRESENT VALUE OF BENEFITS, THEN THE PLAN IS OVERFUNDED, WHILE THE PLAN IS UNDERFUNDED IF THE PRESENT VALUE OF BENEFITS EXCEEDS ASSETS. IF THE PLAN IS UNDERFUNDED, AN UNFUNDED PENSION LIABILITY IS SAID TO EXIST.

7. THE DISCOUNT RATE USED TO DETERMINE THE PRESENT VALUE OF FUTURE BENEFITS IS CALLED THE ACTUARIAL RATE OF RETURN. THIS RATE IS ALSO THE RATE OF RETURN AT WHICH THE FUND’S ASSETS ARE ASSUMED TO BE INVESTED.

8. THE EMPLOYEE RETIREMENT INCOME SECURITY ACT OF 1974 (ERISA) IS THE BASIC FEDERAL LAW GOVERNING THE ADMINISTRATION AND STRUCTURE OF CORPORATE PENSION PLANS.

9. THE PENSION BENEFIT GUARANTEE CORPORATION (PBGC) IS A GOVERNMENT-RUN INSURANCE COMPANY CREATED BY THE ERISA TO ENSURE THAT EMPLOYEES OF COMPANIES WHICH GO BANKRUPT BEFORE THEIR PLANS ARE FULLY FUNDED WILL RECEIVE BENEFITS.


C. WHAT TWO ORGANIZATIONS PROVIDE GUIDELINES FOR REPORTING PENSION FUND ACTIVITIES TO STOCKHOLDERS? DESCRIBE BRIEFLY HOW PENSION FUND DATA ARE REPORTED IN A FIRM’S FINANCIAL STATEMENTS. (HINT: CONSIDER BOTH DEFINED CONTRIBUTION AND DEFINED BENEFIT PLANS.)

ANSWER: THE FINANCIAL ACCOUNTING STANDARDS BOARD (FASB), TOGETHER WITH THE SEC, ESTABLISHES THE RULES UNDER WHICH A FIRM REPORTS ITS FINANCIAL RESULTS, INCLUDING ITS INCOME AND ASSET POSITIONS, TO STOCKHOLDERS. THE REPORTING OF DEFINED CONTRIBUTION PLANS IS RELATIVELY SIMPLE: THE ANNUAL CONTRIBUTION IS SHOWN ON THE FIRM’S INCOME STATEMENT AND A NOTE EXPLAINS THE ENTRY. HOWEVER, THE REPORTING OF DEFINED BENEFIT PLANS IS MORE COMPLEX. IN THIS CASE, THE FUND’S OVERALL FUNDING STATUS MUST BE REPORTED DIRECTLY ON THE BALANCE SHEET IF THE PLAN IS UNDERFUNDED, AND THE ANNUAL PENSION EXPENSE MUST BE SHOWN ON THE INCOME STATEMENT. IN ADDITION, THE FIRM MUST PROVIDE INFORMATION CONCERNING THE BREAKDOWN OF THE FUND’S ANNUAL PENSION EXPENSE AND THE COMPOSITION OF THE FUND’S ASSETS IN THE NOTES SECTION OF THE ANNUAL REPORT.


D. ASSUME THAT AN EMPLOYEE JOINS THE FIRM AT AGE 25, WORKS FOR 40 YEARS TO AGE 65, AND THEN RETIRES. THE EMPLOYEE LIVES ANOTHER 15 YEARS, TO AGE 80, AND DURING RETIREMENT DRAWS A PENSION OF $20,000 AT THE END OF EACH YEAR. HOW MUCH MUST THE FIRM CONTRIBUTE ANNUALLY (AT YEAR-END) OVER THE EMPLOYEE’S WORKING LIFE TO FULLY FUND THE PLAN BY RETIREMENT AGE IF THE PLAN’S ACTUARIAL RATE OF RETURN IS 10 PERCENT? DRAW A GRAPH WHICH SHOWS THE VALUE OF THE EMPLOYEE’S PENSION FUND OVER TIME. WHY IS REAL-WORLD PENSION FUND MANAGEMENT MUCH MORE COMPLEX THAN INDICATED IN THIS ILLUSTRATION?

ANSWER: THE EMPLOYEE WILL DRAW AN ANNUAL PENSION (AN ANNUITY) OF $20,000 FOR 15 YEARS. THUS, THE FIRM MUST ACCUMULATE $152,121.59 IN THE PENSION PLAN BY THE TIME THE EMPLOYEE RETIRES TO FULLY FUND THE RETIREMENT:

$20,000(PVIFA10%,15 YEARS) = $152,121.59.
ALTERNATIVELY, USING A FINANCIAL CALCULATOR, INPUT N = 15, I = 10, PMT = 20000, AND FV = 0, TO SOLVE FOR PV = $152,121.59. SINCE THE COMPANY HAS 40 YEARS TO ACCUMULATE THIS AMOUNT, ITS ANNUAL PENSION CONTRIBUTION IS $343.71:

PMT(FVIFA10%,40 YEARS) = $152,121.59
PMT = $343.71.

ALTERNATIVELY, USING A FINANCIAL CALCULATOR, INPUT N = 40, I = 10, PV = 0, AND FV = 152121.59, TO SOLVE FOR PMT = $343.71.
GRAPH OF THE EMPLOYEE’S PENSION FUND ASSETS LOOKS LIKE THIS:


REAL-WORLD PENSION FUND MANAGEMENT IS MUCH MORE COMPLEX BECAUSE OF UNCERTAINTIES REGARDING (1) HOW LONG THE EMPLOYEE WILL WORK FOR THE FIRM, (2) THE SALARY OF THE EMPLOYEE OVER TIME, AND (3) THE RATE OF RETURN THAT CAN BE EARNED ON PENSION CONTRIBUTIONS.


E. DISCUSS THE RISKS TO BOTH THE PLAN SPONSOR AND PLAN BENEFICIARIES UNDER THE THREE TYPES OF PENSION PLANS.

ANSWER: THE DEFINED BENEFIT PLAN PLACES MOST OF THE RISKS ON THE COMPANY, BECAUSE IT GUARANTEES TO PAY A MORE OR LESS FIXED RETIREMENT BENEFIT REGARDLESS OF ITS ABILITY TO FULLY FUND THE PLAN. CONVERSELY, THE DEFINED CONTRIBUTION AND PROFIT SHARING PLANS PLACE MOST OF THE RISKS ON THE EMPLOYEES, BECAUSE THEIR BENEFITS DEPEND ON THE RETURN THAT THE FUND ASSETS EARN, AND, IN THE CASE OF A PROFIT SHARING PLAN, THE PROFITS OF THE COMPANY.


F. HOW DOES THE TYPE OF PENSION PLAN INFLUENCE DECISIONS IN EACH OF THE FOLLOWING AREAS:

1. THE POSSIBILITY OF AGE DISCRIMINATION IN HIRING?

ANSWER: DEFINED BENEFIT PLANS ARE MORE COSTLY TO FIRMS WHEN OLDER WORKERS ARE HIRED AS OPPOSED TO YOUNGER WORKERS, BECAUSE THE FIRM HAS A MUCH SHORTER TIME TO ACCUMULATE THE NEEDED FUNDS.


F. 2. THE POSSIBILITY OF SEX DISCRIMINATION IN HIRING?

ANSWER: SINCE WOMEN LIVE LONGER THAN MEN, FEMALE EMPLOYEES ARE MORE COSTLY THAN MALE EMPLOYEES TO FIRMS THAT HAVE DEFINED BENEFIT PLANS.


F. 3. EMPLOYEE TRAINING COSTS?

ANSWER: TO THE EXTENT THAT DEFINED BENEFIT PLANS ENCOURAGE EMPLOYEES TO STAY WITH A SINGLE COMPANY, THEY REDUCE TRAINING COSTS.


F. 4. THE MILITANCY OF UNIONS WHEN A COMPANY FACES FINANCIAL ADVERSITY?

ANSWER: SINCE DEFINED BENEFIT PLAN BENEFITS ARE USUALLY TIED TO THE NUMBER OF YEARS WORKED AND THE FINAL (OR LAST SEVERAL) YEAR’S SALARY, UNIONS ARE MORE LIKELY TO WORK WITH A FIRM TO ENSURE ITS SURVIVAL IF IT HAS A DEFINED BENEFIT PLAN.

G. WHAT ARE THE TWO COMPONENTS OF A PLAN’S FUNDING STRATEGY? WHAT IS THE PRIMARY GOAL OF A PLAN’S INVESTMENT STRATEGY?

ANSWER: THE TWO COMPONENTS OF A PLAN’S FUNDING STRATEGY ARE:

HOW FAST SHOULD ANY UNFUNDED LIABILITY BE REDUCED?

WHAT RATE OF RETURN SHOULD BE ASSUMED IN THE ACTUARIAL CALCULATIONS?

THE PRIMARY GOAL OF A PLAN’S INVESTMENT STRATEGY IS TO STRUCTURE THE PORTFOLIO TO MINIMIZE THE RISK OF NOT ACHIEVING THE ASSUMED ACTUARIAL RATE OF RETURN.


H. HOW CAN A CORPORATE FINANCIAL MANAGER JUDGE THE PERFORMANCE OF PENSION PLAN MANAGERS?

ANSWER: PENSION PLAN MANAGERS CAN BE JUDGED IN SEVERAL WAYS. ONE WAY IS TO COMPARE THE REALIZED RETURN ON THE MANAGER’S PORTFOLIO WITH THE EQUILIBRIUM RETURN COMMENSURATE FOR THE RISKINESS OF THE PORTFOLIO. THIS IS CALLED ALPHA ANALYSIS, WHERE ALPHA IS THE REALIZED RETURN MINUS THE SML RETURN FOR A PORTFOLIO WITH THE SAME BETA. ANOTHER WAY TO JUDGE A PORTFOLIO MANAGER IS TO COMPARE HIS OR HER HISTORICAL RETURNS WITH OTHER MANAGERS HAVING THE SAME INVESTMENT OBJECTIVES.


I. WHAT IS MEANT BY “TAPPING” PENSION FUND ASSETS? WHY IS THIS ACTION SO CONTROVERSIAL?

ANSWER: PENSION FUND ASSETS ARE TAPPED WHEN A COMPANY TERMINATES AN OVERFUNDED DEFINED BENEFIT PLAN, USES A PORTION OF THE FUNDS TO PURCHASE ANNUITIES WHICH PROVIDE THE PROMISED PENSIONS TO EMPLOYEES, AND THEN RECOVERS THE EXCESS FOR THE FIRM. THIS ACTION IS CONTROVERSIAL BECAUSE SOME PEOPLE BELIEVE THAT PENSION FUND ASSETS BELONG TO THE EMPLOYEES, AND HENCE FIRMS THAT DO THIS ARE “ROBBING” THEIR EMPLOYEES. CONVERSELY, COURTS HAVE HELD THAT PENSION FUND ASSETS BELONG TO THE FIRM, AND HENCE FIRMS CAN RECOVER ASSETS AS LONG AS THIS ACTION DOES NOT JEOPARDIZE THE EMPLOYEE’S FUTURE PENSION BENEFITS.


J. WHAT HAS HAPPENED TO THE COST OF RETIREE HEALTH BENEFITS OVER THE LAST DECADE? HOW ARE RETIREE HEALTH BENEFITS REPORTED TO SHAREHOLDERS?

ANSWER: BECAUSE OF THE INCREASED NUMBER OF RETIREES, AND THE DRAMATIC ESCALATION IN HEALTH CARE COSTS OVER THE PAST 10 YEARS, MANY COMPANIES ARE FACING SITUATIONS WHERE RETIREE HEALTH CARE COSTS ARE FORECASTED TO BE AS HIGH, OR HIGHER, THAN PENSION COSTS. A 1990 FASB RULE REQUIRES COMPANIES TO ACCRUE, OR SET UP A RESERVE FOR, FUTURE MEDICAL BENEFITS FOR RETIREES. PRIOR TO THIS RULE, COMPANIES MERELY DEDUCTED THESE BENEFIT PAYMENTS FROM INCOME IN THE YEAR OF PAYMENT. NOW, THEY MUST TAKE CURRENT WRITE-OFFS TO ACCOUNT FOR VESTED FUTURE MEDICAL BENEFITS. THIS NEW RULE HAS FOCUSED THE NEED FOR COMPANIES TO CAREFULLY ASSESS THEIR ABILITIES TO CONTINUE GENEROUS HEALTH PLANS FOR RETIREES, AND MANY COMPANIES ARE NOW TRIMMING BENEFITS.