Federal Report: April 2002

Summary

Study: Wisconsin Early Retirement Could Affect 6,000 Government Workers

Trustees' Report on Social Security Adds Three Years to Fund's Life

Head of Social Security Resists GOP Plan for Benefit 'Guarantee' Certificates

House Committee Approves Portman-Cardin Proposal on 401(k) Investments

House Committee Approves President's Plan to Protect Sec. 401(k) Plan Assets

Treasury Secretary Says Regulators Already Can Make Changes in Wake of Enron

Actuarial Assumptions: Are U.S. Funds Assuming Too Much?

House Leaders Take Bipartisan Steps to Strengthen Parts of Social Security

Study: Wisconsin Early Retirement Could Affect 6,000 Government Workers

About 6,000 of the Wisconsin state government's most experienced workers could be expected to retire at ages as young as 48 under a costly early retirement package being considered by Democratic legislators, a new study concluded. Depending on which version of an early retirement incentive package becomes law, the one-time cost would be between $282 million and $362 million, an amount that state agencies would be required to repay over 25 years at 8 percent annual interest, according to a preliminary report issued by a Michigan actuarial firm, and reported in the Milwaukee Journal Sentinel.

The $40,000 report was ordered by state Senate Democrats who wanted to know if an early retirement benefit would save enough money to pay for itself and help state officials solve a $1.1 billion budget deficit. The actuaries found that state government and vocational colleges had 67,831 workers in the state retirement system at the end of 2000, and 17,139 of them could take early retirement under the Democratic plan. About 6,000 workers, or 35 percent of those eligible, would be expected to actually do so, the report said. Actuaries for the firm of Gabriel, Roeder, Smith & Co. said the plan would:

• Boost the number of years of "creditable" service, or years on which pensions would be based.

• Add up to $40,000 more worth of "sick leave credits" — benefits that state workers build up for unused sick leave and, when they retire, must be used to buy future health insurance.

• Allow most eligible employees to retire as early as age 53, but prison guards and other law officers could do so as early as age 48.

• Require eligible general state workers to retire between July 1 and Dec. 31, but University of Wisconsin System and Technical College System workers would have to retire between Jan. 1 and June 30, 2003, to avoid disrupting the academic year.

Democrats are drafting the plan carefully to avoid any backlash similar to what happened in Milwaukee County, when officials voted to give lucrative pensions to county employees. For example, unlike the Milwaukee County Board, Democrats decided not to extend a new early retirement option to elected state officials.

But the Michigan actuaries bluntly cautioned that the 25-year repayment schedule under consideration may be too long. "Twenty-five years is a long period for such a purpose," actuaries Norman Jones and Brian Murphy, told the newspaper.

With a 25-year payback schedule, which legislators are discussing to avoid any losses by the state's retirement fund, "future generations of taxpayers will be funding benefits for individuals who have long since retired," the actuaries said. "Other systems have used periods of five or 10 years for this purpose. We would be more comfortable with a shorter amortization period than we are with special calculations that are designed to prevent negative cash flow."

But shortening the repayment period from 25 to 10 years would double the annual cost, said Tony Mason, a Legislative Fiscal Bureau analyst preparing another report on what possible savings early retirements might achieve. Using the actuary's preliminary report, Mason calculated that annual payments over 25 years for the one-time early retirement package would range from $19.48 million to $29.23 million, depending on which version of it became law.

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Trustees' Report on Social Security Adds Three Years to Fund's Life

The financial outlook for Social Security and Medicare improved in the last year, despite the recession, the Bush administration said March 26. The main reason for the improvement, it said, was an increase in the anticipated growth in the productivity of American workers in the coming decade and in the next 75 years.

Still, the administration said Congress ought to shore up both programs before baby boomers reach retirement age. Baby boomers, the 76 million people born from 1946 to 1964, will reach 65 in the years from 2011 to 2029. With no change in current law, the government now estimates that the Social Security trust fund will run out of money in 2041, three years later than estimated in last year's report.

In its 2002 Annual Report to Congress, the Social Security Board of Trustees said:

• The projected point at which tax revenues will fall below program costs will come in 2017 — one year later than estimated in last year's report;

• The projected point at which program costs will exceed tax revenues plus interest from the trust funds will come in 2027 — two years later than estimated in last year's report;

• The projected actuarial deficit of taxable payroll over the 75-year long period is 1.87 percent — slightly larger than the 1.86 percent projected in last year's report.

"These projections suggest that we have not lost ground in the past year," said Jo Anne Barnhart, Commissioner of Social Security. "However, the report still projects that, once the trust funds are exhausted, payroll tax revenues will be sufficient to meet only 73% of Social Security benefit obligations under current law. And projections for the late 21st century paint an even bleaker picture."

Based upon the most recent experience and updated methodologies, the Social Security Board of Trustees made several changes in assumptions from last year's report. The shorter-term outlook was improved primarily because of higher assumed productivity growth and revenue from taxes paid on Social Security income. The longer-term deterioration in outlook resulted from the passage of another year, a lower death rate assumption and projected higher benefits on average. The combination means that at the end of the 75-year period the program is in a "significantly worse position" than projected in last year's report, SSA said.

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Head of Social Security Resists GOP Plan for Benefit 'Guarantee' Certificates

House Majority Leader Dick Armey's (R-Texas) effort to inoculate Republicans against election-year attacks on President Bush's plan for limited privatization of Social Security suffered a blow when the agency's new commissioner criticized Republican proposals (H.R. 3135, S. 1558) to provide benefit guarantee certificates to enrollees.

Jo Anne Barnhart raised a series of questions about the value and practicality of such a written promise in testimony before the House Ways and Means Subcommittee on Social Security:

"Would such a written reassurance be legally binding on future Congresses?" she asked. "And would it require the government to use general revenue funds to pay future Social Security benefits when the trust funds become exhausted if no changes are made?"

Rep. Robert T. Matsui (D-Calif.), the committee's ranking Democrat, said the certificates "would be about as valuable as the paper they're written on" and called for a "serious" debate of the risks of Bush's proposal to allow workers to invest a portion of their payroll taxes in private retirement account.

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House Committee Approves Portman-Cardin Proposal on 401(k) Investments

The House Ways and Means Committee on March 14 approved, 36-2, the Employee Retirement Savings Bill of Rights Act (H.R. 3669), introduced in February by Reps. Rob Portman (Ohio) and Benjamin Cardin (Md.). The bill aims to empower employees to control their retirement savings accounts through new diversification rights, new disclosure requirements, and new tax incentives for retirement education.

H.R. 3669 would add a new paragraph (35) to IRC Sec. 401(a) to impose diversification requirements on defined contribution plans that hold employer securities. The bill would require employers to furnish participants with investment education notices and advance notices of any blackout periods during which participants are unable to liquidate or divest assets in their plan accounts. Both notices would be required to be provided in writing and could be provided in an electronic format. Failure to comply with the new notice requirements would result in the imposition of excise taxes.

The bill would require employers to furnish "applicable individuals" with investment education notices on a quarterly basis and to furnish participants with an investment education notice upon enrollment in the plan. Applicable individuals would include plan participants, alternate payees under a qualified domestic relations order, and beneficiaries of a deceased participant or alternate payee. The notice requirement would not apply to one-person plans.

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House Committee Approves President's Plan to Protect Sec. 401(k) Plan Assets

On March 20, by a vote of 28-19, the House Education and the Workforce Committee approved the Pension Security Act of 2002 (H.R. 3762), co-authored by Reps. John Boehner (R-Ohio) and Sam Johnson (R-Texas). The bill includes President Bush's proposals for protecting the assets of 401(k) plans.

H.R. 3762 would amend ERISA Sec. 105(a) to require individual account plans to furnish a quarterly pension benefit statement to participants. The statement would have to include the value of investments allocated to each participant's individual account, including the value of any assets held in the form of employer securities; an explanation of any limitations or restrictions on the right of the participant to direct an investment; and an explanation of the importance of "a well-balanced and diversified investment portfolio."

A plan administrator who failed to provide a quarterly statement would be subject to a civil penalty of up to $1,000 per day.

The bill is similar to H.R. 3669, but H.R. 3762 applies only to private plans. It likely will eventually be merged with H.R. 3669 and possibly other bills. There have been discussions, in the context of the merger, about modifying the excise penalty tax of H.R. 3669 as it affects state and local government plans.

On the Senate side, the Health, Labor, Education, and Pensions Committee is working on S. 1992, which covers private plans only. It is quite different from H.R. 3762. The Finance Committee is expected to consider a similar bill. Whether it will contain federal disclosure requirements and excise penalty taxes applicable to state and local government plans is not known at this time.

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Treasury Secretary Says Regulators Already Can Make Changes in Wake of Enron

Treasury Secretary Paul H. O'Neill said March 25 that enacting new laws will not solve the problems that the Enron Corp. bankruptcy exposed in the accounting industry and pension fund management.

"For every new rule that one can imagine, someone can figure out a clever way to get around it," O'Neill told the Council of Institutional Investors, which represents 120 public and corporate pension funds.. O'Neill said that the Securities and Exchange Commission has the power to do much of what is needed.

Congress and the executive branch must "first, make sure we do no harm," O'Neill said. Further, he criticized congressional proposals that would cap the amount of company stock in an employee's retirement plan, saying the government must avoid "telling individual Americans what they can and can't do with their own resources."

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Actuarial Assumptions: Are U.S. Funds Assuming Too Much?

A wide gap is developing between the actuarial assumptions of U.S. Pension Funds and their rate of return (ROR) expectations in various asset classes, according to a study conducted late in 2001 by Greenwich Associates, Greenwich, Conn.

The situation is especially noticeable among corporate funds, where the current actuarial rate of 8.8% is higher than the rate-of-return expectation for every asset class but three: international equity, equity real estate, and private equity, which together account for just over 15% of the average corporate fund's total assets.

"The corporate funds' higher actuarial rate begs the question of where this anticipated surplus is supposed to come from," Greenwich consultant Rodger Smith said. "The 11.1% corporate ROR expectation for private equity seems especially challenging considering the generally dismal performance of private equity in 2001."

While public funds report a more modest actuarial assumption — 8.3% — questions persist there, too, the Greenwich study said. Public-fund ROR expectations in several categories, particularly international equity [9.0%] and private equity [13.5%], anticipate stronger performance levels than recent experience seems to merit, the study found.

One area where a correction seems not only appropriate but inevitable is investment in a company's own securities by corporate defined contribution [DC] plans. Greenwich research conducted as the Enron debacle was emerging in the public consciousness shows a marked degree of investment by 401(k) funds in the stock of their parent corporations.

U.S. corporations' 401(k) plans had some $300 billion placed in their own securities, according to Greenwich's research. The situation is especially acute at the largest corporate funds, where such internal investment represents nearly 36% of total DC assets for funds over $5 billion.

"As concerned observers, our firm questions the wisdom of this practice, in light of not only the Enron case but the commonly understood need for investment diversification," Greenwich consultant Dev Clifford said. "Employees need to know the dangers of double jeopardy when investing in their own company's securities — the fact they could lose a job and their pension savings in one fell swoop — but employers need to do a better job in educating them about the risks, or else share the responsibility for personal catastrophes of the kind we are becoming all-too-familiar with now."

U.S. pension funds and endowments saw domestic equity holdings fall to less than half of their total portfolios in 2001, the first time since 1996 that U.S. stocks represented that small a share of the average funds' assets. Domestic equity accounted for 49.5% of the average fund's portfolio, down from nearly 52% in 2000.

Total fund assets decreased for the first time in 10 years, with funds taking an average 7.6% loss over the year before. Corporate funds and endowments were particularly hard-hit, losing 9% of their total value on average. Based on funds interviewed, Greenwich Associates projects a total market loss of $475 billion, reversing a trend which saw a near-doubling of fund assets over the previous five years.

"The party in equities seems to be over," Clifford said. "Funds took losses in 2001 mainly from their equity exposures, and seem less optimistic about future domestic stock investment results, at least in the near term."

Fixed-income investment rose as much as domestic equity usage fell in 2001, and now represents 26% of the average total fund portfolio, its highest level since 1996, the same year domestic equity investment was last below 50%, the study found.

Fund professionals do not expect this to become a trend. Those expecting a significant decrease in their fixed-income allocation in the next year outnumber those foreseeing an increase by a 5-to-2 margin. "This is in order to rebalance their portfolio allocations," Smith said.

Meanwhile, private equity investment stayed level over 2000, when it took off by a third to represent 3% of total fund assets.

Overall compensation rose 7% in 2000, the most recent year tracked by the research, with end-of-year bonuses especially robust. "Fund officials may be rewarded both when their results are good and when they are less so, enticing them to reach for returns and take risks out of line with their funds' basic policies," Smith said.

Stark differences remained between the compensation of corporate and public officials, with corporate professionals earning an average total pay above $150,000 a year in 2000, while public professionals made less than $90,000.

Greenwich interviewed 1,445 professionals at 805 corporate funds, 341 public funds, and 299 endowments and foundations in the United States. Interview participants were asked about their investment-services providers, their business practices and philosophy, and their future expectations. Interviews were conducted throughout the United States in October and November 2001.

Greenwich Associates is a leading international research and consulting firm in institutional financial services worldwide. Greenwich's studies provide benefits to the buyers and sellers of financial services in the form of benchmark information on best practices and market intelligence on overall trends.

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House Leaders Take Bipartisan Steps to Strengthen Parts of Social Security

The leaders of the House Ways and Means Subcommittee on Social Security took steps March 22 to show their fellow congressmen how they can work together to strengthen the Social Security program. Chairman Clay Shaw (R-Fla.) and ranking member Robert Matsui (D-Calif.) offered legislation to provide increased benefits for women and help prevent waste, fraud and abuse.

"Common ground is a critical place to start, in advance of major reform, to improve the program for women and implement important protections for the entire Social Security system. This is an important first step toward constructive dialogue on Social Security's long-term financial challenges," Shaw said.

"Social Security has been the backbone of Americans' retirement security for two-thirds of a century. I am pleased that we can work together on these steps that will improve Social Security's fairness to women and help make this great program more efficient. I applaud Chairman Shaw for working in a bipartisan way on these bills and hope this is just the beginning of a bipartisan dialogue on how to protect and improve Social Security," Matsui said.

H. R. 4069, The Social Security Benefit Enhancements for Women Act of 2002, would improve fairness and update benefit eligibility requirements, resulting in higher benefits and expanded eligibility for elderly and disabled widows and divorced spouses, who are among the most likely to live in poverty. Once implemented, more than 120,000 women would see enhancements.

H.R. 4070, The Social Security Program Protection Act of 2002 would protect vulnerable beneficiaries from fraud if a third party is handling their benefits on their behalf. It also would protect the integrity of Social Security by imposing new civil monetary penalties for fraudulent acts, denying Social Security benefits to fugitive felons, and preventing persons from misrepresenting themselves as they provide Social Security-related services.

Furthermore, the bill would improve access to legal representation for disabled claimants who need assistance filing their application. It would improve the flexibility of 'Ticket to Work' programs so that we can maximize the number of disabled individuals who seek and find jobs.

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