How To Write A Pension Plan Plan Plan Of American Liability

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1 Reauthorizing PPA Rules for Multiemployer Pension Plans Better Serves Retirement Security Executive Summary By Andrew Wozniak Director, Investment Strategy and Solutions Group* John Donaghey, CFA, CAIA Managing Director, Head of North American Institutional Distribution Funding rules for multiemployer, or Taft-Hartley, jointly-trusteed labor-management pension plans that were set out in the 2006 Pension Protection Act (PPA) are set to expire at the end of We believe it is in the best interests of the retirement security of millions of American workers and their families to reauthorize those rules rather than instituting new requirements that are inconsistent with the specific characteristics of multiemployer plans. It is important to consider and appreciate the different objectives of accounting and funding rules as well as the unique features of multiemployer plans that need to be aligned with funding rules. Multiemployer pension plans require funding rules in line with their collective bargaining process and the longer negotiation time frame needed to establish contribution rates. Funding rules not aligned with these features might force companies unable to meet higher contribution requirements in a timely way to withdraw from plans, increasing the burden on remaining employers and threatening the viability of many multiemployer plans. This would not only hurt plan participants unable to draw their full retirement benefits in the case of insolvency, but also add to the load of the Pension Benefit Guaranty Corporation (PBGC) as it is required to assume responsibility for funding guaranteed benefits under insolvent plans. The following discussion seeks to explain how multiemployer plans work and why we believe the current rules in place are appropriate for the specific needs for retirees and for the PBGC. *The Investment Strategy and Solutions Group is part of The Bank of New York Mellon, a principal banking subsidiary of BNY Mellon.

2 REAUTHORIZING PPA RULES // 2 As the current PPA rules that determine annual contribution requirements for multiemployer plans approach expiry at the end of 2014, an important decision looms on whether to extend the existing framework indefinitely or implement new funding requirements. Securing the Retirements of Millions of Private Union Employees Like many other Americans, we have first-hand experience of the important role that healthy and well-managed multiemployer pension plans play in helping to secure a dignified retirement for millions of private union workers. Without the collective bargaining and past stewardship of the multiemployer pension plans that our parents contributed to, it is unlikely they would have been able to save enough, or properly manage those savings well enough, to achieve the retirement security they now enjoy. While modest, those monthly pension checks provide sufficient income to avoid worries about outliving their savings. As the current PPA rules that determine annual contribution requirements for multiemployer plans approach expiry at the end of 2014, an important decision looms on whether to extend the existing framework indefinitely or implement new funding requirements. That choice will have far-reaching implications for the viability of multiemployer plans and the future welfare of approximately 10 million private union workers and their families. As recent industry and media commentary, has, in our view, shed more heat than light on what is at issue, we wanted to offer a fact-based analysis of how these plans work and the kinds of requirements that are aligned with their distinctive features. How Multiemployer Plans Work There are approximately 1,500 multiemployer plans in the U.S. offering pension benefits to 10 million individuals working in industries such as construction, entertainment, mining, trucking, and other service industries. The exact value of these plan assets varies, but we estimate they amount to approximately $450 billion. 1 Multiemployer plans, also known as Taft-Hartley plans, are collectively bargained pension plans jointly managed by a board of trustees, made up of equal representation from management and labor. Trustees of these plans have a fiduciary duty to act in the best interest of the plan participants. Plan members are promised a monthly benefit equal to a fixed dollar amount (i.e., unit benefit) times years of service. For example, if the unit benefit is $40 and a participant works for 30 years, that participant would receive $1,200 a month in retirement for life. Companies may contribute to one or more multiemployer asset pools. The amount a company contributes to a particular pool each year is based on a contribution formula (e.g., $1.50 per labor hour for each participant). The contribution formula can be found in the collective bargaining agreements, which reset periodically based on a plan s funding position and other factors. 1 As of June 30, 2012.

3 REAUTHORIZING PPA RULES // 3 The attractive and somewhat unique features of multiemployer plans that set them apart from their single employer counterparts are portability and reciprocity. Portability allows a union worker to work for various companies and, assuming those companies are signatories to the pension plan, continue to accrue pension credits while working for a new employer. This portability benefit is a primary reason why multiemployer plans are maintained by multiple employers within the same industry (e.g., construction). In a similar fashion, reciprocity allows workers to move into a new region or jurisdiction and, assuming that the pension funds have reciprocity agreements, continue to accrue pension credits at the new pension fund, without interrupting their vesting schedule. Portability and reciprocity benefit both workers and employers. Workers benefit from the ability to continue making pension contributions without interruption when they change employers, and employers benefit from a more flexible and mobile workforce. It is notable that portability is routinely praised as a major benefit by advocates of defined contribution plans, but is often overlooked in commentaries on multiemployer plans. Multiemployer accounting and funding rules serve different purposes and need therefore to be viewed independently. If a company chooses to withdraw from a multiemployer plan, it needs to fund a proportionate share of the plan s unfunded vested liabilities. The unfunded liability is referred to as a withdrawal liability and is calculated using conservative assumptions (e.g., a solvency discount rate). If a multiemployer plan becomes insolvent and its obligations transferred to the PBGC, a retiree may get only a fraction of what was promised. For example, a 30-year service employee s benefit is insured only up to $12,870 a year by the PBGC. Companies that contribute to multiemployer plans currently pay a $12 annual premium per participant for this insolvency guarantee. Beginning in 2014, this premium will be indexed for inflation. Funding Rules Should Differ From Accounting Rules Multiemployer accounting and funding rules serve different purposes and need therefore to be viewed independently. Most importantly, they refer to different time frames: The primary goal of accounting rules is to allow stakeholders to compare different companies at a single point in time and to compare the same company over multiple time periods. The primary goal of funding rules is to ensure that companies are setting aside sufficient cash over long periods of time to meet long-term benefit obligations.

4 REAUTHORIZING PPA RULES // 4 Exhibit 1 The exhibits below summarize the main differences between funding and accounting rules Interested Entities Purposes Rules Funding Department of Labor Internal Revenue Service PBGC Protect pension promises made to beneficiaries by requiring minimum annual contributions Ensure adequate PBGC funding The discount rate is based on the expected return of the portfolio Annual contributions roughly equal benefit accruals for that year plus a 15 or 30 year amortization of unfunded liabilities Smoothing of assets (5 years) and liabilities (4 years) is permitted in determining contribution requirements Contributions may be accelerated based on the plan s status Accounting Financial Accounting Standards Board International Accounting Standards Board U.S. Securities and Exchange Commission Provide information to stakeholders such as investors and rating agencies, which allows comparisons across companies over time Name and tax ID number of individually significant multiemployer plans Annual contributions to the plans Funding zone (e.g. Endangered ) Whether a funding improvement or rehab plan has been adopted Below is a description of the various plan statuses (or funding zones ) that funding rules require to be set. These funding zones are commonly characterized by color to indicate funding status: green, teal, orange and red. Accounting rules require plans to disclose the funding zone they fall into. Healthy Endangered Seriously Endangered Critical Funded Status Greater than 80% Between 65% and 80% Between 65% and 80%, but has missed required contributions Less than 65% Steps required to restore plan health n/a Must adopt a funding improvement plan which increases future contributions and/ or reduces future benefit accruals Funded status must show measured improvement within 10 years Must adopt a funding improvement plan which increases future contributions and/ or reduces future benefit accruals Funded status must show measured improvement within 15 years Must adopt a rehabilitation plan which increases future contributions and/ or reduces future benefit accruals Certain benefits such as early retirement can be revoked Plan must improve within 10 years Source: The ISSG.

5 REAUTHORIZING PPA RULES // 5 Accounting stakeholders such as rating agencies and equity analysts want to know the market value of pension assets and liabilities as of a measurement date. The market value of liabilities is often calculated using a corporate bond discount rate (e.g., 4%). A corporate bond discount rate is market-related, objective, and provides an indication of a settlement value at a particular point in time. Because pension plans have longer time horizons, they do not need to be fully funded on a solvency basis today. In fact, we believe that kind of requirement would place too high a burden on participating companies and amount to an inefficient use of capital. Inappropriately high funding levels would lead to opportunity costs on a number of different levels. Capital that could otherwise be invested in research and development, productivity improvements or hiring new workers would be allocated to a different purpose. In our view, a more appropriate discount rate for funding purposes, which determines the annual cash contribution requirement, is the expected return on the plan assets. Using an expected return on plan assets (e.g., 7%) to determine how much multiemployer plans need to set aside each year takes advantage of the long time horizons these plans have. If the investment returns are achieved over the long term, the plan will have sufficient assets to pay for the promised benefits. In our view, a more appropriate discount rate for funding purposes, which determines the annual cash contribution requirement, is the expected return on the plan assets. Actuaries use the following formula to efficiently align the future value of contributions plus earnings with liabilities and expenses: Contributions + Investment Returns = Benefit Payments + Expenses Given the volatility of markets, there will be periods from an accounting perspective when the plan will be overfunded or underfunded, and that is fine because these are long-term vehicles. Again, actuaries are focused on future values, not present values. If the multiemployer funding rules are changed to use a corporate bond yield of, say, 4%, those plans will not be able to take advantage of their long time horizons and expected portfolio returns. Using a corporate bond discount rate would require contributing employers to these plans to begin immediately to contribute more cash than under current rules. The short-term nature of such changes in accounting rules is inconsistent with the long-term nature of the plans assets and the collective bargaining process that establishes and maintains these plans as explained below.

6 REAUTHORIZING PPA RULES // 6 Multiemployer Plans Need More Time to Close Deficits Than Single Employer Plans Multiemployer pension plans require funding rules aligned with their collective bargaining process. Collectively bargained agreements specify employee and employer contribution rates. These agreements are renegotiated every three to five years. If plan funding deteriorates shortly after an agreement is ratified, it could take four years to adjust pension contributions. By contrast, single employer plan contribution requirements are not bound over time by contracts. Funding shortfalls can be addressed annually, and therefore a shorter time period (e.g., seven years) is practical. Current legislation provides 15 years for multiemployer plans, which typically covers 3 to 5 collective bargaining cycles. We believe this time frame is consistent with the collective bargaining process that regulates pension contribution rates. Exhibit 2 Possible Unintended Consequences of Changing Funding Requirements Congress passes more aggressive funding rules Distressed companies cannot afford contributions Fewer companies are left to make up the shortfall Remaining companies file for bankruptcy PBGC is forced to take over the pension plan Pensions are not fully guaranteed due to PBGC cap Source: The ISSG.

7 REAUTHORIZING PPA RULES // 7 The Way Forward We believe the prerequisite for any thoughtful debate on funding rules for multiemployer plans is a thorough understanding of how they work and their benefits to the retirement security framework in the U.S. It is important to note that the multiemployer plan represents an attractive hybrid retirement model that embraces both the benefits of a defined benefit plan (professional management, lower fees and reduced longevity risk) with those of a defined contribution plan (portability) and a somewhat unique reciprocity feature. Along with these benefits, it should not be lost that the cost of plan failure, for any reason, including the implementation of misaligned funding rules, would ultimately pose a risk to the economic well-being of millions of private union workers and potentially to U.S. taxpayers if the PBGC were to require assistance. We are concerned that if insufficient knowledge about these plans and how they work results in using a corporate bond rate, preferred by some in the accounting community, to calculate the annual cash contributions for funding purposes, distressed companies will not be able to afford the higher contributions or withdrawal liabilities. This would place a heavy burden on the remaining companies, mostly small employers, to fund the deficit. Many of these small employers could even be unnecessarily forced into bankruptcy as a result of the higher obligations. If this happens, the greatest pain is likely to be felt by plan participants who will lose a portion of their pension benefit due to the low PBGC cap. Because of these concerns, we believe that the current rules should be permanently extended for multiemployer plans rather than instituting new rules that might be inconsistent with the plans features and could jeopardize the future of multiemployer plans and their beneficiaries. Because of these concerns, we believe that the current rules should be permanently extended for multiemployer plans rather than instituting new rules that might be inconsistent with the plans features and could jeopardize the future of multiemployer plans and their beneficiaries. While the timing of the PPA in 2006, just before the worst financial crisis in modern history, was exceptionally unfortunate, we believe its provisions will ultimately have long-term positive effects on the fiscal health of multiemployer plans and the retirement security of their participants. We think the PPA should have time to exert its full benefit and that we should all acknowledge the distinctive nature of these plans and the positive features they represent.

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