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1. ERISA and Multiemployer Plans – Time for an Overhaul?
James J. McKeogh, FSA, MAAA
2. ERISA Enacted in 1974
Effective generally Plan Year beginning in 1976
Relevant in 2003?
3. Situation in 1976 Coming off bad investment years
Growth more from contributions than investments
Low funding levels
High ratios of active participants to retirees
4. S & P 500
5. Example – Local 123 Pension Plan
6. Example – Local 123 Pension Plan
7. Example – Local 123 Pension Plan
8. Example – Local 123 Pension Plan
9. Plan Sponsors were faced with: Confusion regarding DB vs. DC nature of multiemployer plans
New vesting, death benefits, etc. added new liabilities
Compliance with ERISA added expenses (legal, actuarial, communication, reporting, etc.)
10. ERISA Funding Rules Included: 40 year amortization of initial unfunded liability for existing plans
Almost complete freedom as to choice of asset valuation method
11. IRC §412(c)(2)(A) “…value of plan’s assets shall be determined on the basis of any reasonable actuarial method of valuation which takes into account fair market value and which is permitted under regulations prescribed by the Secretary.”
12. Investment Climate A comparison of returns in 10 and 20 year periods preceding 1976 and 2003 shows:
Returns just as volatile
Average return less
13. Investment Climate
14. Investment Climate
15. Contribution Volatility Even though markets are no more volatile than 1976, impact of market volatility is now much greater on funding requirements
Ironically, better funded plans fared worse in market downturn
Consider two plans: one 90% funded and one 30% funded; assume 15-year amortization for simplicity
16. Tale of Two Plans Assumes 15 year amortization at 7.5%Assumes 15 year amortization at 7.5%
17. Amortization Periods At first glance – Amortization Periods are unchanged except plans in existence in 1974 were allowed to amortize initial UAL over 40 years.
On closer look – a world of difference.
18. Amortization Periods When ERISA enacted, 1973-74 losses were part of initial UAL, so 40 year amortization
In 2003, UAL largely attributed to investment losses, so 15 year amortization
But what about “smoothing”?
19. Let’s Talk About Smoothing In theory, lots of options
In practice, limited choice
(would you like to smooth over
5 years or 60 months?)
In effect, amortization is “stretched” from 15 years to about 17 years
If at corridor limit, negative smoothing
20. Did you say “Negative Smoothing”?
21. Suppose you are at corridor limit and incur 10% Loss (MV Basis)…