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 Jim.Rizzo@gabrielroeder.com Piotr.Krekora@gabrielroeder.com

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

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

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

DB vs. DC Comparison Jim

DB vs. DC Comparison Jim

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

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

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

Hybrid Features Jim

Hybrid Features Jim

Hybrid Features Jim

Hybrid Features Jim

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

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

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

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

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

Case Study Without a VBH feature in the legacy DB plan -- It will take over 40 years to reach a 50-50 risk-sharing with employees; in 20 years City/taxpayers still bear 85% of investment risk Employees Bear 100% Risk City/taxpayers Bear 100% Risk

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

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

Case Study With a VBH Feature: Budget Corridor

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Questions and Answers ? Jim