PENSION FUNDS

PENSION PLANS 1.PUBLIC PENSION FUNDS Created by state, local or federal govt. 2.PRIVATE PENSION PLANS Created by private agencies including industrial, labor, service, non-profit and educational organizations.

PRIVATE PENSION PLANS Defined Benefit Plan Under this plan, contributions are determined according to benefits to be provided. If the pension plan value exceeds the benefits: 1.Companies may reduce the future contributions 2.Or may distribute surplus to shareholders but not to employees. Defined Contribution Plan Under this plan, benefits are provided according to accumulated contributions and fund’s performance. Firms know with assurance the amount of funds to contribute but benefits are not predetermined.

UNDER FUNDED PENSIONS In defined benefit plan, future pension obligations are uncertain, as they are defined in terms of fixed payments to retirees. Payments are dependent on salary levels, retirement ages, life expectancies. Due to overestimated future rate of returns, some pension plans became under funded as they reduced their contributions and reported higher earnings.

Pension Benefit Guaranty Corporation PBGC guarantees that defined benefit plan participants will receive their benefits on retirement. It is financed by annual premiums, income generated from investments and income from assets acquired from terminated pension plans. It monitors the pension plans periodically to make sure that they will provide benefits guaranteed by them. In case of inadequacies of funds, they are terminated and is taken over by PBGC.

PENSION FUND MANAGEMENT Regardless of how premiums are collected, premiums must be managed until required to pay benefits. Private pension plans are dominated by stocks while public plans are evenly invested in corporate bonds, stocks and other credit instruments.

PENSION FUND MANAGEMENT Pension fund management can be classified according to strategy used to manage portfolio: Matched Funding investment decision which match planned cash outflow payments with cash inflows generated. They give assurance that future liabilities will be covered regardless of market movements by matching long term liabilities with long term assets (bonds).

It limits the management discretion with respect to investment. It allows only those investments which match future payouts. Investment can not be done in callable bonds. Each liability payout may require a separate investment to which it can be perfectly matched. Thus, it increases transaction costs for the pension fund.

PENSION FUND MANAGEMENT Projective Funding Investment decisions providing greater flexibility in constructing a portfolio to benefit from expected market & interest rate movements. They invest in bond index portfolios which may include investment grade corporate bonds, T- bonds. It does not include entire set of these index bonds but a portion only to mirror market performance. They also invest in equity portfolio indexes as they avoid transaction cost related to frequent trading.

INSURED PLANS VS TRUST PORTFOLIOS Insured plans are managed by life insurance companies. Premiums are invested in annuity policies and benefits are provided by insurance companies on retirement. Some pension funds are managed by trust departments of commercial banks. Companies provide general guidelines to these trust departments to manage their pension plans. These guidelines may include:

GuideLines The percentage of portfolio that should be invested in equity or bonds. A desired minimum return on overall portfolio. Maximum amount to be invested in real estate. Min acceptable quality ratings for bonds The maximum amount to be invested in any one industry. The average maturity of bonds in portfolio. Max amount to be invested in options. Min size of companies in which to invest