Pensions

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Royal
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Pensions

Post by Royal » Wed Aug 15, 2012 12:03 am

Nationwide, the actual size of unfunded public pension liabilities is four times larger than the $900-plus billion that officials are ’fessing up to. That’s right, the bank sees a $3.9 trillion hole; to plug that, states and cities will need large tax hikes, massive budget cuts or both.

Problem?
I got my hands on the report not from an disgruntled employee looking to even up the score with his old firm, but from someone who believed the reason JP Morgan kept it a secret stinks to high heaven: Bankers there are afraid of upsetting state and city officials who hand them large fees to underwrite municipal bonds.

And why draw attention to an issue that might spook investors, cut off funding for municipal governments and for the fees the bank collects on that funding? A muni-market panic could land the bank in far hotter water than its current London Whale travails.

But Morgan’s discretion may have broken the law: The report’s dire predictions didn’t make it into investor-disclosure documents on at least some bond deals that Morgan underwrote for states with the biggest liabilities. Legal experts say that could violate federal anti-fraud statutes.

All of which sounds like far more onerous than anything the Senate Banking Committee could come up with last week: It grilled Dimon over $2 billion trading loss at his London office, while his firm was hiding evidence of a $4 trillion pension disaster.
http://www.nypost.com/p/news/opinion/op ... z23YGKVEgC

What is a Pension?
A pension is a fixed sum paid regularly to a person, typically following retirement from service. Traditionally, retirement plans have been administered by institutions which exist specifically for that purpose, by large businesses, or, for government workers, by the government itself.
http://en.wikipedia.org/wiki/Pension

History
As part of Otto von Bismarck's social legislation, the Old Age and Disability Insurance Bill was enacted in 1889. The Old Age Pension program, financed by a tax on workers, was originally designed to provide a pension annuity for workers who reached the age of 70 years, though this was lowered to 65 years in 1916.

Germany had a tradition of welfare programs in Prussia and Saxony that began as early as the 1840s. In the 1880s his social insurance programs were the first in the world and became the model for other countries and the basis of the modern welfare state. Bismarck introduced old age pensions, accident insurance, medical care and unemployment insurance.

He won conservative support by promising to undercut the appeal of Socialists—the Socialists always voted against his proposals, fearing they would reduce the grievances of the industrial workers. His paternalistic programs won the support of German industry because its goals were to win the support of the working classes for the Empire and reduce the outflow of emigrants to America, where wages were higher but welfare did not exist.

Growing Situation
About 80 percent of public pensions are defined-benefit plans, meaning that the plan’s sponsor promises to pay a specified income that is predetermined by years of service, final average salary, and other factors. To fund the promised income, both the employee and employer typically contribute to a pension trust. The trust invests these payments in a portfolio of assets whose returns are expected to pay the lion’s share of the benefit obligation.

Unfortunately, these expectations are not always met. Historically, public pension plans have invested a large share of funds in stocks, which have offered relatively high returns when averaged over long periods. Since the stock market’s peak in 2000, however, equity returns have been sharply lower than expected. As a consequence, the value of assets held in public pension trusts has not kept pace with the growing promises the plans have made, leaving them substantially underfunded.
http://www.clevelandfed.org/Forefront/2 ... ter_08.cfm


(Pension plans can become underfunded in a variety of ways. Interest rate changes, a weak stock market, mergers and bankruptcies can all greatly affect company pensioners. During times of an economic slowdown pension plans are most susceptible to becoming underfunded.
http://www.investopedia.com/terms/u/und ... z23YToqrND)
An underfunded pension program can signal deeper systemic problems, but it doesn't mean the program is insolvent or unable to meet its obligations. On average, state pension plans are funded at 78 percent, which means they have enough assets and cash on hand to pay participants obligations up to 78 percent. "There's nothing magical about being 100-percent funded," Kim says. "It's essentially like a mortgage. If you buy a house and pay 78 percent of that mortgage and have that 22 percent left, that's not a bad thing."

Pension plans have three streams of income: employee contributions, investment returns, and employer contributions (the state or local government entity). While investment returns have recovered somewhat in recent months, low tax receipts due to the recession have caused many plan sponsors to shortchange their contributions.
http://money.usnews.com/money/personal- ... on-problem

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Royal
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Re: Pensions

Post by Royal » Wed Aug 15, 2012 12:10 am

Pension Updates per State as of August 6th, 2012
http://www.statebudgetsolutions.org/the ... ust-6-2012


Solutions to the public pension crisis
Read more: http://www.statebudgetsolutions.org/pub ... z23ZJXFf53

Public pensions at the state and municipal levels are unsustainable in their current form. State Budget Solutions' recent study by Andrew Biggs found that public pensions are underfunded by $4.6 trilion. States and municipalities must achieve fundamental reform. If reform does not happen, essential public services will have to be cut and dedicated government workers laid off, disrupting or eliminating public health, safety and education.

Switch to Defined Contribution System
The most effective reform is implementing a defined contribution pension plan. By putting all employees, both new and existing, into a defined contribution plan, which is similar to a 401(k) style plan found in the private sector. Such a move means that existing defined benefit accruals for current employees would be frozen and employees would be moved to a defined contribution plan with the previously accrued amount placed in their new defined contribution account.
The best solution is moving all employees to a defined contribution system, but at a minimum, new employees should be enrolled in a defined contribution system.

Other Reform Options
Although implementing a defined contribution system for all employees is the most effective pension reform, other solutions are also available.

Primary Reforms to existing defined benefit plans
Cap employer cost (i.e. state will pay no more than 10% of salary toward an employee benefit);
Require the full ARC (or Normal Cost) of the plan to be paid each calendar year or legislative per diem will be canceled until full ARC is paid;
Require that the ARC (or Normal Cost) be calculated using a realistic discount rate (either the treasury rate or the bond rate of the plan sponsor);
Smooth pension wealth accrual making it a constant % of earnings(i.e. a cash balance or constant accrual plan).

Close Loopholes to Reform Pensions
Eliminate double-dipping;
Eliminate spiking;
When calculating base pay, do not based the calculation of retirement pay on anything other than base salary;
Require any purchase of service credit to be at full actuarial cost or prohibit the purchase of service credit;
Eliminate cost-of-living adjustments or tie them to the CPI.

Secondary Reforms to existing defined benefit plans
Increase employee contributions;
Increase retirement age;
Increase vesting period;
Impose penalty on retire/rehire -new employer must pay pension;
Increase the number of years used in final-average-salary calculation;
Require that any purchase of service credit be at full actuarial cost (or prohibit the purchase of service credit);
Cap retirement benefits at not more than 100% of final average salary;
Eliminate pensions for employees who are convicted of work-related crimes;
No pension benefit for voluntary service;
Have tight review of disability claims.

Increase transparency
Use generally accepted accounting practices;
Discount rate for liabilities should either be the treasury rate or bond rate of sponsor;
Eliminate smoothing of asset valuation in favor of market or fair value as of the actuarial reporting date;
Same realistic discount rate should be used to calculate the ARC/Normal Cost;

Require retirement system to annually report to Governor, Legislature and put on its public website:
Committee and board meeting minutes online;
The discount rate used to calculate pension liabilities and the value of those liabilities if a risk-free discount rate was used;
Assumed rate of investment return for the purpose of projecting contributions and how the contributions would change if a lower assumed investment return was used;
The period over which unfunded liabilities are amortized and how contributions would change if unfunded liabilities were amortized over a period equal to the estimated average remaining service periods of employees covered by the contributions;
The period over which gains or losses are written on/off (smoothing): and also disclose the funded status on the basis of market value with no smoothing;
The market value of assets and the difference between market value and the system's actuarial value of those assets;
Require the State Auditor or State Treasurer is to evaluate the report and submit an opinion of it to the legislatures.

When addressing the difficult topic of pension reform, it is worth keeping in mind the lessons Utah legislators learned as they enacted pension reform. Those lessons include:
Ask the hard questions/demand data.
Be hypothesis driven/avoid ideology.
Involve all parties/build partnerships.
Circulate reform proposal broadly.
Be kind, polite and responsive.
Keep moving forward.
Demand comprehensive, long-term financial modeling from pension actuaries.
Reality is NOT negotiable- let the data do the work.
Future employees are not an effective lobbying force.
Know the details and you will own the issue.

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Pigeon
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Re: Pensions

Post by Pigeon » Wed Aug 15, 2012 3:24 am

And people still trust the financial industry. Wonder when most people will wake up.

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Royal
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Re: Pensions

Post by Royal » Wed Aug 15, 2012 5:51 am

Defined Benefit Plan
Sponsor company's responsibility to ensure that contributions to the plan are sufficient to pay benefits as they come due.
Complex accounting
Multiple J/Es

Defined Contribution Plan
Employees retirement benefits are based on the amount of funds in the plan.
Simple
One Journal Entry

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Royal
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Re: Pensions

Post by Royal » Wed Aug 15, 2012 5:55 am

DEFINED BENEFIT PLAN has two main components:
1. Pension Plan Liability
2. Plan Assets


Pension Plan Liability
Accumulated Benefit Obligaiton (ABO)
The actuarial present value of benefits attributed by a formula by a formula based on current and past compensation levels. An ABO differs from a PBO only in that the ABO includes no assumption about future compensation levels (uses current salaries)

Projected Benefit Obligation (PBO)
Acturial present value of all benefits attributed by the plan's benefit formula to employee service rendered prior to that date. PBO only uses an assumption as to future compensation levels. IFRS: DBO
Formula can be used to calculate the projected benefit obligation:
Beginning projected benefit obligation
+ Service cost
+ Interest cost
+ Prior service cost from current period plan amendments
+ Acturial losses incurred in the current period
- Acturial gains incurred in the current period
- Benefits paid to retirees
Ending projected benefit obligation
Service Cost
The PV of all pension benefits earned by company employees in the current year. It is provided by the actuary. The service cost component increases the projected benefit obligation.

Interest Cost
The increase in the projected benefit obligation (PBO) due to the passage of time. Measuring the PBO as a present value requires accrual of an interest cost on the projected benefit obligation, at rates equal to the assumed discount rates. Interest cost always increases the PBO because the PV of any liability increases as you get closer to the due date.

Prior Service Cost
Cost of benefits based on past service granted for:
Service prior to the initiation of a pension plan that employees retroactively receive credit for when the plan is implemented (in the timeline above, benefits based on service provided from Year 1 to Year 10) Subsequent plan amendment, reflecting new or increased benefits, that also is applied to service already provided (year 1 to Year 20 in the timeline above) Prior service costs increases the PBO in the period of the plan initiation or amendment and should be amortized to pension expense over the future service periods of the affected employees.

Acturial Gains and Losses
Adjustments to the projected benefit obligation that arise when the actuary changes one or more of the assumptions used to calculate the PBO. Acturial gains descrease the PBO and acturial losses increase the PBO.

Benefit Payments
Paid to pension plan participants after retirement. The payment of pension benefits reduces the projected benefit obligation and reduces plan assets.
Last edited by Royal on Wed Aug 15, 2012 6:10 am, edited 2 times in total.

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Royal
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Re: Pensions

Post by Royal » Wed Aug 15, 2012 6:06 am

Plan Assets
Generally stocks, bonds, and other investments, set aside to provide for pension benefits.
Reported at FV. Increase each period by contributions to the pension plan (funding) and by the return on the plan assets.

The following formula can be used to calculate the ending FV of plan assets or to solve for the actual return on plan assets:
Beginning FV of plan assets
+ Contributions
+ Actual return on plan assets
- Benefit payment
Ending FV of plan assets

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Pigeon
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Re: Pensions

Post by Pigeon » Wed Aug 15, 2012 6:19 am

You are appointed financial conspiracy expert.

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Royal
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Re: Pensions

Post by Royal » Wed Aug 15, 2012 6:42 am

I relinquish my title and nominate the ghost in the machine.

But really, it's pretty easy... Here's an example:

"Employees are expected to live longer after they retire, that is bad for the pension plan because it increases the amount of benefits it expects to pay, therefore it is a loss (even though it is good for the employee who expects to live longer)."
:)

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Royal
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Re: Pensions

Post by Royal » Wed Aug 15, 2012 6:55 am

Income Statement Accounting

Pension Expense or "Net Periodic Pension Cost"
Mneumonic: SIR-AGE
Current Service Cost
Interest Cost
<Return on Plan Assets>
Amortization of Prior Service Cost
<Gains> And Losses
Amortization of Existing Net Obligation or Net Asset
Net Periodic Pension Cost

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Royal
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Re: Pensions

Post by Royal » Wed Aug 15, 2012 7:25 am

Current Service Cost
PV of all benefits earned in the current period. The increase in the projected benefit obligation (PBO).

Interest Cost
<Return on Plan Assets>
Standards allow an offset to pension expense by either "return on plan assets" or "expected return on plan assets".

Actual Return on Plan Assets
Calculated based on FV of plan assets at the beginning and ending of the period, adjusted for contributions and benefit payments (a squeeze). Not a popular method as actual return can vary drastically from period to period.

Expected Return on Plan Assets
Difference between Actual and Expected return must be recognized on other comprehensive income each period and the amortize to pension expense.

Amortization of Unrecognized Prior Service Cost
The period that a pension plan is initiated or amended, the resulting prior service cost increases the PBO and is recordedd s uncrecognized prior service cost in other comprehensive income. The unrecognized prior service cost in accumulates other comprehensive income is amortized to pension expense over the the plan participant's remaining years of service.

IFRS: Prior service cost is not booked to other comprehensive income in the period incurred.

<Gains> and Losses
The difference between the expected and actual return on plan assets when the expected return on plan assets is used to calculate pension expense and
Changes in acturial assumptions (acturial gains and losses) If the company actually earns more than expected on its plan assets --> actual return >
expected --> Gain Employees are expected to live longer after they retire, that is bad for the pension plan because it increases the amount of benefits it expects to pay, therefore it is a loss (even though it is good for the employee who expects to live longer). Entities have two choices when accounting for gains and losses:

Recognize gains and losses on the income statement in the period incurred.
or
Recognize the gains and losses in other comprehensive income in the period incurred and the amortize the unrecognize gains and losses to pension expense over time using the corridor approach. Most companies choose this option to smooth earnings.

Corridor Approach
Entity's net unrecognized gain or loss is amortized over the employees avaerage remaining service period, if as of the beginning year, this amount exceeds 10% of the greater of the beginning of the year balances of:
Market Related Value of Plan Assets = Assets
Projected Benefit Obligation (PBO) = Liabilities

Beginning of the year -->

Amortization of Existing Net Obligation or Net Asset at Implementation
An employer was required to determine the funded status of the pension plan (FV plan assets - PBO) as of the beginning of the first year FASB 87 was applied.

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