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ERISA and Multiemployer Plans Time for an Overhaul

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ERISA and Multiemployer Plans Time for an Overhaul

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    1. ERISA and Multiemployer Plans – Time for an Overhaul? James J. McKeogh, FSA, MAAA November, 2003

    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”? Yes

    21. Suppose you are at corridor limit and incur 10% Loss (MV Basis)…

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