Employee Benefit Plans
Joseph Applebaum, FSA
October 4, 2002
Views expressed are those of the speaker and do not represent the views of
the U.S. General Accounting Office. applebaumj@gao.gov
Employee Benefit Plans
•What is the Big Picture Issue?
•Ageing of the U.S. Population
•U.S. is not alone – G-7 countries have similar, if
not worse trends.
•Key Drivers
•Increased Life Expectancy
•Decreased Fertility
Fertility Rates
4
3.5
3
2.5
2
1.5
1
0.5
0
1940
1950
1955
1960
1970
1975
1980
1990
2000
2025
2050
2075
Fertility Rates
1940
2.23
1950
3.03
1955
3.5
1960
3.61
1970
2.43
1975
1.77
1980
1.85
1990
2.07
2000
2.13
2025
1.96
2050
1.95
2075
1.95
Life Expectancy at Birth
90
85
Females
80
75
70
Males
65
60
1940
1950
1955
1960
1970
1975
1980
1990
2000
2025
2050
2075
Life Expectancy at Age 65
24
22
20
Females
18
16
14
Males
12
10
1940
1950
1955
1960
1970
1975
1980
1990
2000
2025
2050
2075
Life Expectancy
Year
1940
1950
1955
1960
1970
1975
1980
1990
2000
2025
2050
2075
At Birth
Males
Females
61.4
65.7
65.6
71.1
66.7
72.8
66.7
73.2
67.2
74.9
68.7
76.6
69.9
77.5
71.8
78.9
73.7
79.4
76.5
81.5
79
83.5
81.1
85.3
At Age 65
Males
Female
11.9
13.4
12.8
15.1
13.1
15.6
12.9
15.9
13.1
17.1
13.7
18
14
18.4
15
19
15.7
19
17.3
20.3
18.8
21.8
20.2
23.1
Employee Benefit Plans
Demographic trends have implications for
•Size and composition of work force,
•Pension costs,
•Healthcare costs
Structure of U.S. pension programs
•Mixed system – part voluntary, part governmental program
•Three ( four ?) legged stool – Social Security, employment
based pensions, personal savings ( post-retirement earnings)
Social Security
•Financed on a modified pay-as-you-go basis
•Combined employer/employee tax rate for 2002 of
12.4% on earnings up to $84,900
•Maximum amount subject to tax is updated each
year for change in average wage in covered
employment
•Benefits are paid to retired and disabled workers,
their eligible spouses, children, and their survivors
(esp. aged widows)
Social Security
•Big Issue for Social Security is cost rising relative to payroll.
•Because current system is pay-as-you-go (more or less) cost of
system is related to number of workers supporting each beneficiary.
Let’s look at costs over next 75 years or so.
•The costs go sharply upward, a few years from now, when Baby
Boomers start retiring.
•Under current program benefit rules, costs keep growing well after
the Boomers retire.
• Principal drivers are demographic – life expectancy, particularly
life expectancy at retirement age, and fertility which determines,
with a lag, number of workers.
Social Security Costs and Income Rates
25%
Cost as % of taxable payroll
20%
15%
10%
Income as % of taxable payroll
5%
0%
1990
2000
2010
2020
2030
2040
2050
2060
2070
2080
Social Security Costs and Income Rates
Year
1990
2000
2010
2020
2030
2040
2050
2060
2070
2080
OASDI Cost as
a Percentage
of Taxable
Payroll
10.7%
10.4%
11.0%
14.2%
17.2%
17.8%
17.9%
18.6%
19.4%
20.1%
OASDI Tax
Income as a
Percentage of
Taxable
Payroll
12.7%
12.7%
12.8%
13.0%
13.2%
13.3%
13.3%
13.3%
13.4%
13.4%
Social Security
Two sets of measures of demographic trends: dependency ratios
– the ratio of those over 65 ( or those under 20 plus those over
65) to those between ages 20 and 64, and; ratio of beneficiaries
to workers.
Some observations
•Around 1950, only a portion of the elderly were eligible for
social security benefits
•The percentage of workers covered by social security has
grown
•The labor force participation rates of women have increased
•Labor force participation rates of older (greater than 55)
men declined.
•Disability benefits were introduced in 1950’s, but didn’t
expanded rules later.
Aged and Total Dependency Ratios
100%
90%
Total Dependency
80%
70%
60%
50%
40%
30%
Aged Dependency
20%
10%
1950
1960
1970
1975
1980
1990
2000
2025
2050
2075
Aged and Total Dependency Ratios
Year
1950
1960
1970
1975
1980
1990
2000
2025
2050
2075
Aged
13.8%
17.3%
18.2%
18.5%
18.9%
20.9%
21.1%
31.9%
37.1%
42.3%
Total
71.9%
90.4%
94.7%
89.8%
74.9%
70.1%
69.9%
77.1%
81.2%
85.1%
OASDI Covered Workers and Beneficiaries
(in millions)
200
Covered Workers
175
150
125
100
75
Beneficiaries
50
25
0
1950
1960
1970
1975
1980
1990
2000
2025
2050
2075
OASDI Covered Workers & Beneficiaries
(in millions)
Year
1950
1960
1970
1975
1980
1990
2000
2025
2050
2075
Covered
Workers
48.3
72.5
93.1
100.2
113.6
133.7
153.7
175.4
187.3
200.5
OASDI
Beneficiaries
2.9
14.3
25.2
31.1
35.1
39.5
45.2
77.4
94.1
109.9
OASDI Covered Workers
(in millions)
200
175
150
125
100
75
50
25
0
1950
1960
1970
1975
1980
1990
2000
2025
2050
2075
OASDI Covered Workers
(in millions)
1950
48.3
1960
72.5
1970
93.1
1975
100.2
1980
113.6
1990
133.7
2000
153.7
2025
175.4
2050
187.3
2075
200.5
OASDI Beneficiaries
(in millions)
110
100
90
80
70
60
50
40
30
20
10
0
1950
1960
1970
1975
1980
1990
2000
2025
2050
2075
OASDI Beneficiaries
(in millions)
1950
2.9
1960
14.3
1970
25.2
1975
31.1
1980
35.1
1990
39.5
2000
45.2
2025
77.4
2050
94.1
2075
109.9
Worker to OASDI Beneficiary Ratio
20
18
16
14
12
10
8
6
4
2
0
1950
1960
1970
1975
1980
1990
2000
2025
2050
2075
Worker to Beneficiary Ratio
1950
16.7
1960
5.1
1970
3.7
1975
3.2
1980
3.2
1990
3.4
2000
3.4
2025
2.3
2050
2.0
2075
1.8
Social Security
Problems are well understood
Last major reform culminated in 1983 Amendments
•Incremental changes in benefits and taxes
•Put program in balance for 75 years –
Program is now out of actuarial balance
•Valuation period change
•Experience & assumption changes
What are criteria for solution?
•Continue to provide layer of protection against insured
events
•Program should be sustainable
•Cost levels should be near current levels
Demographic Impacts on Private Plans
Demographic forces also impact private sector employee benefit
plans.
Phased retirement
•Most defined benefit pension plans allow early retirement (
i.e. before 65)
•Some plans require a reduction in monthly payments to
make up for longer payout period – others don’t; virtually
none do not subsidize early retirement – that is, the value of
the early retirement benefit is greater than the value of
deferring starting receipt of those benefits until 65.
Phased Retirement
Let’s consider a hypothetical employee who is now, say age 60
and is entitled, based on her service with the company, to a
monthly pension benefit of 50% of final pay. If she retires, she
can go to work elsewhere and get her pension benefit and
increase her current compensation. (She might even go on to
collect a pension from the second employer!).
Under current law before she attains NRA, there are significant
impediments for the employee to collect her pension benefits
while continuing to work for her current employer.
This economic conundrum has existed since the wide spread
introduction of pension plans – however, the relatively slow
growth in the labor force supply has increased the importance of
addressing this problem.
OASDI Covered Workers
(in millions)
1950
48.3
1960
72.5
1970
93.1
1975
100.2
1980
113.6
1990
133.7
2000
153.7
2025
175.4
2050
187.3
2075
200.5
Changes in Pension Plan Design
Around 1975, the dominant pension benefit design was the final average pay
defined benefit plan – a typical formula is the product of
•Years of service
•Final pay
•A number around 1.5%
The trend over the last 25 years or so has been towards other designs –
defined contribution plans, and hybrid defined benefit plans like cash balance
plans.
Changes in Pension Plan Design
Regulatory Environment
•Introduction of Section 401(k) of the Internal Revenue Code.
•Greater rigidity of defined benefit funding
Current designs are more attractive to mobile,typically younger, workers.
Changes in employment patterns
•Service economy
•Greater job mobility
•Less attachment to firm
•Employer Views
•Risk aversion
•Changing demographics – the relative scarcity of younger workers
Trends in Pension Plan Coverage
(millions)
Year
1979
1980
1985
1990
1995
1996
1997
1998
Source: U.S. Dept. of Labor
DB
DC
Participants Participants
29.4
17.5
30.1
18.9
29.0
33.2
26.3
35.5
23.5
42.7
23.3
44.6
22.7
48.0
23.0
50.3