Defined Contribution Schemes
Should Employers or Countries be
Permitted to Sponsor Them?
This article shows that the goals of DC plans can be
achieved by permitting participants full access and
control over their accumulations. It suggests that
to do otherwise subjects the accumulations to
unreasonable risks of loss. We believe that
actuaries fulfill their obligation to participants by
supporting separation from employer control upon
vesting
New Zealand Society of Actuaries Conference, 14 November 2002, P12
2002年11月9日 Rotorua
Lohmann International Associates ©2002, slide 1/50
Introduction
• Les Lohmann
– Defined Benefit (DB) actuary
– Cultural issues
New Zealand Society of Actuaries Conference, 14 November 2002, P12
2002年11月9日 Rotorua
Lohmann International Associates ©2002, slide 2/50
Introduction
• Thrift
– Saving money for a later need
– Defined Contribution (DC)
• DB Retirement
– Cannot pay before actual departure
– Life annuities also depend on age of vesting
New Zealand Society of Actuaries Conference, 14 November 2002, P12
2002年11月9日 Rotorua
Lohmann International Associates ©2002, slide 3/50
Introduction
• Importance of Culture
– Canada
– Japan
• Importance of history
– Merrick, Aberdeen and Grennock
• Importance of the numbers
– Expose and explain
New Zealand Society of Actuaries Conference, 14 November 2002, P12
2002年11月9日 Rotorua
Lohmann International Associates ©2002, slide 4/50
Introduction
• Goals
– Startling
– Unbalanced
– Stimulating
New Zealand Society of Actuaries Conference, 14 November 2002, P12
2002年11月9日 Rotorua
Lohmann International Associates ©2002, slide 5/50
Introduction
• Who controls the disposition of the money?
– Participant
– Employer
– Government (investment quality requirements
excepted)
• "Holding the money" refers to where the
center of gravity of control lies.
New Zealand Society of Actuaries Conference, 14 November 2002, P12
2002年11月9日 Rotorua
Lohmann International Associates ©2002, slide 6/50
Important definitions
• Sponsor
The sponsor of a scheme maintains a
significant relationship with the
accumulating contributions of the
participant, even after the participant is
"fully vested" in any contributions made by
the sponsor.
New Zealand Society of Actuaries Conference, 14 November 2002, P12
2002年11月9日 Rotorua
Lohmann International Associates ©2002, slide 7/50
Important definitions
• Participant
– "Someone with rights, vested or not, in a
scheme”
– Employees not yet eligible count
• Portable
• Saturated with savings
• Retirement scheme
– Age retirement
New Zealand Society of Actuaries Conference, 14 November 2002, P12
2002年11月9日 Rotorua
Lohmann International Associates ©2002, slide 8/50
Important definitions
• Pension scheme
– When a "pension scheme" provides severance
benefits, it is in the form of or equivalent to the
value of a deferred annuity payable at normal
retirement age
• Severance scheme
– Termination
– Like "pension scheme," the formal name of the
arrangement does not change the fact of the
benefits provided.
New Zealand Society of Actuaries Conference, 14 November 2002, P12
2002年11月9日 Rotorua
Lohmann International Associates ©2002, slide 9/50
Assumptions
• Retirement schemes provide the money in
one or a mix of two forms
– annuity
– lump sum
• A retirement scheme can provide severance
benefits.
New Zealand Society of Actuaries Conference, 14 November 2002, P12
2002年11月9日 Rotorua
Lohmann International Associates ©2002, slide 10/50
Assumptions
• Lump sum
– When a scheme determines benefits as a lump
sum, the fact that a beneficiary has
opportunities to purchase, with the scheme
lump sum disbursement, an annuity does not
change a scheme into a pension scheme, even
when that annuity is an alternative form
available from the scheme
New Zealand Society of Actuaries Conference, 14 November 2002, P12
2002年11月9日 Rotorua
Lohmann International Associates ©2002, slide 11/50
Assumptions
• This article does not apply to schemes that
are merely tax deferral schemes or
severance schemes
• The scheme sponsor has decided to
implement a retirement scheme as opposed
to a severance scheme.
New Zealand Society of Actuaries Conference, 14 November 2002, P12
2002年11月9日 Rotorua
Lohmann International Associates ©2002, slide 12/50
Assumptions
• Capital efficiency Always plays a role
– the sponsor has developed some ideas of how
much money should be provided at age
retirement and that this concept is being applied
in the development of the sponsored scheme
New Zealand Society of Actuaries Conference, 14 November 2002, P12
2002年11月9日 Rotorua
Lohmann International Associates ©2002, slide 13/50
Assumptions
• Capital efficiency Always plays a role
– Employees have an idea of how much money
they will need at retirement and will try to save
this amount in a cost-effective way. For an
employee, "cost-effective" means achieving a
reasonable balance between satisfying
immediate needs and thrift.
New Zealand Society of Actuaries Conference, 14 November 2002, P12
2002年11月9日 Rotorua
Lohmann International Associates ©2002, slide 14/50
Characteristics of DC Schemes
• Not pension schemes
• Often require participant contributions in
order to attract employer contributions.
• Benefits
– Taxable
– Portable
• DC schemes shift risk from the employer to
the participant when compared with defined
benefit (DB) schemes.
New Zealand Society of Actuaries Conference, 14 November 2002, P12
2002年11月9日 Rotorua
Lohmann International Associates ©2002, slide 15/50
Characteristics of DC Schemes
• Employer costs are more certain than DB
schemes.
• Are career-average
• No participant ever gets the
retirement/severance benefits designed or
expected
• DC schemes encourage saving over
consumption, often with a tax subsidy
New Zealand Society of Actuaries Conference, 14 November 2002, P12
2002年11月9日 Rotorua
Lohmann International Associates ©2002, slide 16/50
DC schemes are not pension
schemes
• DC schemes are either severance schemes
and/or tax deferral schemes.
• DC schemes recharacterize current pay.
They are perceived as retirement vehicles
only because employee participants are not
permitted access to their accumulated
money until they quit.
– Japan actually denies access until age 60
New Zealand Society of Actuaries Conference, 14 November 2002, P12
2002年11月9日 Rotorua
Lohmann International Associates ©2002, slide 17/50
DC schemes often require
participant contributions
• In the absence of enabling legislation,
participant contributions are fully taxable as
ordinary income before being saved.
New Zealand Society of Actuaries Conference, 14 November 2002, P12
2002年11月9日 Rotorua
Lohmann International Associates ©2002, slide 18/50
DC schemes often require
participant contributions
• American enabling legislation recharacterize
participant contributions as employer
– Vesting rules recognize these funds as truly
belonging to the participant - requiring
immediate vesting and participant control.
– Even without enabling legislation, amounts
paid by the employer sponsor to a DC scheme
are tax-deductible as a reasonable employment
expense.
New Zealand Society of Actuaries Conference, 14 November 2002, P12
2002年11月9日 Rotorua
Lohmann International Associates ©2002, slide 19/50
DC Scheme Benefits
• Taxable to the beneficiary upon receipt.
• Portable. There is no reduction for
– early retirement
– survivorship
New Zealand Society of Actuaries Conference, 14 November 2002, P12
2002年11月9日 Rotorua
Lohmann International Associates ©2002, slide 20/50
DC schemes shift risk from the
employer to the participant
New Zealand Society of Actuaries Conference, 14 November 2002, P12
2002年11月9日 Rotorua
Lohmann International Associates ©2002, slide 21/50
DC Scheme Costs are certain
• Equal to the contribution
• Over the long term, costs are higher than
DB schemes for the same planned age
retirement benefits.
• Employers have more flexibility
New Zealand Society of Actuaries Conference, 14 November 2002, P12
2002年11月9日 Rotorua
Lohmann International Associates ©2002, slide 22/50
DC Schemes are Career-average
• Can't provide benefits related to the
participant's final standard of living
• Penalize better than average performance
near the end of a career
• Do little to reward better than average
performance occurring early or mid-career
• Tend to reward savings made during the
years of career development and family
formation
New Zealand Society of Actuaries Conference, 14 November 2002, P12
2002年11月9日 Rotorua
Lohmann International Associates ©2002, slide 23/50
DC Schemes Cannot Deliver
• No participant ever gets the
retirement/severance benefits designed or
expected from a DC scheme
– If investments have done well, (s)he will get
more than planned
– If investments have soured, (s)he will get less
than planned.
New Zealand Society of Actuaries Conference, 14 November 2002, P12
2002年11月9日 Rotorua
Lohmann International Associates ©2002, slide 24/50
DC Schemes Encourage Thrift
over Consumption
• Often with a tax subsidy
– Taxes are deferred to a later date, then taxed as
ordinary income (U.S. approach).
– Taxes are reduced regardless of payment timing
or other income (Japan approach).
New Zealand Society of Actuaries Conference, 14 November 2002, P12
2002年11月9日 Rotorua
Lohmann International Associates ©2002, slide 25/50
Characteristics of employersponsored DC schemes
• Employees must pay to participate.
• Employer contributions must be "invested"
in company shares.
• Employer contributions vest only on service
- not by reason for termination.
• The employer sponsor has no liability once
the contribution is made.
New Zealand Society of Actuaries Conference, 14 November 2002, P12
2002年11月9日 Rotorua
Lohmann International Associates ©2002, slide 26/50
Characteristics of employersponsored DC schemes
• The employer has the use of both the
participant and employer money for a
period before being invested. During that
period, the participant is a general creditor.
• "Investment options" are totally controlled
by the employer sponsor.
• Scheme costs are borne by participants
usually through a reduction in investment
earnings.
New Zealand Society of Actuaries Conference, 14 November 2002, P12
2002年11月9日 Rotorua
Lohmann International Associates ©2002, slide 27/50
Common Misconceptions of DC
Schemes
• Investment returns are higher than for funds
invested for DB schemes.
• DC schemes cost less for employers.
• Higher benefit security
• DC schemes benefit the economy.
New Zealand Society of Actuaries Conference, 14 November 2002, P12
2002年11月9日 Rotorua
Lohmann International Associates ©2002, slide 28/50
DC Schemes have Higher
Returns
•
•
•
•
Current return vs assumed discount rate
Shorter horizons
Lower risk tolerance
Diversification (efficient frontier)
New Zealand Society of Actuaries Conference, 14 November 2002, P12
2002年11月9日 Rotorua
Lohmann International Associates ©2002, slide 29/50
DC schemes cost less
• Administration
• Cost shifting
• Lower overall benefits
– Less than 100% participation
– Matching
New Zealand Society of Actuaries Conference, 14 November 2002, P12
2002年11月9日 Rotorua
Lohmann International Associates ©2002, slide 30/50
DC Schemes Provide Higher
Benefit Security
• Principal protection/Risk
• Employer shares
New Zealand Society of Actuaries Conference, 14 November 2002, P12
2002年11月9日 Rotorua
Lohmann International Associates ©2002, slide 31/50
DC Schemes Benefit the
Economy
• Japan
– Investment losses
– Participant ignorance
• Economic consequences
– Savings vs consumption
– Supply vs demand
• Economic activity
• New capital
New Zealand Society of Actuaries Conference, 14 November 2002, P12
2002年11月9日 Rotorua
Lohmann International Associates ©2002, slide 32/50
Recent "discoveries" about DC
Performance and Weaknesses
•
•
•
•
•
Average people/lottery
Market volatility
Employer flexibility
Investment fees vs fund performance
Investment choice cycles vs capitalizing
losses
New Zealand Society of Actuaries Conference, 14 November 2002, P12
2002年11月9日 Rotorua
Lohmann International Associates ©2002, slide 33/50
The Average Investor is Below
Average
• Buys and sells on emotions.
• Does not have prompt access to the
information that drives markets.
• Bets the farm on a "sure thing."
• Believes that his/her own account will
outperform the illustrated investment
returns.
New Zealand Society of Actuaries Conference, 14 November 2002, P12
2002年11月9日 Rotorua
Lohmann International Associates ©2002, slide 34/50
How to Make Money with a DC
Scheme
• Percentage of gross assets under
management
• Per transaction
New Zealand Society of Actuaries Conference, 14 November 2002, P12
2002年11月9日 Rotorua
Lohmann International Associates ©2002, slide 35/50
How to Make Money with a DC
Scheme
• Corporate insiders
– Personal trading
– Using participant equity assisting or opposing
takeover efforts
– Less than arms length loans
• Penalties vs profits
– How to become president!
New Zealand Society of Actuaries Conference, 14 November 2002, P12
2002年11月9日 Rotorua
Lohmann International Associates ©2002, slide 36/50
How to Make Money with a DC
Scheme
• Can employees be sufficiently educated?
– Gambling?
• Market volatility/Ruin theory
New Zealand Society of Actuaries Conference, 14 November 2002, P12
2002年11月9日 Rotorua
Lohmann International Associates ©2002, slide 37/50
Recent cases
• Tyco, GE and Intel illustrate the ease with
which management can transfer all
corporate earnings into their own pockets
• Enron and Worldcom tell us something
about the ways management can unload
shares on insider knowledge without notice
and engage in cross transactions that benefit
a few at the expense of the owners,
transferring sums wildly exceeding earnings
into their own pockets
New Zealand Society of Actuaries Conference, 14 November 2002, P12
2002年11月9日 Rotorua
Lohmann International Associates ©2002, slide 38/50
Recent cases
• AOL taught us that actuarial probabilities
can apply to allocating an income stream to
CDs that are passed out for free.
• Bell Labs, owned by Lucent, reported
scientific discoveries of Nobel prize stature.
They were faked.
• Several companies taught us how to borrow
money and report it as income.
New Zealand Society of Actuaries Conference, 14 November 2002, P12
2002年11月9日 Rotorua
Lohmann International Associates ©2002, slide 39/50
Pro-Forma Sins
•
•
•
•
•
•
Double/Triple/Infinite counting
Misallocation of expenses
Funny income
Swaps
"Round trips"
Buying political advantage with someone
else's money
New Zealand Society of Actuaries Conference, 14 November 2002, P12
2002年11月9日 Rotorua
Lohmann International Associates ©2002, slide 40/50
Investment Rules
• Wrong sets of investment rules
– DB
– Full funding vs employer liability
– Payment of contribution
New Zealand Society of Actuaries Conference, 14 November 2002, P12
2002年11月9日 Rotorua
Lohmann International Associates ©2002, slide 41/50
Control
• Participants investment discretion
• Employer shares vs full vesting
• Investment option control
– Perception of value versus risk
– Unilateral rights of the sponsor vs abuse
• Privacy
• Universe of investment options
New Zealand Society of Actuaries Conference, 14 November 2002, P12
2002年11月9日 Rotorua
Lohmann International Associates ©2002, slide 42/50
Conflicts of Interest
• Why would your employer set up a bank
account for you?
• Smoke and mirrors
• Scheme expenses
• American unions
• "Total pay systems"
New Zealand Society of Actuaries Conference, 14 November 2002, P12
2002年11月9日 Rotorua
Lohmann International Associates ©2002, slide 43/50
Conflicts of Interest
• Choosing investment vehicles
–
–
–
–
–
Employer liability
Expense levels
Investment performance
Existing business relationships
Who pays for the analyses?
New Zealand Society of Actuaries Conference, 14 November 2002, P12
2002年11月9日 Rotorua
Lohmann International Associates ©2002, slide 44/50
Conflicts of Interest
• Risks of fiduciaries and sponsor
–
–
–
–
Completed transaction
Insurance
Insolvency law
Cost of legal actions
New Zealand Society of Actuaries Conference, 14 November 2002, P12
2002年11月9日 Rotorua
Lohmann International Associates ©2002, slide 45/50
Participant interest
• Low expenses
• High Return
New Zealand Society of Actuaries Conference, 14 November 2002, P12
2002年11月9日 Rotorua
Lohmann International Associates ©2002, slide 46/50
Government-sponsored schemes
• Governments are subject to the same
temptations, perhaps more so, as private
industry
• Japan EPF
• Japan "401K"
New Zealand Society of Actuaries Conference, 14 November 2002, P12
2002年11月9日 Rotorua
Lohmann International Associates ©2002, slide 47/50
Benefits to Society
•
•
•
•
•
•
Pressure on Social Security vs DC Schemes
Tax-deferred savings vehicles
Loans
Turnover
Payroll deduction
Broader economic issues (Japan)
New Zealand Society of Actuaries Conference, 14 November 2002, P12
2002年11月9日 Rotorua
Lohmann International Associates ©2002, slide 48/50
The Bottom Line
• The basic question is, why should fully
vested participant money require
termination of employment to become
completely controlled by the participant and
independent of the employer?
New Zealand Society of Actuaries Conference, 14 November 2002, P12
2002年11月9日 Rotorua
Lohmann International Associates ©2002, slide 49/50
The Bottom Line
• Employers and governments that wish to
provide retirement security to their people
should be required to do so with the
technique that is not readily available to
individuals - DB retirement schemes.
• DC scheme funds should be placed outside
the reach of the employer or the government
as soon as practicable.
New Zealand Society of Actuaries Conference, 14 November 2002, P12
2002年11月9日 Rotorua
Lohmann International Associates ©2002, slide 50/50