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Towers Watson experts Mike Archer and Kevin Wagner discuss practical approaches to: • Evaluating the future design of retirement programs and retiree health plans as part of your approach to HCR • Working with account-based designs, such as cash balance and 401(k) plans • Reaching out to your effected employees on strategies associated with tax-rate changes • Communicating strategically to ensure your employees understand and are engaged in their own retirement planning
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© 2010 Towers Watson. All rights reserved.
Revisiting Retirement in thePost Health Care Reform World
A Towers Watson Webcast presented by:Michael ArcherAlan GlicksteinKevin Wagner
May 20, 2010
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Today’s experts:Revisiting Retirement in the Post-HCR World
Mike Archer Based in Towers Watson’s Parsippany office, Mike’s background is primarily in retirement and other benefit consulting including actuarial valuations, retirement financial management, asset/liability studies, retirement and benefit strategy, executive retirement benefits, retiree medical benefit design, acquisitions and divestitures, merger integration and union negotiations. He is a Fellow of the Society of Actuaries, a Member of the American Academy of Actuaries and an Enrolled Actuary.
Alan GlicksteinBased in the Dallas office of Towers Watson, Alan specializes in the strategic design and financing of total compensation packages, with a particular concentration in the retirement benefit area. His areas of focus include the retail industry, cash balance plans and the financial aspects of benefit plans. Alan’s client relationships are balanced between finance and human resource issues. Earlier in his career, he was responsible for developing several financial analysis tools and systems. Alan is an Enrolled Actuary with the IRS and an Associate of the Society of Actuaries.
Kevin WagnerBased in Towers Watson’s Atlanta office, Kevin consults with major clients on design, implementation, administration, funding, and ongoing evaluation of all types of benefit programs. He has focused primarily on assisting clients with the alignment of corporate benefit philosophies with the organization’s strategic plans, and working with clients on the integration and due diligence activities associated with mergers and acquisitions. He is a Fellow of the Society of Actuaries and an Enrolled Actuary.
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What we hope to accomplish today
Discuss state of retirement income plans — pre health care reformAnalyze implications of health care reform for design of retiree health and retirement income plansAddress implications of likely rising taxesProvide a strategic framework for rethinking retirement
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External pressures “squeezing” the retirement system
Business Pressures
EmployeePressures
EnvironmentalPressures
Trends
Shift from retirement income to wealth accumulation
Greater emphasis on risk management
Elimination of early retirement subsidies
Curtailment of traditional retiree medical plans
General downward trend of size of plan
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Declining employer-provided retirement plan benefit values
The average employer provided retirement benefit has fallen significantly during the last decadeTowers Watson data on 183 companies shows a 12% decline in retirement benefit value relative to payroll since 2002
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Health Care Reform may further weaken employer commitment to retirement
Disincentives to provide retiree health care
programs
Improved Medicare prescription drug
program
Guaranteed issue and underwriting restrictions for pre-Medicare retirees
Certain reconsideration of
employer role
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Findings from Towers Watson’s Post-Health Care Reform Survey
42%
30%
19%
53%
39%
17%Effect of health care reform on your ability to meet early retirement objectives for some employees
Positive NegativeNone
2010 No plans2011
Will health care reform decrease the number of large employers offering employer-sponsored
retiree medical programs?
Percentage Responding Affirmatively
Percentage Responding
8%
53%
85%
Do you have plans to reexamine health benefit strategy for retirees?
Will your organization change the level of retirement plan benefits you offer in response to health care reform?
Will your organization eliminate or reduce retiree medical programs in response to health care reform?
Defined Benefit (DB) and Defined Contribution (DC) Plans
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Fortune 100 retirement plan prevalence (for newly hired employees)
89
67
49
4034
30 2824
20 1711
33
51
6066
70 7276
8083
1985 1998 2002 2004 2005 2006 2007 2008 2009 Today
Traditional DB Plan Account-based plans (Hybrid and DC)
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Choice between traditional DB and account-based plan is about allocating benefit dollars between career and more transient employees
Retirement Funding
Termination Funding
Life Event Funding
Account-based Plan Traditional DB Plan
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Risk is often shifted rather than eliminated in plan design
Employees who Outlive their Life Expectancy
By at least 1 year 66%By more than 10 years 29%
Account plans do not spread mortality riskIn a traditional DB plan, monies for employees who die earlier than expected go to pay benefits of those that die later than expected
Mortality Risk
Investment Risk
-15%-10%
-5%
0%
5%
10%15%
20%
25%
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
DB DC
DB plans outperformed DC PlansEmployees are less sophisticated investorsEmployees don’t have ready access to expert adviceEmployees need to diversify along their life-cycle
Average Median Returns From 1995 – 2007
DB: 10.13% DC: 9.21%
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Design changes are deferring the age at which employees can retire with sufficient resources
Before Programmatic ChangesRetirement Income Adequacy
After Programmatic ChangesRetirement Income Adequacy
Net Present Value(Today’s $)
Net Present Value(Today’s $)
$0$500
$1,000
$1,500$2,000$2,500$3,000
$3,500$4,000
55 56 57 58 59 60 61 62 63 64 65 66 67 68 69 70
Retirement Age
Current PlanNeeds (100%)
$0
$500
$1,000
$1,500
$2,000
$2,500
55 56 57 58 59 60 61 62 63 64 65 66 67 68 69 70
Retirement Age
Current PlanNeeds (100%)
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Potential increased labor costs if older workers are unable to retire
DB Pension
Retiree Medical
Active Medical
Other (e.g., LTD)
401(k)
FICA
Total pay PTO
Savings from lower pay and reduced benefit
costs
Active Medical
Retiree Medical
DB Pension
Other (e.g., LTD)
401(k)
FICA
Total pay PTO
Lower cost if younger age
Lower cost if lower pay
Working Later Career New Hire
Lower pay
Pay Benefits
TotalLaborCost
Overall labor cost savings may outweigh cost of retiree medical
ConsiderationsSkill levels
Productivity
Replacement
Engagement
ADEA/age discrimination
Caution on “softness” of savings; highly variable and difficult to predict
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Older employees who work solely for financial reasons are less engaged
Source: Towers Watson 2010 Global Workforce Study — U.S.
18%
46%
42%
41%
45%
31%All respondents
To work throughout retirement for financial reasons
Their standard of living to decline in retirement
To retire at or after age 70
To not have sufficient resources for a financially secure retirement
To have sufficient resources for a financially secure retirement
Respondents who expect…
Percentage of Respondents Who are Disenchanted or Disengaged
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Pension
Trust
EmployeeAccount Balance
Pay Credits Interest Credits
Rethinking DB design: Cash balance plans are back in play
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Cash balance plans are designed to leverage advantages of DB and DC plans
Efficiency of DB funding
Employer retains tax advantages on investment returns
Accrued benefit cannot decrease
DB Plan Features
Valuable benefits for a mobile workforce
Reduce cost volatility
Level accrual pattern rather than backloading towards end of career
DC Plan Features
Portable, account-based plans that are easy to understand
Managing Pension Risk
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Two capital market crises in ten years have coincided with funding and accounting rules changes that offer much less short-term “forgiveness”
83%
106%99%
91%90%89%
82%
101%
124%
77%
60%
70%
80%
90%
100%
110%
120%
130%
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
Aggregate PBO
Source: Towers Watson, “Strong Market Returns Boost Funding Levels of Fortune 1000 DB Plans for 2009,” Insider, January 2010.
Funding StatusPercent by Year
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How can this volatility and risk be managed?
$0
$100
$200
$300
$400
$500
$600
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
Calendar YearCurrent Inactives Current Actives Future Pay Future Service Future Hires
Projected Pension Liability
Addressed through plan design
Addressed through investment strategy and/or exit strategy
Pension Liability($ in Millions)
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Pension risk management framework
Accounting Strategy
Objectives and
Thresholds
Ongoing Benefit StrategyLegacy Benefit/Exit Strategy
Funding Strategy
Investment Strategy
This framework allows for parallel assessment of multiple plan management options
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Perspectives vary greatly by plan sponsor
Many employers today are in a very different position than where they were six months ago with regard to…
Balance sheet flexibility
Access to cash
Sensitivity to P&L changes
Tolerance of PPA threshold issues
Future economic outlook
Long-term goals and objectives for plan
Variety of views as to future pension risk management still call for a spectrum of solutions
ONGOING MANAGEMENT AND FINANCING STRATEGY EXIT STRATEGY RISK TRANSFER
RISK ASSESSMENT AND OBJECTIVE-SETTING
MAINTAIN PLAN SPONSORSHIP EXIT PLAN SPONSORSHIP
RevisedContribution
Strategy
IMPROVEDFUNDING
Liability-Driven
Investing
LESS FINANCIAL VOLATILITY
DeferredParticipantCash-Outs
SMALLER VALUE AT RISK
Captives andAlternativeFinancing
MORE CONTROL;REGULATORY EXIT
Custom Insurance Solutions
PARTIAL RISK TRANSFER
Annuity Purchase
TRADITIONAL SETTLEMENT
ONGOING MONITORING
TRANSFERFINANCING
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A coordinated “journey” plan can help a company take advantage of opportunities as they arise
Legacy Benefit Strategies
Keep all obligationsOffer Bulk Lump
Sums to TV’sSettle/transfer
Retiree Obligations
Settle/transfer Remaining Obligations
Currentallocation
Reduce interest rate risk
Reduce equity risk
Option A
Option B
AssetAllocationStrategies
Keep all obligationsOffer Bulk Lump
Sums to TV’sSettle/transfer
Retiree Obligations
Settle/transfer Remaining Obligations
Currentallocation
Reduce interest rate risk
Reduce equity risk
Option A
Option B
Goal
Current
Retiree Medical Programs
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Key elements of health care reform with direct implications for retiree plans
Tax-Related Employer Plan Related Market RelatedHigh-cost plan excise tax Early retiree reinsurance Medicare Part D doughnut
hole and drug discountElimination of RDS tax
advantageElimination of lifetime
maximumsMedicare Advantage payments reduced —
benchmarking programTax increases for high wage
employeesDependent children coverage (age 26)
Higher Part D premiums for higher income seniors
Guaranteed issueUnderwriting restrictions
Federal subsidies
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Part D PlanRetiree Drug Subsidy
Federal Value Comparison Per Member Per Year (2010 Cost Terms)
The loss of the tax-free nature of the Part D subsidy makes participation in government funded plans more efficient
RDS$500
Reinsurance$400
Direct payment$700 Direct payment
$700
Reinsurance
Direct paymentCurrentNew benefit enhancements
Today Reform Standard No doughnut hole
Today
Reform
$750
$500
$1,100
$700
$1,500
Tax benefit$250
RDS$500
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Post-Medicare retirees: “Filling” the Part D “Doughnut Hole”may ease employer hesitation to exit program sponsorship while focusing on continued financial support
Increasing coinsurance
75% initial coverage
95% catastrophic
coverage
$250 rebate in 2010
50% brand discount starting 2011
Enhanced coinsurance phased in 2011 to 2020
GenericBrand
Current Doughnut Hole
Perc
enta
ge
Full 75%
benefit in 2020
Ded
uctib
le
Dollars
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Pre-Medicare retirees: New insurance market opportunity
Pre-65 retirees may be better off under the insurance exchange coverage than participating in an employer plan
Retiree with $60,000 Family Income (Including Investment Earnings)
Employer premium contributions
Federal subsidy
Employee premium contributions
Employee cost sharing
$12,500 $12,600
$12,500
$5,400
$5,000
$5,000
Employer Plan
Insurance Exchange
This presents tremendous opportunities for rewards redeployment for employers
Exchange underwriting restrictions may require lower premiums for individuals age 55 – 64
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Responsibility
Employee
Employer EmployeeEmployer
Risk
Contribution/design strategies
Uniform Contribution
ManagedCompetition
Employer Funded
Acct
Access Only
Employee Funded
Acct
CappedPlan
Defined Dollar Plan
CappedStrategies
Health Care
Account
Account-based strategies
ExitStrategy
No Access
FAS 106 Impact
HCR may result in accelerated movement to account-based and exit strategies
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Rethinking retiree medical: Viewing wellness as an economic asset
Employee Age 45, Retiring at Age 62
Healthy Lifestyle Average Health Poor HealthRetiree’s health care accumulated need
HSAs can help fundthis need
Employer provided account may also help
$600,000
$580,000
$20,000
$425,000
$480,000
$20,000$100,000
$300,000
$375,000
$50,000
$275,000
$50,000$100,000
$200,000
$100,000
$100,000$100,000$100,000
Key message: Average health may force delayed/inadequate retirement
Benefit Implications of Higher Tax Rates
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Expected increases in tax rates
Looming tax increases due to …$1.8 trillion FY09
federal deficit$11.4 trillion in total
U.S. debt$58 trillion in
unfunded entitlements
Bush tax cuts to expire in 2011
Potential tax rate increases on …Personal income
Capital gains Corporate FICA Social Security taxable wage
base
Other (estate, AMT, VAT, etc.)
Considerations for compensation and benefits environment include…Trauma of market drop
continues to affect 401(k) environment
DB plans facing funding challenges
Increased scrutiny of executive compensation vehicles and employee
behavior
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Benefit implications of higher tax rates — short term
Potential Opportunities
Nonqualified deferred compensation plan
Incentive pay plans and long-term incentive programs
DC SERPs and elective deferred compensation plans
401(k) plan does not currently permit Roth Contributions
401(k) plan does not allow in-service distributions
DB SERPs
Rethinking Retirement — Strategic Framework
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Regardless of approach, effective retirement programs will likely seek to achieve six key objectives
Financially sustainable for the sponsoring organizationCreate a framework for employees to reach a level of benefits adequacy that will allow for a reasonable retirement ageMeet workforce management goalsCompetitive in the talent marketplaceImprove employee financial literacyLeverage market opportunities
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What might rethinking retirement yield? A potential new retirement framework — involving benefit design and employee engagement
Defined BenefitCompany provided
annuity to account or none
Retiree MedicalPrimary Subsidy to
Access + limited subsidy
Defined Contribution
Retirement enhancement to Retirement income
Active MedicalSickness treatment to
Health promotionorientation
Medical Savings
Education
BehaviorsAwareness
