T H E A M E R I C A N A C A D E M Y O F A C T U A R I E S

I

4fnrolled AduanesVolume 20/ Number 2/May 1995

zVantage Point

3General Session #1 :ERISA's First 20 Years

3Letters to the Editor

ession 1 C : Trends inthe Benefit Profession

5General Session #2 :The Next 20 Years

11Professional Standardsand Pension Actuaries

cc

American Academy ofActuaries

1100 Seventeenth Street, NW7th Floor

Washington, DC 20036

Statements of fact and opinion in thispublication, including editorials andtern to the editor, are made on thesponsibility of the authors alone

and do not necessarily imply or rep .resent the position of the AmericanAcademy of Actuaries, the editor, or

the members of the Academy .

4

1995 Enrolled Actuaries MeetingThe twentieth annualFA Meeting-bedd March 20-22 at theSheraton Washington Hotel-offered a look back at the twodecades since ERISA'c passage and many informed guesses aboutthe future of the private pension system. The meeting sessionssummarized in this special issue of the Enrolled Actuaries Reportexamine the legislative, regulatory, and economic trends thatwill shape the future role of the actuary in the benefits industry .

GATTIRPA IssuesBy Ron Gebhardtsbauer

T

he two heaviest-attended sessions atthe 1995 EA Meeting were on non-funding issues and funding changesunder the Retirement Protection Actof 1994 (RPA), which was enacted last

December as part of the General Agreement onTariffs and Trade (GATT). The appearance ofauthoritative speakers from the IRS, PensionBenefit Guaranty Corporation (PBGC), andTreasury indicates that those agencies are try-ing to be responsive . Session speakers alsonoted that in drafting the RPA, Congress andthe executive branch were much more open toour industry than in past benefits -related bills .Maybe a new day has come!

Session 7K Non-Funding IssuesModerator: Nicholas Damico, Damico & Assoc .Panel: Deborah Forbes, PBGC

Paul Gilbert, William M.Mercer, Inc.Jim Holland, IRSLinda Laarman, Spencer Fane Britt

& BrowneStuart Sirkin, PBGC

L inda Laarman discussed how the RPAextended IRC §420 another 5 years, afterstrong lobbying from AT&T, IBM, and

DuPont. Congress liked the extension because itraised revenue needed to pay for the tariff reduc-

Academy Vice President Howard Fluhr addressed the March 21 gen-eral session (see page 5) . Lawrence Sher, chairperson of the 1995 FAMeeting joint Program Committee, is at right .

tions in GATT. The revenue comes from fewertax-deductible contributions to health plans .

Paul Gilbert then discussed the effects of theRPA on minimum lump sum amounts . Thenew RPA minimum uses 30-year Treasuryrates and the '83 GAM table (50% male, 50%female) .

Minimum lump sums at age 35 can decreaseto 30% of pre-RPA amounts and are about90% of prior minimums around age 65 . If theplan had subsidized lump sums, then the411(d)(6) protection is not waived .

The RPA also decreased IRC §415 maximumlump sums. This change must be made immedi-ately for the 1995 plan year . The old lump sumformula on the last day of the 1994 plan year canbe grandparented, but only on accruals throughthe 1994 plan year. Thus, participants at themaximum will not get the lump sums they wereexpecting from their plans .

The §415 calculation method was alsochanged . For lump sums before age 62 , the 30-year Treasury rate must be used for equivalencyon lump sums, but not for most annuities. Thismeans that the §415 maximum lump sum at age55 will have less value than the maximum annu-ity at age 55 (i .e ., Notice 87-21 no longer applies

continued on page 6

American Academyof Actuaries

PresidentCharles A . Bryan

President-ElectJack M . Tumqulst

Vice PresidentsJohn M . BertkoHoward FluhrDavid P . Flynn

Paul F. KolkmanCharles Barry H . Watson

Secretary/TreasurerJames R . Swenson

Executive DirectorWilson W. Wyatt, Jr.

Executive Office1100 Seventeenth Street, NW

7th FloorWashington, DC 20036

202/223-8196202/872-1948 (Fax)

MembershipAdministration

475 Martingale RoadSuite 800

Schaumburg, IL 60173-2226708/706-3513

Enrolled ActuariesReport

Chairperson , Committeeon PublicationsE. Toni Milder

EditorRichard G . Schreitmueller

Associate EditorsJohn W . Atteridg

Ronald GebhardtsbauerJames A. Kenney

Adrien R . LaBombardeDonald J . SegalJames E . Turpin

Managing EditorJeffrey Speicher

Contributing EditorKen Krehbiel

Production ManagerRenee Saunders

VANTAGE POINT

Impact of Two NewPension RulesBy Dick Schreitmueller

N ew rules fromthe Depart-ment of Labor(DOL) andthe PBGC are

changing the landscapeyet again for definedbenefit plans .

Who Has the Safest Annuity of All?On March 6 the DOL published standards forplans that buy annuities to transfer benefit obli-gations to an insurer: Defined benefit plansgenerally must choose the "safest availableannuity provider ." According to DOL, any-thing less would give participants too little pro-tection against insurer insolvency, contrary toERISA's fiduciary standards . This safest annu-ity rule, effective back to 1975, is consistentwith DOL's legal position in lawsuits againstemployers who bought annuities from Execu-tive Life before its collapse in 1991, but is likelyto cause problems in practice .

How should an employer terminating a planselect the safest annuity provider? Ratings ofinsurers' financial strength are a starting point,quickly eliminating most insurers . Then theemployer will usually need an independentexpert to check prospective insurers' capital andsurplus, investments, size, exposure to risks, etc .,to find a few with the right stuff. Some insurersmay decline to quote because of the size of thecase, mix of deferred vs . immediate annuities,etc ., and the goal is to select the strongest insur-er who will quote . An employer may considerprice when choosing an annuity provider only iflower rates would benefit participants, e .g ., notwhen buying conventional annuities for a non-contributory defined benefit plan .

What will be the impact on annuity markets?In recent years many insurers have alreadydropped out of the ERISA annuity market, andthese rules will further narrow the field . Supplyand demand should let an annuity providercharge high rates after surviving the winnowingprocess . Meanwhile, concepts of risk andreward suggest that some independent expertadvisers may want combat pay before enteringthis minefield of potential liability for beingwrong. Clearly, the total cost for a DB plan tobuy conventional annuities must go up .

Alternatively, terminating plans may invest ina separate account to provide annuities that have

an insurer's guarantee plus insulation frominsolvency. That approach makes sense but isn'tavailable to small plans ; for example, one majinsurer wants at least $10 million to set up san arrangement. Of course plans may find aeasy way around these annuity rules by payinglump sum benefits, but experience shows thatnot many employees are likely to preserve thelump sums for retirement purposes .

What happens to insured DA and IPG con-tracts under the DOL rule? In theory, ongoingannuity purchases or benefit commitmentsunder such contracts would seem subject to thesame selection process. In practice, chances areslim that the existing insurer could satisfy anobjective definition of safest available annuityprovider. Thus, many insurers may want to paybenefits from unallocated funds under DA orIPG contracts, without purchasing or guaran-teeing annuities .

Some practitioners don't expect these newrules to make much difference, noting thatDOL says more than one insurer can be the"safest available," Another possibility is thatthe existence of state guaranty funds to back upinsolvent insurers will embolden plan sponsorsto use annuity providers with only mediocrefinancial ratings . My own view is that it's awhole new ballgame for annuity purchases, andas matters stand more terminating plans willuse lump sums,

In the wake of Executive Life's failure 101991, the private pension system needed newways to guarantee annuities. We suggested thenthat government, insurers, plan sponsors, andactuaries go back to the drawing board . Insteadof heading down the road to standards so strictthat a handful of annuity providers would get themarket to themselves, terminating plans neededguaranteed annuities available at reasonable cost .DOL's safest annuity rule may be a wake-up callthat encourages the private pension system toreengineer the way the PBGC uses insurers topay pensions after a plan terminates .

The Last PBGC Top-50 List?The PBGC recently issued rules for underfund-ed plans to satisfy the GATT requirement forannual disclosure to participants about theextent of underfunding and limitations onPBGC guarantees at plan termination . ThePBGC states this will affect some 1,500employers in 1995, increasing to 4,000 in 1996when the rules the rules take effect for planswith 100 or fewer participants .

Mechanically , this rule isn't too bad . Anemployer first gets the actuary to work throughthe numbers and make sure no exemption frodisclosure is available , then fills in the planfunded percentage on a one-page model noticedrafted by the PBGC . Calendar -year plans

continued on page 6

2 May 1995

General Session #1 :•RISA's First 20 Years

Moderator- Richard Watts, The Wyatt Company

Panel: Ira Cohen, Puce WaterhouseDonald P. Harringrma, AT&TI nceMttrheA Law nceMtt hd4 InrcTheodore E. Rhodes, Steptoe &Johnson

By James A. Kenney

T itne has a way of gilding our memories ofeven the worst events . No doubt in 20years, actuaries will look back on our pre-

sent circumstances with nostalgia and reminisceabout the simpler days of the mid-'90s .

Perhaps this phenomenon explains why thedistinguished general session panelists spoke sofondly of ERISA. Only one panelist discussedthe dismay caused by its passage . Instead, therewas a glowing evocation of the halcyon days ofpension plans, when the rules made sense andan actuary could understand them all .

Ira Cohen dramatically illustrated thegrowth in governmental control over pensionsy holding up a slim volume containing all pre-RISA law and regulations. He described howe Studebaker bankruptcy and an NBC televi-

sion series on pensions called "Broken Promis-es" helped create the climate that led to ERISA .

Cohen also related several amusing anecdotesabout the congressional hearings on ERISA .One concerned an arithmetically challengedsenator who insisted that one-and-a-quarter wasequal to 1 .4, thus giving rise to the 1 .4 rule ofthe original Code §415(e) . Another storyexplained why the PBGC was not named thePension Benefit Insurance Company, as origi-nally proposed : because one member ofCongress kept referring to the acronym PBIC as"pubic."

Core credit was never so easy .Larry Mitchell discussed the boom in small-

er plans that ERISA ushered in . He lamentedthe legislation of the early '80s that led to anavalanche of small plan terminations. "What aterrible thing it is to have to tell someone thebest thing he can do is terminate his pensionplan," Mitchell said.

All the panelists deplored the government'smicromanagement of defined benefit pensionplans. Ironically, according to Cohen, the gov

ent's estimate of the revenue loss associatedthintroduction of Code §401(k) was "neg-e

ligible," yet this type of plan has largely sup-planted the defined benefit plan . "When I gettogether with actuaries these days, all the talk is

C T U A R I E S R

about daily valuations and recordkeeping, notabout pension plans," Rick Watts commented .

Unfortunately, none of the panelists seemedwilling to grapple with the issues that have ledCongress to amend its rules regarding pensionplans over and over again : the negative impactof traditional plan design on women and highlymobile workers, and the widespread perceptionthat highly paid employees reap significantlygreater advantages from pension plans thanrank and file workers . The session would havebeen more valuable had it shed light on whythe law has become so increasingly complex,instead of merely bemoaning this trend.

Kenney is a consulting actuary in Berkeley , Calif.

LETTERS TO THE EDITOR

Academy and Policy

Perhaps I missed some earlier announce-ment of the Academy's public policy posi-tion opposing state taxation of former res-

idents' pensions , but I was surprised to findthat fact out from the February issues of TheActuarial Update (See Practice Council Boxs-core) and the Enrolled Actuaries Report ("SourceTax Unfair?") .

Why is this an actuarial issue, rather than ageneral policy question outside the scope of theappropriate activity for the Academy? Doesthe Academy also intend to take a position onstate taxation of residents ' pensions; if not,what is the actuarial basis for a differencebetween these two issues?

Howard YoungLivonia, Mich.

The managing editor replies:

While the Academy does not take positions on publicpolicy questions, it does discuss the implications ofpolicy decisions, especially when those decisions affectissues of importance to the actuarial profession . Akey objective of the Pension Practice Council is topromote a sound private pension system that pro-vides adequate income for American retirees. Thepractice council believes that pension funds should beused for their primary purpose-retirementincome-and not as a source of general revenue forthe states. The council's concern fm• un#f rm statetax treatment for nonresidents' pension incomestems from its commitment to educate policy makerson the need for a national retirement income policythat will strengthen private pensions.

E P 0 R T

The Enrolled Actu-

aries Report

welcomes letters

from its readers.

Letters for publi-

cation should he

submitted to

"Letters to the

Editor" and must

include the

writer's name,

address, and

telephone number

Letters may he

edited for style

and space require-

ments. Eleetib

messages may be

sent via Actuaries -

online to the

attention of

Jeffrey Speiche ;

74764,2620

Lcompuserue.cam.

E N R 0 L L c D A C T U A R

Session IC: Trendsin the Benefit ProfessionModerator: Alec LeBlanc, ADP Benefit Services

Panelist: Robert F. Karsch, Bankers Trust Co .

By James A. Turpin

T his session presented a nonactuarial viewof the direction that benefit consultingfirms will be moving in over the next

decade. Factors that are chang-ing the traditional role of actu-aries as benefit consultantsinclude :

∎ The shift from traditionaldefined benefit plans to definedcontribution plans with empha-sis on the 401(k) salary deferraloption. All benefits consultingfirms are beginning to feel thepressure to reduce fees at a timewhen their clients are alsodownsizing their work force .Actuaries need to look for newareas in which to provide ser-vices while focusing onimproved technical skills todeliver those services .∎ Changing relationships between plan spon-sors and consulting actuaries. Services providedby actuaries have become a commodity that doesnot reflect the historical long-term professionalrelationship of mutual trust and respect betweenclient and consultant . Plan sponsors use perfor-mance standards to measure the adequacy oftheir consulting firms and seek fee caps to mini-mize the potential large upside expenditures for

IRS Down for the Count?In the last of three appeals court rulings on the small plan actuarial audit cases, the Ninth Circuit

Court of Appeals has affirmed the tax court decision that the actuarial assumptions in the Phoenix

cases were reasonable . The appeals court also found that the traditional accrued benefit fundingmethod was reasonable and not in conflict with requirements under IRC Sections 412 and 415 .

This is a direct contradiction to an eerier Appeals Court decision in Jerome Mitza Y. The Commis-

sioner. Without a conflict between the circuits on the actuarial assumptions issue, the IRS may not

have an opportunity to appeal the issue to the U .S. Supreme Court.

I F S R E P 0 R

consulting services. Thus, profit margins on feesare much narrower than they have been histori-cally, and it is necessary to do a greater volumeof work to produce the same net income .∎ Need for improved quality of data. As firemove into such areas as defined contributionplan recordkeeping, COBRA work, and cafete-ria plan administration, actuaries are discover-ing the substantial difference between theamount of data required for these plans and thedata typically maintained for defined benefitplans. Such data as the selection of vendors,physicians, location of employees, and the ser-vices available to them have become criticaldatabase elements. The eligibility of depen-

James Turpin

dents is also important formany group benefits andrequires constant, meticulousmaintenance of databases thatwas not necessary for definedbenefit plans . To be competi-tive, consultants will need toseamlessly integrate all suchdata.∎ As clients expand the typesof postretirement health carecoverage available to retirees,the ability to provide accurateFAS 106 information becomesequally important. Consutants will need to maintadatabases for retired employ-ees. Voice response systemsmay also be more important

since it can he difficult to communicate withretirees without the typical workplace commu-nication vehicles . Clients are outsourcing tofirms that can provide these kinds of communi-cation and recordkeeping services .∎ Clients now expect a level of expertisegreater than previously available . Efficientelectronic links between vendors and the con-sulting firm, as well as the payroll system andthe human resources function, will become aprimary consideration in the selection of firmsfor benefit outsourcing.

Ten years ago clients looked for a single car-rier to provide one-stop shopping for their ben-efit package . Now, they may be looking forone-stop shopping for their consulting firm toprovide a variety of vendors to support theirbenefit programs . The consulting firm must beable to link together and manage the resourcesof clients who have multiple payroll and multi-ple human resources systems, and a wide vaneof benefit programs geared to specific location

Turpin is a consulting actiuuy in Albuquerque, N.M.

4 May 1995

General Session #2 :*he Next 20 Years

Moderator: Richard Watts, The Wyatt Company

Panel: Elaine K Church, Price WaterhouseHoward Fluhr,The Segal CompanyRandall L. Johnson, Motorola, Inc .Dallas Salisbury, Employee Benefit

Research Institute

By Cindy Levering

T his session offered a thought-provokinglook at the next 20 years from four per-spectives .

Dallas Salisbury covered the demographicand economic outlook. The year 2015 repre-sents "the beginning of the age swing," whenthe baby boom generation's retirement will bein full swing. In 2015, current projectionsindicate that Medicare will have beenbankrupt for 14 years, and Social Securitybenefits will exceed tax revenue . Employerswill be looking at pension plans they cut backin the past for possible improvement . Howev-

he predicts the demographic factors will beoutweighed by economic factors, including tax

policy. Salisbury pointed to the comingdebate on switching from an income-based toa consumption-based federal tax system . Theoutcome of that debate, he said, may welldetermine whether or not we have a pensionsystem in 2015 and to this end, we need toeducate public policy makers .

Elaine Church covered the legislative out-look, where there are more questions thananswers. Should Social Security he means-test-ed, capped, or privatized? Social Security willhave to be very different in 2015 if it is to sur-vive. Will Congress and the electorate face upto the actions needed to keep it from goingbust? Will employers switch back to definedbenefit plans? If benefit payments exceed con-tributions, will employers reduce benefits orshift costs to employees? Can we shift policy-making from a short-term revenue-drivenbasis to a long-term policy basis? Does thefailure of health care reform jeopardize theretirement efforts? While ERISA is generallyconsidered a success, we need a policy for thefuture . She predicted that the so-called Amer-.

n Dream savings account proposal will beaWacted, but that mandatory cost-of-living

increases and a mandatory universal pensionsystem will not .

Randall Johnson offered an employer's per-

E P 0

spective. He believes that employers expecttheir actuaries to provide quality, creative,timely service from a global perspective. Actu-aries also need to be proactive, not just in deal-ing with clients but also in representing clientsto outside agencies, such as the governmentand FASB .

Finally, Howard Fluhr, Academy pensionvice president, presented an actuary's perspec-tive . He called for long-term rather thanshort-term thinking . The profession must playa key role in public policy to combat the taxrevenue obsession and retirement plan conspir-acy theory. Actuaries have become more visi-ble, most recently through health care reform,but we need to contribute more to publicdebates on such issues as Social Security sound-ness, low savings rates, investment diversifica-tion, retirement income adequacy, tax expendi-tures, and pension simplification . The multipleorganizations that now represent actuaries justconfuse the public. He called for actuaries topush for unification so we can speak with onevoice and move more quickly to lend ourexpertise . To this end, he announced theappointment of Bob Heitzman as senior pen-sion fellow to spearhead the Academy's workwith Washington pension policy makers .

Levering is a principal with Alexander & Alexan-der Consulting Group in Baltimore .

Academy Vice President Howard Fluhr concluded his general session address by saluting Leslie Shapiro(right) for his 20 years as executive director, of the Joint Board for the Enrollment ofActuaries . Shapiroleft hi; Treasury Department post in February to become general counsel of the National Society of PublicAccountants. In his brief remarks, Shapiro recalled the joint Board's early of farts to implement ERISA'senrolled actuary provisions, which "burst the bubble of mystique surrounding actuaries. " He underscoredthe need for the profession to maintain independence, competence, and integrity into the next century.Attorney Shapiro also announced that the Joint Board has granted him honorary EA status with anenrollment number of 0001 .

T

May 1995 5

E N R 0 L E D A C T U A R

Gebhardtsbauer, continued from page 1

here). Mortality can still be ignored pre-NRA, ifthere is no forfeiture at death .

Is an ERISA §204(h ) notice needed to letemployees know lump sums are decreasing? JimHolland of IRS said the Service will not issueguidance (probably because a literal reading of§204(h) would not require a notice ) . Lawmakersprobably never contemplated that accrued bene-fits would be cut so they never thought torequire the notice in this situation . The spirit of§204(h) would probably require a notice, andsome practitioners suggest that plans notify theiremployees on this volatile issue of reducinglump sums. Employees can claim detrimentoccurred if they weren 't notified in advance .They could contend they would have quit to gettheir lump sums under the old rules .

One other good result of the change in §417minimum lump sum rules is that it helps cashbalance plans . Their lump sum cashouts can nowmore easily be equal to their account balances!Gilbert also pointed out that there was a middle-class tax cut embedded in RPA. Employees willpay less tax on their smaller lump sums! Ugh .Somehow, we didn't think that was the tax cutNewt and Company proposed.

Some other issues discussed were :∎ Privately owned employers with large under-

Vantage Point , continuedfrom page 2

may distribute 1995 notices in September alongwith 1994 summary annual reports .

The real issue is employee relations . Up tonow, large employers with underfunded plansfound this out by getting on PBGC's highlypublicized list of the fifty plans with the largestunfunded liabilities . Employees really don'tlike being in a plan that's among the mostunderfunded, especially employees in collectivebargaining groups . Accordingly, large employ-ers have gone out of their way to contributeenough to stay off the list, or if that didn'twork, have sent employees carefully timedcommunications to soften the news . Smalleremployers who haven't had to play this gamewill soon find out how it works .

Unlike some other ERISA disclosures, noticesof underfunding may make a difference, motivat-ing employers to contribute more so they won'thave to send them . Because the notices serveessentially the same purpose as the top-50 list buton a broader scale, it would make sense for thePBGC not to issue that list after 1994 .

Schreitmueller is director of regulatory and legisla-tive servicesfor the Alexander Consulting Group inAtlanta .

I E S R E P 0 R T

funded plans must notify the PBGC 30 days inadvance of certain reportable events, (Furiouslobbying by publicly owned employers elimined this rule for them .) PBGC TechnieUpdates 95-1 and 95-3 describe in more detailthis rule, which affects only 200 employers .∎ The PBGC will handle missing participantsat cost for terminating plans (as long as the plannfirst performs a diligent search for them). ThePBGC won't have to follow minimum cash-outrules or honor all optional forms, etc . Code§401(a)(34) exempts the PBGC from certainqualification rules . This reminds me of therules that Congress used to exempt itself from .Instead of simplifying the rules however,Congress now is supposed to abide by them . Iwonder if this will ever happen to the PBGC?They have never complied with the §417(e)rule to use interest rates at date of distributionor the Norris Supreme Court decision on unisexbenefits in plans that were not amended tocomply with Norris.

Session 5D : RPA Changes inFunding RequirementsPanel: Chris Bone, ASA

Heidi Dexter, A. Foster HigginsJim Holland, IRSHarlan Weller,Treasury DepartmentNick White, Towers Perrin

T

his session covered many technical issuesin the transition to GATT/RPA funding,including the following :

∎ Current liability will increase due to : the spec-ified use of the '83 GSM mortality table perRevenue Ruling 95 -28 . (The '83 GAM in theRev. Rul. matches the table in my 1983 SOATransactions but not other copies-you shouldcheck your version with the ruling ' s) ; and a lowerinterest rate (the top of the corridor decreases to105% by 1999 PY for minimum funding purpos-es-not for FFL or §420 purposes) .∎ Excluding preretirement mortality will prob-ably still be permitted. You might use thisminor idea for increasing deductions, or toreach FFL and thus avoid variable premiums(along with using the interest rate at the top ofthe corridor) .∎ The DRC rules affect plans funded under90% of CL. There are complex triggersexempting certain plans funded 80 % of CL ormore. They arc for plans that are generallyfunded over 90%, but have a couple bad yeof investment returns . The credit balancenot subtracted for the funded status triggers,but is still subtracted in determining the mini-mum contribution .

6 May 1995

E N E 0 L L L D A

∎ Some practitioners are using a lower CL inter-est rate in 1995 to throw more CL into old CL,

ch gets amortized over 12 years . It also low-your §412 (l)(11)target funding ratios (FR)

over the next 7 years, because they are based onadding percents to the initial FR. Actuaries arealready finding the loopholes! Looks like we willhave a son of RPA and PPA someday.∎ One problem with the target FR minimumincrease is that if a large asset loss occurs, itmay have to be made up immediately (unlessit's more than 30% of the new CL) .∎ A plan can elect to treat all CL as old CL .This can then be amortized over 12 years .However, with this irrevocable election comesa minimum of the PPA additional fundingcontribution . Thus, this election may not beworth the price . This is different from theminimum that comes with the target FR. Inthis election (which can be elected on or offeach year), the target FR cannot be less thanthe PPA additional funding contribution . Theultimate RPA contribution can be less, becausethe phase-in is only a maximum on the RPAcontribution, not a replacement of it .

∎ One change to the current §412(b) rules isthat collectively bargained plans must recog-nize scheduled benefit increases immediatelyfor their regular funding (not current liabilitythough) rather than on the scheduled dates .

The end result is that we consultants havemuch to do in calculating and forecasting con-tributions . We will need to advise our clientsnow on the effects of the different elections .Since I couldn't include everything in this arti-cle, I suggest you read GATT/RPA (law, com-mittee reports, analysis, and regulations), andattend future SOA, CCA, and ASPA sessions .

For those with unanswered questions, JimHolland and Harlan Weller encouraged us tocontact them with our concerns, questions, andsuggestions. Let's take them up on the offer .

Gebhardtsbauer is a principal and practice head atWilliam M. Mercer, Inc. in New York City and vicechairperson of the Academy Pension Practice Council .He was formerly chief actuary of the PBGC.

Session 2H: Completing the 1994 Schedule BWoderator

& Instructor. James A. Kennet', Coates Kenney, Inc.

Instructor: Paulette Tino, Internal Revenue Service

By Arthur W. Anderson

J ames Kenney began the session by praisingSchedule B as "the best government formever," having been unchanged for nearly 20

years, an example of successful cooperationbetween actuaries and the IRS .

Kenney discussed the broad principles thatunderlie the form, starting with the credit bal-ance in the funding standard account, whichrepresents the extent to which actual contribu-tions have exceeded those required, and theequation of balance : Unfunded liability equalsamortization bases less credit balance, less rec-onciliation account .

Why do we have full funding limitations?Because, said Kenney, without them the equa-tion of balance for a fully funded plan would besatisfied only by a negative unfunded liability,and the IRS has always abhorred the idea of anegative unfunded. Why have they been soadamant on this point? Kenney answered bypposing a plan had always had minimum con-ibutions, so its credit balance is zero. Suppose

the plan is fully funded. If the plan realizedlarge investment gains, for example, these gainscould give rise to amortization credits that

would exceed the normal cost . But then thecredit balance would grow without any contri-butions having been made, which would negatethe credit balance's value as a measure of mini-mum funding, making a mockery of Schedule Bby giving the employer a sort of reversion ofplan assets (because the credit balance offsetsfuture required contributions) .

Thus, continued Kenney, insisting on a non-negative unfunded liability requires us to wipeout the amortization bases when assets grow tomatch the accrued liability, in order to preservethe equation of balance . So we need a fullfunding liability in order to avoid negativeunfunded liabilities, which in turn would wreckthe funding standard account .

Paulette Tino went on to discuss the compli-cations that the recent Retirement ProtectionAct has introduced to the 1995 funding stan-dard account. The act revises the computationof the additional funding charge, as well as thedefinition of current liability . It also mandatesmortality and disability tables used for comput-ing current liability. The act's various phase-inrules have resulted in no fewer than five differ-ent, concurrent definitions of current liability,which will necessarily complicate the design ofthe 1995 Schedule B .

Anderson is a consulting actuary in Hull, Mass.

0 9

May 1995 7

E N A 0 L L E D A C U A R

Session 3E: Computation ofFICA Tax on NonqualifiedDeferred CompensationInstructors: lames C. Glick, Towers Pemn

John F. Woyke, Towers Perrin

By Edna De Vera

B

efore 1994, highly compensated employ-ees' cash compensation usually exceededthe FICA wage base for both OASDI and

Medicare . Therefore , deferred compensationaccrual did not generate FICA taxable income .Effective in 1994, the cap on wages subject tothe tax for the hospital insurance (HI) portionof Medicare was eliminated , which increasedthe number of employees who are subject tothe 1.45% Medicare tax on vested non-quali-fied deferred compensation .

IRS Notice 94-96, issued in November1994, provides guidance for determining whenamounts deferred under a nonqualifieddeferred compensation plan are included inwages for FICA purposes .

The notice provides that for periods prior tothe issuance of regulations , employers will be incompliance with the FICA rules by following areasonable , good faith interpretation of IRCSections 3121 (v) and 3306 (r). However, thenotice did not answer many difficult questionsregarding compliance , particularly for definedbenefit plans .

This session dealt with acceptable calcula-tion methods and applicable regulations .

Academy Executive Director Wilson Wyatt (right) and Bob Heitzman, newly appointed Academy seniorpension fellow, confer with Academy Assistant Director of Public Policy Christine Cassidy .

R E P 0 H T

Taxable Amounts

For defined contribution plans, accumulatedcontributions are subject to FICA tax in the ycontributions vest. Under current regulationis unclear whether investment earnings associat-ed with nonvested contributions are taxed in theyear that the contributions initially vest . On theother hand, investment earnings on previouslytaxed contributions are taxable when paid . Sub-sequent to vesting, new vested contributions aresubject to FICA tax immediately.

For defined benefit plans, the terms of theplan or arrangement will dictate when benefitsare earned or when they vest . The value ofbenefits is taxed if not subject to substantial riskof forfeiture, which can have different meaningsdepending on the provisions and design of thearrangement. For example, substantial risk offorfeiture could exist for an otherwise vestedbenefit if that benefit is subject to forfeiture for"bad behavior" (e .g., misconduct, fraud, releas-ing company secrets) . In addition, in someplans even if the benefit is vested, the amountmay decrease or disappear depending on futureevents .

Calculation of Vested Accrual

A measure of the value of deferred compention treated as FICA wages is the value of thincrease in vested benefit. The increase in vest-ed benefit is a function of the assumptions usedto determine present value . If the employeradopts a calculation method that allocates morevested benefits in the future instead of recog-nizing the benefit immediately, current taxeswill generally be lower. However, thisapproach means that a substantial "true-up"will be needed when the employee subsequentlyterminates. On the other hand, if the amountof vested benefits is overestimated, excess taxespaid may not be recoverable .

Good faith compliance with Notice 94-96requires that the approach be consistent foreach employee in the plan . New plans cannotallocate accruals to periods before the existenceof the plan .

The quality of data required for good faithcompliance is unclear. Use of precise data canoverstate or understate the tax liability if finalregulations allow valuation data . There is apossibility that 1994 FICA withholding mayexceed the final amount due . There is no clearmethod to recoup excess FICA withholding in1995 . 40De IVera is an associate with William M. Mercer,Inc. in New York City.

8 May 1995

E N R D L L E D A

2B: Creative Plan Design

.nel:Marty Collins, Kwasha LiptonGordon L. Gould, Towers PerrinEric P. Lofgren, The Wyatt Company

By Joel I . Rich

E ric Lofgren led off with a review of vari-ous plans from a replacement-ratio ratherthan a plan-provision standpoint-assisted

by an electronic actuary, which Lofgren noted,probably had more personality than the averagehuman actuary. Lofgren and his assistant com-pared replacement ratios under a traditionalfinal average pay plan, a cash balance plan, andpension equity (pep) plan, which in essence is afinal average pay lump sum plan. Using vari-ous entry ages, Lofgren demonstrated that inmost situations when looking at cost andreplacement ratios, the accrual patterns of thepep plan fall somewhere between the final aver-age pay and cash balance plan and similarly forthe costs (no surprises here) . He also demon-strated that under the formulas he studied, fasttrackers were not really a big problem under acurrent cash balance plan, but slow trackerscould be a big problem because earlier accruals

`take on a greater weight when interest credits

C T U A R I E S R E P 0 H

are greater than their salary increases .Gordon Gould described Rethinking Retire-

ment, a case study undertaken by his organiza-tion. The case study determined that employeeswant competitive, understandable benefits overwhich they have some control . The study alsoidentified two types of employees : the securityminded who want inflation protection and littlerisk, and mobile employees who want cash bene-fits, investment opportunities, and portability.

Companies want financial control, sharedrisk and responsibility with employees and,most of all, a program that supports their busi-ness strategy. Based on these findings, TowersPerrin designed a plan that includes an accountbalance and a three-tier program of employeecommitment to a basic safety net, a variableportion tied to company performance, andmatching contributions .

Mary Coffins discussed the next generation ofcash balance plans, including plans that tie inter-est rate credits to outside indices. A minimumand maximum rate would ensure no reduction inaccrued benefits and give employers some finan-cial control . She also discussed a profit sharingkicker after year-end that could be amortized .

Rich is a principal with William M. Mercer, Inc. inMorrictown, N. J.

3 G: Trends in the Defined Contribution Plan MarketplaceInstructors: Thomas S Doty, Barkers Trust Company

Lawrence A. Heller, Kwasha Lipton

By Harvey Pastemack

I n this well-presented session, Thomas S .Doty and Lawrence A . Heller reminded usof the vast changes in recordkeeping that

have occurred in the past 5 years . First, planparticipants' expectations have changed dramat-ically. In this era of ATMs, voice response, andreal-time financial transactions, participantssimply will no longer accept having to contactan on-site benefits administrator to obtain anaccount balance that may be a month or moreout of date, or waiting 6 or 8 weeks for a loanor distribution. Second, economic pressureshave led to cutbacks in human resource staffand to outsourcing benefit functions to profes-sional service providers . Third, growing fears of

igation, the need to provide better investmentformation to plan participants, and ever more

burdensome regulations [such as the final DOLregulations under ERISA 404(c)] have ledemployers to stop playing the middleman and

encourage participants to contact the serviceprovider directly. Fourth, as always, serviceusers want all this on a cost-efficient basis .

The big question in defined contribution ser-vices in the 1990s is how all these diverse needscan be met at the same time. The answer: tech-nology. Today's clients demand one-stop, seam-less service that includes not only traditionalrecordkeeping, administration, communications,and consulting functions, but investment man-agement and financial services functions as well .

For some larger financial organizations thishas meant internal realignment to provide ser-vices on an integrated basis . For smaller tradi-tional consulting firms, it means establishingalliances with financial services organizationsthrough which participants can obtain anaccount balance, move funds between invest-ment options, request a distribution or loan, ordiscuss investment options with a firm repre-sentative .

Pasternack is a consulting actuary in State College,Pa.

May 1995 9

N P 0 L L D A C T l1 A R I E S R E P 0 R T

Sessions 4G: ContributoryDefined Benefit Plan ProblemsModerator& Inst r a tor: . John Woyke, Towers Perrin

Instructor: William. Torrie, Kwasha Lipton

By Lloyd A . Katz

A t the beginning of their presentation, theinstructors asked the audience two ques-tions : "How many of you have actually

worked with a contributory defined benefit plan?How many of you have recently helped toimplement a new contributory defined benefitplan?" The first question elicited hands frommost in the room, while not a single hand wasraised in response to the second . Why, in thesecost-conscious times when employers are mak-ing every effort to encourage employees to sharethe cost of their benefits, haven't these plansbecome a popular means of achieving employercost savings while at the same time preservingtraditional annuity-type benefit plans :

While not explicitly focusing on the answerto this question, the session offered a broadoverview of the many complicating factors that

Continuing Professional Education SitesThis table lists major meetings scheduled during the balance of 1995 at which enrolled actuaries canearn part of the 36 hours of continuing professional education credits needed for reenroliment in1996 . Later this year, the Society of Actuaries and other organizations plan to make availableopportunities for CPE credit, including videotapes of past meetings . We encourage meeting spon-sors to notify EAR of other meetings for inclusion on this list .

Date & Site Meeting & Sponsor Credits

June 4-7Newport, R .I .

ASPA RegionalSeminar

19 .5

June 26-28Vancouver, B .C.

SOA Spring Meetingon Pensions & Health

14 .4

July 16-19San Diego

ASPA RegionalSeminar

19 .5

Oct. 16-18Boston

SOA Annual Meeting est .14

Oct. 30- Nov. 1Washington, D.C .

ASPA Annual Meeting est . 14

Nov . 6-8Orlando

CCA Annual Meeting 19 .8

sponsors of these plans and their consultantsmust deal with. Among these complexities arethe calculation of the employee accrued benefit,nondiscrimination testing of employer beneand employee contributions, and the calculauof taxable and non-taxable portions of each dis-tribution and benefit. This last complicationarises from one of these plans' key disadvan-tages-employee contributions must be madeon an after-tax basis. These assorted drawbackshave resulted in contributory defined benefitplans occupying an increasingly insignificantpart of the post-retirement benefit landscape .They are the retirement plans of choice for onlya small number of sponsors, primarily unions .

Calculation of Employee-Derived Benefits

The speakers began by providing a history ofhow this calculation has had to be done, begin-ning with the establishment of §411 (c) byERTSA.

The complexities introduced by OBRA '87were then discussed, including the requirementfor the projection of interest at 120% of thefederal mid-term rate . Since projecting interestfor future periods at this rate introduced greatvolatility into the calculation of an employee'svested accrued benefit, OBRA '89 providedtechnical correction that resulted in projectio4based on plan lump-sum rates of interest .These rates will be affected by the recentlyenacted GATT legislation, yielding increasedlump sum rates and employee-derived benefits .

Nondiscrimination Testing

Before testing can begin, benefits must be allo-cated between those derived from employercontributions and those derived from employeecontributions. The instructors summarizedand reviewed the six methods allowed by regu-lation for performing this calculation : the gen-eral rule, composition-of-workforce method,minimum benefit method, grandfather rule,government plan method, and cessation ofemployee contributions .

A further complexity of contributory definedbenefit plans is the need to calculate the por-tion of the total benefit subject to income tax,as well as to calculate the taxable portion of anylump sum distribution made to the participant .These calculations are subject to the rules ofInternal Revenue Code §72, governing annu-ities and lump sum distributions .

Katz is an associate with William M. Mercer, Inc.in New York City .

10 May 1995

E N R 0 L L E D A

8B: Professional Standards•Tecting Pension ActuariesModerator: Heidi R Dexter, A. Foster Higgins & Co.

Panelist: Harper L. Garrett, Jr., Alexander& Alexander Consulting group

By Thomas D . Levy

0 ver the years, the actuarial profession ingeneral and pension actuaries in particularhave been subject to increasing direction

and oversight from governmental agencies, audi-tors, and attorneys. In some cases, outside orga-nizations have provided standards for actuarialwork in connection with professional practiceunder their jurisdiction . Sometimes these stan-dards have been in place of standards set by theactuarial profession ; in other cases the outsidebodies have promulgated standards where theactuarial profession had none. The ActuarialStandards Board (ASB) and its operating com-mittees have been extremely active in mattersaffecting pension actuaries .

ASB member Harper Garrett provided anoverview of the ASB, its operations and its pur-pose. He differentiated between actuarial stan-

rds of practice (ASOPs), which represent gen-ally accepted actuarial principles and practice

(GAAPP), and actuarial compliance guidelines(ACGs), which spell out compliance with rulesimposed by others that may not be in accordancewith GAAPP. He emphasized that both arebinding on actuaries . Garrett also stressed thatthe Code of Professional Conduct, includingqualification standards and requirements forcontinuing professional education, applies topension actuaries . He also identified as relevantfor pension practitioners ASOPs Nos . 2, 4, 6, 17,21, and 23 ; ACGs Nos . 1, 2, and 3 ; and ASBInterpretive Opinions Nos. 3 and 4 .

Heidi Dexter, chairperson of the ASB Pen-sion Committee, followed with a discussion ofhow and why standards are developed and iden-tified standards that are currently under devel-opment. ASOP No . 4, Measuring Pension Obliga-tions, is the basic statement of GAAPP for pen-sion actuaries. It is being expanded to includestandards on economic assumptions, demo-graphic assumptions, asset valuation, and liabilityvaluation and cost methods . Ultimately, theASB's plan is to redraft ASOP No . 4 as anumbrella for these new standards . In addition astandard is under development with respect to

.alified domestic relations orders (QDROs) .Dexter also outlined final revisions to the pro-

posed standard on economic assumptions,expected to be finalized in the fall. The revisionswill: clarify the scope of the standard (it does not

C T Li A P J E S R E P 0 R T

apply to current liability interest rate and the401(a)(4) general test interest rate) ; delete theprovision for adverse deviation ; add conser-vatism; add measurement-specific factors forinvestment volatility, unfavorable experience,and expected plan termination ; and clarify con-sistency among assumptions and the distinctionbetween investment return and discount rate .

The audience discussion included extensivecomments on the actuary's responsibility whenassumptions are dictated by nonactuaries. Sen-timent was expressed in favor of the view thatFASB pronouncements call for assumptions tobe set by the employer, that the actuary's role ispurely as a technician, and that there should beno requirement to express a professional opin-ion on the assumptions . (Garrett reminded theaudience that existing standards require actuar-ies to disclose their disagreement with employ-er-selected assumptions if they believe that theyare outside FASB's stated requirements .) Actu-aries for government plans, on the other hand,made it clear that the requirement to discloseprofessional disagreement with assumptionsand methods selected by others was their onlyrecourse when governments tried to underfundpension plans for public employees, and thatassuming purely a technician's role would beagainst the public interest in their practice .Also discussed was the actuary's responsibilityto plan participants .

Ultimately, the session's message was thatthe actuarial profession is becoming increasing-ly self-regulated in response to unacceptablywide variation in practice, complaints to theActuarial Board for Counseling and Discipline,inadequate standards, accounting standards andlegal requirements, and that practicing pensionactuaries must know and follow GAAPP andASB standards if the profession is to retain therespect and independence it has always enjoyed .

Levy is senior vice president and chief actuary of TheSegal Co. in Washington, D.C.

Utah Insurance Cammissioner and Academy Board Member RobertWikox at an FA lbleeting session .

May 1995 11

Ask An(Enrolled)Actuary!

Here's someadvice for

retirees whosuspect anerror in the

calculation oftheir pensionfrom Jane

Bryant Quinn'sApril 23

syndicatedcolumn: "Askyour library forthe Enrolled

Actuaries Direc.tory of theAmericanAcademy ofActuaries andstart calling

local members,looking for

someone whotakes individualcases. For per-haps a few hun-dred dollars(depending onyour situation),

an actuaryshould be ableto check your

monthly pensionpayment orlump-sum

distribution ifyou have all the

records."

D A C T U A R

3H: Determination LettersUnder Nondiscrimination RulesModerator: Howard Peyser, The Wyatt Company

Instructor: David Weingarten, Sanders, Schnabel

By Tim Hedlund

T he time has finally come (and has evengone for calendar year plans) to submitapplications for determination letters

concerning changes going all the way back tothe Tax Reform Act of 1986 . The deadline fortimely submission is the last day of the 1994plan year or March 31, whichever is later ; how-ever if the 1994 plan year ends before March31, a 3-month extension is granted . Tax-exempt plans have until the end of 1996 .

Although determination letters are notrequired for qualified plans, most decide to filebecause administrators and fiduciaries, not tomention actuaries, want the protection a letteraffords . Also, determination letters arerequired to apply amendments retroactively .

We are now amending plans for laws thattook effect quite a few years ago . Those who donot submit during the remedial amendmentperiod provided by the law will lose the right toamend retroactively to correct defects . This is avery good reason to submit to the IRS, andoffers an opportunity to encourage clients to gettheir plans in order and up-to-date .

Technically, a determination letter is only"the opinion of the Service" regarding the qual-ified status of a plan and its exempt trust, basedon the facts presented to the Service by the tax-payer. As such, it may not be relied upon aftera material change in fact or the effective date ofa change in law, except as provided .

Use Revenue Procedure 95-6 as your roadmap in obtaining a determination letter anddon't forget the interested party notification .You will also need to refer to Revenue Proce-dure 93-39 for certain demonstrations to submitas part of your application. With 93-39 the IRShas indeed done something new under the sun .The applicant has the option of electingwhether the determination letter will addressissues such as nondiscrimination under§401(a)(4) or the average benefit test of§410(b)(2) . Unless these are specifically chosen,the determination letter will contain a caveataccordingly. Even if you elect for all optionsand make all demonstrations, you may be audit-ed at a later date and have to test again on then-current data . But you will have gained at leasttwo things : a 3-year reliance if there are no sig-nificant changes, and IRS blessing of yourmethodology. Also new is a varying fee sched-ule depending on options elected. Section 3 of

the procedure states this schedule "was deter-mined to reflect the degree of difficulty inher-ent in reviewing the plan submitted ." Is tIRS staff finally admitting that things h'become so complicated that even they will nreview their own procedures unless forced to,and then only for more money?

Hedlund is a consulting actuary in Topeka, Kans .

21 Late Breaking DevelopmentsBy Karen Imler

Moderator: Kyle N. Brown, The Wyatt Company

Panel: Adrien R LaBomharde,Milliman & Robertson, Inc.

Seth H. Tievsky, Ernst & Young

U nder the Retirement Protection Act of1994 (RPA), a contributing sponsor of aPBGC-covered plan shares responsibility

for required reporting to the PBGC . The RPAalso added four new reportable events, which arewhen a controlled group member: leaves thecontrolled group ; liquidates in bankruptcy ;declares an extraordinary dividend or redee10% or more of the stock of the control!group in 12 months; or transfers 3 % or more ofplan liabilities outside the controlled group with-in 12 months. The PBGC does not requireadvance notice if all parties involved are publiclytraded, the aggregate unfunded vested benefits(on a controlled group basis) are less than $50million, or the aggregate funded vested benefitpercentage is at least 90% .

To correct a noncash contribution, IRSAnnouncement 95-14 prescribes a procedurefor late filing of Form 5330 and payment of the5% excise tax. If the procedure is followed byAugust 2, the 100% excise tax and additions totax applicable for late payment will not apply ;however interest for underpayment of taxes willbe assessed. Bulletin guidance is effective Jan-uary 1, 1975. Session attendees suggested thestatute of limitations may protect some taxyears .

Recently the U .S. Supreme Court let stand adecision that allowed offset of retirement planbenefits by worker's compensation, ruled thatplan language that reserves the company's rightto amend a plan is a valid amendment procedure,and ruled that interest begins to accrue on thefirst day of the plan year following withdrawalfrom a multiemployer pension plan .

Imler is a consulting actuary with W. A46-ed Hayes& Co. in St. Louis.

12 May 1995