Pension plans are big in the employment industry. They are important to employers, employees, governments, and the overall society. With the increasing concern over dwindling retirement benefits and the affect on the public awareness of recent pension fund crises, when it comes to managing pension plans have never been more critical and the pressure on those who are responsible for them has only intensified. About 53 percent of the employed labor force lacked a pension plan in 2008, a decrease in those without coverage of 5 percent points from 10 years earlier. The improvement in pension coverage may stem from the economic expansion under way since 2001 that has encouraged firms to offer pensions as part of their compensation packages and from an increased interest in pension coverage by persons in the labor force.
About 40 percent of the employed labor force lacked a pension plan because they worked for firms that did not sponsor a plan, while 14 percent lacked a plan because they were not eligible or chose not to participate in their firm's plan. In 2008, about 90 percent of employees not in a firm's plan had one or more of the following characteristics: They had relatively low income, were employed part of the year, worked for a relatively small firm, or were relatively young. "Many workers failed to earn a pension benefit during their work lives." (Bovbjerg, 2009, pg.65) About 48 percent of persons who had retired lacked pension income or annuities; retired people without pension income were more likely to be single, female, less educated, and Hispanic or not white.
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However, retired persons who lacked pension income were more likely to be poor. About 21 percent of retired person without pension income had incomes below the federal poverty threshold, compared with 3 percent with pension income. Recognizing the importance of pension income to economic well-being, the federal government uses the income tax system to encourage firms to sponsor and employees to participate in such plans.
What do pension plans do
Pension plan management starts by understanding why employers have pension plans in the first place. The historical reason for the growth in pension plans was the existence of government mandated wage and price controls during World War II and the Korean War. If not for the following controls, pension plans in the United States might not have grown nearly as rapidly as they have. Accordingly, many employers raised total compensation by adding pension plans to the compensation package. Pensions did not count as wages under the various wage price control laws. The wage and price controls and force employers to learn about pension plans and their advantages.
Defined Benefit Plans
Defined benefit plans were the predominant type of employee retirement program for many years. Many years ago, the percentage of pension plan participants who had a defined contribution as their primary plan was only 29 percent, but has increased to 60 percent by 2002. "Some larger companies still offer defined benefit plans, but many have converted to cash balance plans, which merges aspects of defined benefits plans and 401k's." (Sergeant, 2007, pg.40) Defined benefit plans may thus be overfunded, adequately funded, or underfunded.
Over time, unfunded benefits must be funded either through additional contributions from the sponsor or through investment returns. The funding status of a pension plan partially describes, at a specific point in time, the financial health of the plan as well as the ability of the plan as well as the ability of the plan to bear risk. For defined benefit plans, the pension recipient is entitled to the promised pension even though the asset pool and future investment returns may be insufficient to pay it.
Defined Contribution Plans
In a defined contribution plan, the employer makes a regular contribution to an individual account of a given employee. Typically, the contribution equals a set percentage of the employee's wages. Such contributions are subsequently invested based on a choice made by the employee, although the variety of choices available to the employee is generally defined by the employer. "Unlike defined benefit plans, defined contribution plans let employees decide how they would like their pension funds invested." (Johne, 2010, pg.5) In some cases it is the employers who make the contributions on an employee's behalf.
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In other cases the employee makes the contribution to his or her own account. As with defined benefit plans, defined contribution plans can have vesting provisions. An employee may have a positive balance in his or her individual account, but no right to actually receive funds from the account. Defined contribution plans are not back loaded like final-pay defined benefit plans.
Projected Benefit Obligation vs. Accumulated Benefit Obligation
Projected benefit obligation is the actuarial present value, as of a specified date, of the total cost of all employees' vested and non-vested pension benefits that have been attributed by the pension benefit formula to services performed by the employees to that date. The projected benefit obligation includes the actuarial present value of all pension benefits attributed by the pension benefit formula. In the event a pension plan is discontinued, a vested benefit obligation remains a liability of the employer. Payments of pension benefits decrease both the projected benefit obligation and the fair value of plan assets, while contributions to a plan decrease cash and the fair value of plan assets, while contributions to a plan decrease cash and the financial statement liability.
The projected benefit obligation does not appear on the books of the employer, but the difference between the projected benefit obligation and the fair value of the pension plan's assets is recognized as a pension plan asset or liability. In addition, the employer maintains a worksheet record of the projected benefit obligation. Accumulated benefit obligations is an alternative measure of the pension obligation; it is calculated like the projected benefit obligation, except that current or past compensation levels instead of future compensation levels are used to determine pension benefits. In the event a pension plan is discontinued, the balance of any unfunded accumulated benefit obligation remains a liability of the employer.
Basically, there are two types of pension benefit formulas; pay-related benefit and non pay-related benefit. For a non pay-related benefit formula, the accumulated benefit obligation and the projected benefit obligation are the same.
Reporting Postretirement Benefits
In the United States, the cost of the postretirement benefits tends to represent the largest portion of a company's total costs of benefits. A liability, labeled accrued cost of other postretirement benefits, is reported in the balance sheet if the Net Periodic Postretirement Benefit Cost (NPPBC) exceeds the amounts contributed to the plan or paid to or for the plan participants during the reporting period. The expected postretirement benefit obligation (EPBO) is the actuarial present value of the postretirement benefits expected to be paid under the terms of the substantive plan. The portion of the EPBO representing the percent value of benefits attributed to the employee's service rendered to date, assuming the plan continues in effect and that all assumptions about future events are met, is referred to as the accumulated postretirement benefit obligation (APBO).
The APBO obligation and the plan assets are measured as of the company's reporting year end date based on the assumptions used for the previous reporting period or adopted during the current year.
What is an Actuary?
An actuary is a business professional who deals with financial impact risk and uncertainty. Actuaries have a deep understanding of financial security systems, with a focus on their complexity, their mathematics, and their mechanisms. Actuaries evaluate the likelihood of events and quantify the contingent outcomes in order to minimize losses, emotional and financial, associated with uncertain undesirable events. Since many events, such as death, cannot be avoided, it is helpful to take measures to minimize their financial impact when they occur.
The following can affect both sides of the balance sheet, and require asset management, liability management, and valuation skills. In 2002 and 2009, a Wall Street Journal Survey on the best jobs in the United States listed actuary as the second best job, while in previous editions of the list, actuaries had been the top rated job.
Actuary duties are to compute or supervise the computation of the premiums for the different forms of insurance contracts which the company issues. To compute or supervise the computation of the reserve liabilities at the end of the year or at any intervening period; to consult with the higher officers of the company whenever requested to do so on any question which may require their presence; to sign innumerable checks and policies and answer questions from clerks coming from all divisions of the office where they need advice or counseling.
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There are many thing that pension plans do for employers and employees that are more qualitative than quantitative. The U.S. pension system has worked well as an employee motivator and as a provider of a special form of social insurance for employees. Many decisions about pension plans have significant workforce and financial implications. Because pension plans are part of the total compensation package, they are useful in attracting and selecting employees and may motivate what the sponsor believes to be desirable behavior. Addressing pension issues requires close collaboration and the employees for whom the plan is designed for.