PENSION PLANS 1. PUBLIC PENSION FUNDS • Created by state, local or federal govt. 2. PRIVATE PENSION PLANS • Created by private agencies including industrial, labor, service, non-profit and educational organizations.
PRIVATE PENSION PLANS • • Defined Benefit Plan Under this plan, contributions are determined according to benefits to be provided. • If the pension plan value exceeds the benefits: 1. Companies may reduce the future contributions 2. Or may distribute surplus to shareholders but not to employees. • Defined Contribution Plan • Under this plan, benefits are provided according to accumulated contributions and fund’s performance. • Firms know with assurance the amount of funds to contribute but benefits are not predetermined.
UNDER FUNDED PENSIONS • In defined benefit plan, future pension obligations are uncertain, as they are defined in terms of fixed payments to retirees. • Payments are dependent on salary levels, retirement ages, life expectancies. • Due to overestimated future rate of returns, some pension plans became under funded as they reduced their contributions and reported higher earnings.
Pension Benefit Guaranty Corporation • PBGC guarantees that defined benefit plan participants will receive their benefits on retirement. • It is financed by annual premiums, income generated from investments and income from assets acquired from terminated pension plans. • It monitors the pension plans periodically to make sure that they will provide benefits guaranteed by them. • In case of inadequacies of funds, they are terminated and is taken over by PBGC.
PENSION FUND MANAGEMENT • Regardless of how premiums are collected, premiums must be managed until required to pay benefits. • Private pension plans are dominated by stocks while public plans are evenly invested in corporate bonds, stocks and other credit instruments.
PENSION FUND MANAGEMENT • Pension fund management can be classified according to strategy used to manage portfolio: • Matched Funding • investment decision which match planned cash outflow payments with cash inflows generated. • They give assurance that future liabilities will be covered regardless of market movements by matching long term liabilities with long term assets (bonds).
• It limits the management discretion with respect to investment. It allows only those investments which match future payouts. • Investment can not be done in callable bonds. • Each liability payout may require a separate investment to which it can be perfectly matched. Thus, it increases transaction costs for the pension fund.
PENSION FUND MANAGEMENT • Projective Funding • Investment decisions providing greater flexibility in constructing a portfolio to benefit from expected market & interest rate movements. • They invest in bond index portfolios which may include investment grade corporate bonds, Tbonds. It does not include entire set of these index bonds but a portion only to mirror market performance. • They also invest in equity portfolio indexes as they avoid transaction cost related to frequent trading.
INSURED PLANS VS TRUST PORTFOLIOS • Insured plans are managed by life insurance companies. Premiums are invested in annuity policies and benefits are provided by insurance companies on retirement. • Some pension funds are managed by trust departments of commercial banks. Companies provide general guidelines to these trust departments to manage their pension plans. • These guidelines may include:
Guide. Lines • The percentage of portfolio that should be invested in equity or bonds. • A desired minimum return on overall portfolio. • Maximum amount to be invested in real estate. • Min acceptable quality ratings for bonds • The maximum amount to be invested in any one industry. • The average maturity of bonds in portfolio. • Max amount to be invested in options. • Min size of companies in which to invest