Pension Funds Overview

1
Pension Funds Overview

• Pension funds offer savings plans through which
  fund participants accumulate tax-deferred savings
  during their working years for their retirement
• First established in 1759 to benefit the widows
  and children of church ministers
• American Express established the first corporate
  pension fund in 1875
• By 1940, only 400 pensions funds were in
  existence
• Currently there are over 700,000 pension funds

2
Pension Funds, Two Distinct Sectors

• Private pension funds
• funds administered by a private corporation
  (e.g., insurance company, mutual fund)
• Public pension funds
• funds administered by a federal, state, or local
  government (e.g., Social Security)

3
Pension Fund Reserves, 1993-1999 (Bn.)
4
Insured versus Noninsured Pension Funds

• Pension plan - document that governs the
  operations of a pension fund
• Insured pension plan - a pension fund
  administered by a life insurance company
• there is no separate pool of assets backing the
  pension plan but the funds are pooled and
  invested in the general assets of the insurance
  company
• Noninsured pension plans - a pension fund
  administered by a financial institution other
  than a life insurance company

5
Defined Benefit versus Defined Contribution
Pension Funds

• Defined benefit pension - pension plan in which
  the employer agrees to provide the employee with
  a specific cash benefit upon retirement -- 3
  types
• Flat benefit formula - pays a flat amount for
  every year of employment
• Career average formula - pays benefits based on
  the average salary over the entire period of
  employment
• Final pay formula - pays benefits based on a
  percentage of the average salary during a
  specified number of years times the number of
  years of service
• Defined contribution benefit plan - pension plan
  in which the employer agrees to make a specified
  contribution to the pension fund during the
  employees working years

6
Private Pension Funds

• Created by private entities (e.g., manufacturing,
  mining, or transportation firms) and are
  administered by private corporations (FIs)
• Increasingly dominated by defined contribution
  plans
• Types of private pension plans
• 401(k) - employer-sponsored plans that supplement
  a firms basic retirement plan
• individual retirement accounts (IRAs) - self
  directed, tax deferred retirement accounts, may
  contribute up to 2,000/yr.
• Keogh accounts - retirement account available
  only to self-employed, tax deferred

7
Public Pension Funds

• State or local government pension funds
• set up for state or local government employees
• funded on a pay as you go basis meaning that
  collections from current employees are the source
  of payments to the current retirees
• Federal government pension funds - two types
• federal government employees, civil service
  employees, military and railroad employees not
  covered by SS
• Social Security - funded on a pay as you go
  basis with benefits paid to most retired
  individuals from employees present contributions

8
Financial Asset Investments

• Employer and employee pension fund contributions
  are invested in financial assets
• Private pension funds
• the largest institutional investor in the U.S.
  stock market
• totaled 4,624.1 billion in 1999 of which 64.70
  is invested in corporate equities or equity
  mutual funds
• Public pension funds
• state and local pension funds held most of their
  assets in corporate equities (64.69 in 1999)
• Social security contributions are invested in
  relatively low-risk, low-return Treasury
  securities

9
Regulation of Pension Funds

• Employee Retirement Income Security Act (ERISA)
  of 1974
• Funding - ERISA established guidelines for
  funding and set penalties for fund deficiencies
• Vesting of Benefits - ERISA requires that a plan
  must have a minimum vesting requirement
• Fiduciary Responsibilities - ERISA set standards
  governing the pension plan management
• Transferability - allowed employees to transfer
  pension credits from one employer to another
• Insurance - ERISA established the Pension Benefit
  Guarantee Corporation (PBGC)