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Published on October 22, 2007
BusinessWorld Wealth Manager Section
Going on a world tour, running a small business, drawing income from a
property or simply taking care of the whims of their children and grandchildren
largely make up the post-retirement dreams of Baby Boomers.
The reality is... a major concern of Baby Boomers, those born from 1946 up to
1964, is whether their retirement plan benefits are sufficient for them to
maintain their current standard of living in their retirement years. They look
to their employers to provide retirement plans that would give substantial
retirement benefits. While many employers recognize this responsibility, their
major concern is the increasing cost of setting up and maintaining a substantial
and competitive retirement program. Due to the impending retirement of Baby
Boomers, employers and plan sponsors are confronted with the ever increasing
liabilities of their current employer-provided retirement programs.
It helps to understand the various types of retirement plans and the inherent
risks each plan carries in relation to designing a cost effective retirement
plan. Below are the five relevant items that a plan sponsor should consider in
amending a currently established retirement program.
- Types of Retirement Plans
Basically, retirement plans can be divided into two broad types: Defined
Contribution (DC) and Defined Benefit (DB) plans.
Under a DC plan, the benefits are based on the amount contributed for each
plan member and are affected by income, expenses, gains and losses on these
contributions.
In contrast, a DB plan promises the plan member a specific benefit at
retirement which may be an exact amount or calculated through a formula that
considers a plan member’s salary and service.
- Investment Risks
Investment risk and investment rewards are assumed by each plan member and not
by the plan sponsor in a DC plan. On the other hand, plan sponsors bear the
investment risk of low returns on contributions to DB plans as the employee
benefits are guaranteed at retirement. Since investment risks are borne by the
employer under a DB plan, there is an open ended nature of risk to the plan
sponsor.
- Plan Costs
Under a DB plan, the cost of benefits grows slowly early in an employee’s
career and accelerates considerably in mid-career. Therefore, the cost of a DB
plan may be low for a young workforce, but extremely high for an older
workforce. This may pose some challenges and risks to the employers and plan
sponsors.
Since most retirement plans in the Philippines are DB in nature, retirement
plan conversion is one of the most common responses of plan sponsors for
mitigating the risks of increasing liabilities under a DB type of plan. A
retirement plan conversion refers to switching from a DB plan to a DC plan, or
a Hybrid plan, which is a combination of the two.
- Communication
Our experience on plan conversions has shown that communication with employees
is very critical to ensure a successful and smooth transition from a DB plan
to a Hybrid plan or a DC plan. Employees should be well informed as to why
these changes are taking place and how they will be affected by the plan
conversion. The communication of this information should be an integral part
of the conversion process from the moment a plan sponsor begins considering
the adoption of a DC or Hybrid plan.
There are a number of issues to be considered before adopting any modification
to a retirement program. Before these modifications take place, most plan
sponsors undertake a review of their existing plan and typically consider a
range of amendments that may be made to the program. The people who are going
to be responsible for communicating any plan changes should be involved in
this crucial aspect of the project.
They need to understand the underlying motivations behind any plan changes
that are adopted. Moreover, they should provide valuable input as the
motivations are evaluated. The vital interventions of good benefits
communicators are essential in designing a plan that can be clearly explained
to both management and rank and file workers in order to facilitate their
acceptance of the new plan.
- Managing Risks
Below are some of the ways that plan sponsors and members can help manage the
risks inherent in retirement plans:
- The plan sponsors should use realistic scenarios and reasonable assumptions
when modeling plan design changes.
- DC plan members should seek the assistance of qualified consultants in
selecting the assumptions used in any forecasting they intend to undertake.
- DC plan members should be educated regarding
the importance of saving for
their retirement and the consequences of inappropriate asset allocation
decisions.
- Plan sponsors should spend time in the plan design stage to consider the
objectives of the retirement program, the nature of their workforce, the
potential risks associated with DB, DC or Hybrid plans as well as the need to
possibly compare their proposed plan with the assumed generosity of their
competitor’s retirement programs. By this, the plan sponsors would be able to
implement the appropriate retirement program for their employees.
All things considered, what’s most important is to make both employees and
plan sponsors understand the consequences and benefits attached to the
retirement plan they mutually select. After all, at the end of the day,
effectively planning and properly preparing ourselves for what lies ahead is the
ultimate goal of these retirement plans—whether it’s as simple as spending your
retirement days in the comforts of your own home or touring the world with your
loved ones.
Ella Marasigan, is an Associate Consultant of Watson Wyatt Worldwide. Watson
Wyatt Worldwide is a leading global consulting firm on people and financial
issues. For more information on retirement valuation and employee benefits,
please contact Ella at ella.marasigan@watsonwyatt.com or call 841-5123.
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