Employee Benefit PlansJoseph Applebaum, FSA

October 4, 2002

Views expressed are those of the speaker and do not represent the views of the U.S. General Accounting Office. applebaumj@gao.gov

Employee Benefit Plans

•What is the Big Picture Issue?•Ageing of the U.S. Population

•U.S. is not alone – G-7 countries have similar, if not worse trends.•Key Drivers

•Increased Life Expectancy•Decreased Fertility

Fertility Rates

0

0.5

1

1.5

2

2.5

3

3.5

4

1940 1950 1955 1960 1970 1975 1980 1990 2000 2025 2050 2075

Fertility Rates

1940 1950 1955 1960 1970 19752.23 3.03 3.5 3.61 2.43 1.77

1980 1990 2000 2025 2050 20751.85 2.07 2.13 1.96 1.95 1.95

Life Expectancy at Birth

60

65

70

75

80

85

90

1940 1950 1955 1960 1970 1975 1980 1990 2000 2025 2050 2075

Females

Males

Life Expectancy at Age 65

10

12

14

16

18

20

22

24

1940 1950 1955 1960 1970 1975 1980 1990 2000 2025 2050 2075

Females

Males

Life Expectancy

Year Males Females Males Female1940 61.4 65.7 11.9 13.41950 65.6 71.1 12.8 15.11955 66.7 72.8 13.1 15.61960 66.7 73.2 12.9 15.91970 67.2 74.9 13.1 17.11975 68.7 76.6 13.7 181980 69.9 77.5 14 18.41990 71.8 78.9 15 192000 73.7 79.4 15.7 192025 76.5 81.5 17.3 20.32050 79 83.5 18.8 21.82075 81.1 85.3 20.2 23.1

At Birth At Age 65

Employee Benefit Plans

Demographic trends have implications for•Size and composition of work force,•Pension costs, •Healthcare costs

Structure of U.S. pension programs •Mixed system – part voluntary, part governmental program•Three ( four ?) legged stool – Social Security, employment based pensions, personal savings ( post-retirement earnings)

 

Social Security

•Financed on a modified pay-as-you-go basis•Combined employer/employee tax rate for 2002 of 12.4% on earnings up to $84,900•Maximum amount subject to tax is updated each year for change in average wage in covered employment•Benefits are paid to retired and disabled workers, their eligible spouses, children, and their survivors (esp. aged widows)

Social Security

•Big Issue for Social Security is cost rising relative to payroll.•Because current system is pay-as-you-go (more or less) cost of system is related to number of workers supporting each beneficiary. Let’s look at costs over next 75 years or so.•The costs go sharply upward, a few years from now, when Baby Boomers start retiring. •Under current program benefit rules, costs keep growing well after the Boomers retire.• Principal drivers are demographic – life expectancy, particularly life expectancy at retirement age, and fertility which determines, with a lag, number of workers. 

Social Security Costs and Income Rates

0%

5%

10%

15%

20%

25%

1990 2000 2010 2020 2030 2040 2050 2060 2070 2080

Cost as % of taxable payroll

Income as % of taxable payroll

Social Security Costs and Income Rates

Year

OASDI Cost as a Percentage

of Taxable Payroll

OASDI Tax Income as a

Percentage of Taxable Payroll

1990 10.7% 12.7%2000 10.4% 12.7%2010 11.0% 12.8%2020 14.2% 13.0%2030 17.2% 13.2%2040 17.8% 13.3%2050 17.9% 13.3%2060 18.6% 13.3%2070 19.4% 13.4%2080 20.1% 13.4%

Social SecurityTwo sets of measures of demographic trends: dependency ratios – the ratio of those over 65 ( or those under 20 plus those over 65) to those between ages 20 and 64, and; ratio of beneficiaries to workers.Some observations

•Around 1950, only a portion of the elderly were eligible for social security benefits•The percentage of workers covered by social security has grown•The labor force participation rates of women have increased•Labor force participation rates of older (greater than 55) men declined.•Disability benefits were introduced in 1950’s, but didn’t expanded rules later.

Aged and Total Dependency Ratios

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1950 1960 1970 1975 1980 1990 2000 2025 2050 2075

Total Dependency

Aged Dependency

Aged and Total Dependency Ratios

Year Aged Total 1950 13.8% 71.9%1960 17.3% 90.4%1970 18.2% 94.7%1975 18.5% 89.8%1980 18.9% 74.9%1990 20.9% 70.1%2000 21.1% 69.9%2025 31.9% 77.1%2050 37.1% 81.2%2075 42.3% 85.1%

OASDI Covered Workers and Beneficiaries(in millions)

0

25

50

75

100

125

150

175

200

1950 1960 1970 1975 1980 1990 2000 2025 2050 2075

Covered Workers

Beneficiaries

OASDI Covered Workers & Beneficiaries (in millions)

YearCovered Workers

OASDI Beneficiaries

1950 48.3 2.91960 72.5 14.31970 93.1 25.21975 100.2 31.11980 113.6 35.11990 133.7 39.52000 153.7 45.22025 175.4 77.42050 187.3 94.12075 200.5 109.9

OASDI Covered Workers (in millions)

0

25

50

75

100

125

150

175

200

1950 1960 1970 1975 1980 1990 2000 2025 2050 2075

OASDI Covered Workers(in millions)

1950 1960 1970 1975 198048.3 72.5 93.1 100.2 113.6

1990 2000 2025 2050 2075133.7 153.7 175.4 187.3 200.5

OASDI Beneficiaries (in millions)

0102030405060708090100110

1950 1960 1970 1975 1980 1990 2000 2025 2050 2075

OASDI Beneficiaries(in millions)

1950 1960 1970 1975 19802.9 14.3 25.2 31.1 35.1

1990 2000 2025 2050 207539.5 45.2 77.4 94.1 109.9

Worker to OASDI Beneficiary Ratio

02468101214161820

1950 1960 1970 1975 1980 1990 2000 2025 2050 2075

Worker to Beneficiary Ratio

1950 1960 1970 1975 198016.7 5.1 3.7 3.2 3.2

1990 2000 2025 2050 20753.4 3.4 2.3 2.0 1.8

Social Security

Problems are well understoodLast major reform culminated in 1983

Amendments•Incremental changes in benefits and taxes•Put program in balance for 75 years –

Program is now out of actuarial balance •Valuation period change•Experience & assumption changes

What are criteria for solution?•Continue to provide layer of protection against insured events•Program should be sustainable•Cost levels should be near current levels

Demographic Impacts on Private Plans

Demographic forces also impact private sector employee benefit plans.Phased retirement

•Most defined benefit pension plans allow early retirement ( i.e. before 65)•Some plans require a reduction in monthly payments to make up for longer payout period – others don’t; virtually none do not subsidize early retirement – that is, the value of the early retirement benefit is greater than the value of deferring starting receipt of those benefits until 65.

Phased Retirement

Let’s consider a hypothetical employee who is now, say age 60 and is entitled, based on her service with the company, to a monthly pension benefit of 50% of final pay. If she retires, she can go to work elsewhere and get her pension benefit and increase her current compensation. (She might even go on to collect a pension from the second employer!). Under current law before she attains NRA, there are significant impediments for the employee to collect her pension benefits while continuing to work for her current employer.

This economic conundrum has existed since the wide spread introduction of pension plans – however, the relatively slow growth in the labor force supply has increased the importance of addressing this problem.

OASDI Covered Workers(in millions)

1950 1960 1970 1975 198048.3 72.5 93.1 100.2 113.6

1990 2000 2025 2050 2075133.7 153.7 175.4 187.3 200.5

Changes in Pension Plan Design

Around 1975, the dominant pension benefit design was the final average pay defined benefit plan – a typical formula is the product of

•Years of service•Final pay•A number around 1.5% 

The trend over the last 25 years or so has been towards other designs – defined contribution plans, and hybrid defined benefit plans like cash balance plans.

Changes in Pension Plan Design

Regulatory Environment•Introduction of Section 401(k) of the Internal Revenue Code.•Greater rigidity of defined benefit funding

Current designs are more attractive to mobile,typically younger, workers.Changes in employment patterns

•Service economy•Greater job mobility •Less attachment to firm

•Employer Views•Risk aversion•Changing demographics – the relative scarcity of younger workers

Trends in Pension Plan Coverage(millions)

YearDB

ParticipantsDC

Participants1979 29.4 17.51980 30.1 18.91985 29.0 33.21990 26.3 35.51995 23.5 42.71996 23.3 44.61997 22.7 48.01998 23.0 50.3

Source: U.S. Dept. of Labor