Plop, DROP, Fizzle: Discussion of the Sustainability of ... Docs/Public... · Partial Lump Sum...

National Conference on Public Employee Retirement SystemsNational Conference on Public Employee Retirement Systems

Plop, DROP, Fizzle: Discussion of the Sustainability of DROP Plans

NCPERS 2019 Public Safety Conference October 28 – 30New Orleans, LA

By Brad Heinrichs, FSA, EA, MAAAPresident/CEOFoster & Foster Consulting Actuaries, Inc.


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Agenda

DROPBack‐DROPPLOPDiscussion


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Deferred Retirement Option Plan (DROP)

• Participant works until their DROP eligibility date

• Participant elects to enter DROP at that time.

• Benefit is calculated based upon DROP entry pay/service

• Participant continues to work until retirement or to the end of the DROP period, whichever comes first

• Participant receives accumulated DROP balance (checks he would have received if “really” retired, plus interest) in addition to a monthly annuity


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Advantages1. Retiree may receive large lump sum in addition to an

annuity2. Benefits may receive a high fixed or variable rate of

interest during the DROP period3. DROP participants continue to receive a salary during

which time the DROP balances are accumulating


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Advantages (continued)4. Plan may earn “extra” interest on balances5. The employer is able to retain experienced workers as

part of the workforce past their Normal Retirement Age6. Member contributions typically cease upon entry into

the DROP Plan7. Potential for fewer delays in commencement of the

monthly annuity8. Continues to receive highly subsidized health benefits


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Deferred Retirement Option Plan (DROP)Disadvantages1. Ineligible for benefit improvements or disability benefits

that occur during DROP period2. Loss of pay/service credits during DROP period3. Hinders upward mobility of membership4. DROP Plans add leverage to pension plan costs...see Dallas

Police & Fire!5. DROP Plans may have additional administrative expenses

that would not have otherwise occurred6. Could be costly if designed inappropriately


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Back‐DROP

• Contains all of the characteristics of a DROP Plan, except that participant may work past eligibility date and retroactively enter the DROP

• Excess pay/service accruals since DROP date are forfeited

• Member contributions are refunded• DROP balance accumulated with fixed interest


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Back‐DROPAdvantages

1. All of the advantages of DROP Plans apply to a BACK‐DROP arrangement

2. Participant may continue to weigh his/her options as to whether going into the DROP would have been a good idea, and then may choose to make an election to retroactively enter the DROP

3. A BACK‐DROP arrangement allows participants who might have gone into the DROP at eligibility date to see if promotions, increases in salary, or benefit improvements occur, and if not, then could retroactively enter the DROP. If so, then retire in a regular manner with a higher monthly benefit.

4. Member preserves disability and death benefits


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Back‐DROPDisadvantages1. Same DROP disadvantages exist2. Adverse selection!3. Administratively complex4. Fixed interest is only interest option available5. Cost of benefit improvements will be higher6. Costs more than forward DROP because there will only be

“winners” who utilize it


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Partial Lump Sum Option (PLOP)

• Been around forever, yet just recently becoming more popular

• PLOP is another optional form of benefit, just like 10 Yr Certain‐and‐Life, or 100% Joint‐and‐Survivor

• Difference is that portion of benefit is taken as a lump sum


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Partial Lump Sum Option (PLOP)Advantages

1. May receive part of the benefit as a lump sum without having to forgo future pay and service accruals.

2. Easier to administer, and DROP balances do not need to be kept

3. Member receives pay and service accruals after DROP eligibility age

4. Member receives benefit improvements or disability benefits that he wouldn’t have been eligible for in DROP since they are still active

5. May enhance the upward mobility of the membership, since participants can receive a lump sum at retirement.

6. Member could receive partial lump sum at Early Retirement Age


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Advantages (continued)7. A PLOP could be added in addition to a DROP. A participant selecting a PLOP would have an

initial DROP Balance that is the partial lump sum


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Disadvantages 1. Partial lump sums typically smaller than DROP Balances2. PLOPs can be more difficult to calculate than a typical retirement

benefit, and may result in higher benefit calculation fees3. PLOP distribution is restricted to 5%, 10%, 15%, 20%4. Low pay increases or less overtime post DROP eligibility date may make

the PLOP a worse option than DROP


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Numerical AnalysisSample Plan

– Normal Retirement Age: 50/0 or 25 & Out– 3.25% FAP * Svc– Normal Form = 10 Yr Certain & Life– FAP = $50,000– DROP Interest = 6.5%– COLA= 3.0% deferred

1 year– FAP is average of best 5

years of total pay


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DROP vs PLOP50 w/ 10 Yrs of Svc at Normal Retirement Age

RegularAge Service 10 CL Bft 10 CL LS 10 CL LS 10 CL LS Present Value 10 CL Bft LS Present Value

50 10 $1,354 $1,219 $25,719 $1,151 $38,578 $1,083 $51,437 $257,187 $1,354 $0 $257,187

55 15 2,916 2,625 51,567 2,479 77,350 2,333 103,133 515,667 1,354 95,748 335,209


50 10 $1,354 $1,219 $25,719 $1,151 $38,578 $1,083 $51,437 $257,187 $1,354 $0 $257,187

55 15 2,442 2,198 43,178 2,076 64,768 1,953 86,357 431,785 1,354 95,748 335,209


50 10 $1,354 1,219 $25,719 1,151 $38,578 1,083 $51,437 $257,187 $1,354 $0 $257,187

55 15 2,031 1,828 35,919 1,727 53,879 1,625 71,838 359,192 1,354 95,748 335,209

15% PLOP 20% PLOP

20% PLOP

DROP

DROP10% PLOP 15% PLOP

10% PLOP 15% PLOP 20% PLOP

10% PLOP

7.5% Pay Increases

3.75% Pay Increases

7.5% Pay Increases

3.75% Pay Increases

0 % Pay Increases0% Pay Increases

DROP


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DROP vs PLOP50 w/ 25 Yrs of Svc at Normal Retirement Age


50 25 $3,385 $3,047 $64,297 $2,878 $96,445 $2,708 $128,593 $642,967 $3,385 $0 $642,967

55 30 5,832 5,249 103,133 4,957 154,700 4,666 206,267 1,031,333 3,385 239,370 838,023


50 25 $3,385 $3,047 $64,297 $2,878 $96,445 $2,708 $128,593 $642,967 $3,385 $0 $642,967

55 30 4,884 4,395 86,357 4,151 129,535 3,907 172,714 863,569 3,385 239,370 838,023


50 25 $3,385 3,047 $64,297 2,878 $96,445 2,708 $128,593 $642,967 $3,385 $0 $642,967

55 30 4,063 3,656 71,838 3,453 107,758 3,250 143,677 718,384 3,385 239,370 838,023

15% PLOP

15% PLOP 20% PLOP

20% PLOP

DROP

10% PLOP 15% PLOP 20% PLOP

0 % Pay Increases0% Pay Increases

DROP

DROP10% PLOP

10% PLOP

7.5% Pay Increases

3.75% Pay Increases

7.5% Pay Increases

3.75% Pay Increases


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Conclusions From Numerical Analysis

• DROPs tend to provide the larger lump sums• PLOPs tend to beat DROPs when you have less

service at DROP eligibility age or if you receive large pay increases post DROP eligibility age

• DROPs beat PLOPS when you have large amounts of service at DROP eligibility age or if you receive low pay increases post DROP eligibility age


Do DROP Programs Cost Money?

Answer: Very likely yes, but it depends upon how they are designedItems that add to the cost:

– High fixed interest guarantees– Late DROP entry dates– COLAs while in DROP– Ability to leave money in DROP after true retirement with a high fixed interest rate

– BACK DROPs and antiselection– Member contributions cease while in DROP

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Do DROP Programs Cost Money?

Items that make DROPs more cost neutral:– Low or zero fixed interest guarantees– DROP eligibility only at Normal Retirement Age or at ages where less service is required

– COLAs disallowed while in DROP– Continued contributions by Members in DROP– Provide a penalty to the benefit for each year in DROP

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Are DROP Plans Popular?

Foster & Foster is the actuary for approximately 350 public pension boards in the United States– 270 of these plans have a DROP component– Approximately 100 of these have undergone some sort of revision in the last 5 years

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Example 1(a): Current Forward DROP Provisions

Age Salary AFC Service

Annual Accrued Benefit

Forward DROP Benefit

Benefit Interest

Benefit Account Balance

Member Contributions

Member Contribution

Interest

Member Contribution

BalanceForward DROP

Balance

50.25 84,870 82,000 25 65,600 n/a n/a n/a n/a n/a n/a n/a51.25 87,840 84,903 26 70,639 65,600 797 66,397 11,419 128 11,547 77,94452.25 90,914 87,875 27 75,924 65,600 2,290 134,287 11,819 393 23,759 158,04653.25 94,096 90,950 28 81,491 65,600 3,819 203,706 12,232 672 36,663 240,36954.25 97,389 94,133 29 87,355 65,600 5,380 274,686 12,661 967 50,291 324,97755.25 100,798 97,428 30 93,531 65,600 6,977 347,263 13,104 1,279 64,674 411,937

328,000 19,263 61,235 3,439

Scenario Present Value Annual Benefit DROP BalanceA 1,121,932 65,600 411,937B 1,012,295 93,531 n/a

Increase in PVB Due to Forward DROP (A - B) 109,637Forward DROP Assumptions: % Increase in PVB 10.8%-- Age 55.25 at Termination of Employment-- Age 50.25 at Forward DROP Entry Date-- 25 Years of Service at Forward DROP Entry Date-- 5-Year Forward DROP Period Elected-- $82,000 Average Final Compensation at Forward DROP Entry Date-- 2.25% Interest Crediting during Forward DROP Period (when applicable)-- 3.50% Salary Increases

Forward DROP Analysis - Hypothetical Retiree A

DescriptionForward DROP

Normal Retirement


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Example 2(a): Eliminate Return of Member Contributions




Benefit Interest



Member Contribution

Interest

Member Contribution

BalanceForward DROP

Balance

50.25 84,870 82,000 25 65,600 n/a n/a n/a n/a n/a n/a n/a51.25 87,840 84,903 26 70,639 65,600 797 66,397 n/a n/a n/a 66,39752.25 90,914 87,875 27 75,924 65,600 2,290 134,287 n/a n/a n/a 134,28753.25 94,096 90,950 28 81,491 65,600 3,819 203,706 n/a n/a n/a 203,70654.25 97,389 94,133 29 87,355 65,600 5,380 274,686 n/a n/a n/a 274,68655.25 100,798 97,428 30 93,531 65,600 6,977 347,263 n/a n/a n/a 347,263

328,000 19,263


Forward DROP Assumptions:-- Age 55.25 at Termination of Employment Increase in PVB Due to Forward DROP (A - B) 44,963-- Age 50.25 at Forward DROP Entry Date % Increase in PVB 4.4%-- 25 Years of Service at Forward DROP Entry Date-- 5-Year Forward DROP Period Elected-- $82,000 Average Final Compensation at Forward DROP Entry Date-- 2.25% Interest Crediting during Forward DROP Period (when applicable)-- 3.50% Salary Increases



Normal Retirement


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Example 3(a): Eliminate Interest Crediting




Benefit Interest



Member Contribution

Interest

Member Contribution

BalanceForward DROP

Balance

50.25 84,870 82,000 25 65,600 n/a n/a n/a n/a n/a n/a n/a51.25 87,840 84,903 26 70,639 65,600 n/a 65,600 11,419 n/a 11,419 77,01952.25 90,914 87,875 27 75,924 65,600 n/a 131,200 11,819 n/a 23,238 154,43853.25 94,096 90,950 28 81,491 65,600 n/a 196,800 12,232 n/a 35,470 232,27054.25 97,389 94,133 29 87,355 65,600 n/a 262,400 12,661 n/a 48,131 310,53155.25 100,798 97,428 30 93,531 65,600 n/a 328,000 13,104 n/a 61,235 389,235

328,000 61,235


Forward DROP Assumptions: Increase in PVB Due to Forward DROP (A - B) 86,935-- Age 55.25 at Termination of Employment % Increase in PVB 8.6%-- Age 50.25 at Forward DROP Entry Date-- 25 Years of Service at Forward DROP Entry Date-- 5-Year Forward DROP Period Elected-- $82,000 Average Final Compensation at Forward DROP Entry Date-- 2.25% Interest Crediting during Forward DROP Period (when applicable)-- 3.50% Salary Increases



Normal Retirement


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Example 4(a): Eliminate Return of Member Contributions and Interest Crediting




Benefit Interest



Member Contribution

Interest

Member Contribution

BalanceForward DROP

Balance

50.25 84,870 82,000 25 65,600 n/a n/a n/a n/a n/a n/a n/a51.25 87,840 84,903 26 70,639 65,600 n/a 65,600 n/a n/a n/a 65,60052.25 90,914 87,875 27 75,924 65,600 n/a 131,200 n/a n/a n/a 131,20053.25 94,096 90,950 28 81,491 65,600 n/a 196,800 n/a n/a n/a 196,80054.25 97,389 94,133 29 87,355 65,600 n/a 262,400 n/a n/a n/a 262,40055.25 100,798 97,428 30 93,531 65,600 n/a 328,000 n/a n/a n/a 328,000

328,000


Forward DROP Assumptions:-- Age 55.25 at Termination of Employment Increase in PVB Due to Forward DROP (A - B) 25,700-- Age 50.25 at Forward DROP Entry Date % Increase in PVB 2.5%-- 25 Years of Service at Forward DROP Entry Date-- 5-Year Forward DROP Period Elected-- $82,000 Average Final Compensation at Forward DROP Entry Date-- 2.25% Interest Crediting during Forward DROP Period (when applicable)-- 3.50% Salary Increases

Description


Forward DROPNormal Retirement


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Example 6(a): Implement Universal DROP Charge & Eliminate Return of Member Contributions and Interest Crediting



Forward DROP Charge


Benefit Interest



Member Contribution

Interest

Member Contribution

Balance

Forward DROP

Balance

50.25 84,870 82,000 25 65,600 n/a n/a n/a n/a n/a n/a n/a51.25 87,840 84,903 26 70,639 5% 62,320 n/a 62,320 n/a n/a n/a 62,32052.25 90,914 87,875 27 75,924 5% 62,320 n/a 124,640 n/a n/a n/a 124,64053.25 94,096 90,950 28 81,491 5% 62,320 n/a 186,960 n/a n/a n/a 186,96054.25 97,389 94,133 29 87,355 5% 62,320 n/a 249,280 n/a n/a n/a 249,28055.25 100,798 97,428 30 93,531 5% 62,320 n/a 311,600 n/a n/a n/a 311,600

311,600

Scenario Present Value Annual Benefit DROP BalanceA 986,096 62,320 311,600B 1,012,295 93,531 n/a

Forward DROP Assumptions:-- Age 55.25 at Termination of Employment Increase in PVB Due to Forward DROP (A - B) -26,199-- Age 50.25 at Forward DROP Entry Date % Increase in PVB -2.6%-- 25 Years of Service at Forward DROP Entry Date-- 5-Year Forward DROP Period Elected-- $82,000 Average Final Compensation at Forward DROP Entry Date-- 2.25% Interest Crediting during Forward DROP Period (when applicable)-- 3.50% Salary Increases

Forward DROPNormal Retirement


Description


Are DROP Plans Sustainable?

YES!!• Modifications may be necessary moving forward

• May need to eliminate explicit cost or implicit risk• May want to remove provision of being able to continue to leave

DROP monies in the plan after retirement• Do whatever is necessary to remove the political risk

• Pay attention to the percentage of assets associated with DROP balances

• Learn from the experiences of others

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Questions?

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Plop, DROP, Fizzle: Discussion of the Sustainability of ... Docs/Public... · Partial Lump Sum...

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