Private Wealth E-Book

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Serie: CFA Institute Investment Perspectives
• Sprache: Englisch

Seitenzahl: 1250

Veröffentlichungsjahr: 2009

Beschreibung

An in-depth examination of today's most important wealth management issues Managing the assets of high-net-worth individuals has become a core business specialty for investment and financial advisors worldwide. Keeping abreast of the latest research in this field is paramount. That's why Private Wealth, the inaugural offering in the CFA Institute Investment Perspectives series has been created. As a sister series to the globally successful CFA Institute Investment Series, CFA Institute and John Wiley are proud to offer this new collection. Private Wealth presents the latest information on lifecycle modeling, asset allocation, investment management for taxable private investors, and much more. Researched and written by leading academics and practitioners, including Roger Ibbotson of Yale University and Zvi Bodie of Boston University, this volume covers human capital and mortality risk in life cycle stages and proposes a life-cycle model for life transitions. It also addresses complex tax matters and provides details on customizing investment theory applications to the taxable investor. Finally, this reliable resource analyzes the use of tax-deferred investment accounts as a means for wealth accumulation and presents a useful framework for various tax environments.

Leseprobe

Table of Contents

Title Page

Copyright Page

Foreword

Introduction

PART I - LIFE-CYCLE INVESTING

CHAPTER 1 - THE FUTURE OF RETIREMENT PLANNING

DEFINED-BENEFIT RETIREMENT PLANS

DEFINED-CONTRIBUTION RETIREMENT PLANS

The Next Generation of Retirement Planning

Qualities of Plan Design: Simplicity and Constancy

TECHNOLOGY AND TOOLS FOR CREATING PRODUCTS

CONCLUDING ILLUSTRATION

QUESTION AND ANSWER SESSION

REFERENCES

CHAPTER 2 - IS PERSONAL FINANCE A SCIENCE?

NOTES

CHAPTER 3 - LIFETIME FINANCIAL ADVICE: HUMAN CAPITAL, ASSET ALLOCATION, AND INSURANCE

FOREWORD

INTRODUCTION

HUMAN CAPITAL AND ASSET ALLOCATION ADVICE

HUMAN CAPITAL, LIFE INSURANCE, AND ASSET ALLOCATION

RETIREMENT PORTFOLIO AND LONGEVITY RISK

ASSET ALLOCATION AND LONGEVITY INSURANCE

WHEN TO ANNUITIZE

SUMMARY AND IMPLICATIONS

APPENDIX 3A: HUMAN CAPITAL AND THE ASSET ALLOCATION MODEL

APPENDIX 3B: LIFE INSURANCE AND THE ASSET ALLOCATION MODEL

APPENDIX 3C: PAYOUT ANNUITY VARIATIONS

ACKNOWLEDGMENTS

NOTES

REFERENCES

CHAPTER 4 - THE THEORY OF OPTIMAL LIFE-CYCLE SAVING AND INVESTING

THEORETICAL INTRODUCTION

FIVE KEY CONCEPTS

NEW FINANCIAL PRODUCTS

CONCLUSION

ACKNOWLEDGMENTS

NOTES

REFERENCES

CHAPTER 5 - IS CONVENTIONAL FINANCIAL PLANNING GOOD FOR YOUR FINANCIAL HEALTH?

METHODOLOGY

RESULTS

CONSUMPTION SMOOTHING VS. MIS-TARGETING SPENDING

PORTFOLIO “ADVICE”

CONCLUSION

NOTES

REFERENCES

CHAPTER 6 - THE LIFE CARE ANNUITY

NOTES

REFERENCES

CHAPTER 7 - THE LONGEVITY ANNUITY: AN ANNUITY FOR EVERYONE?

WHAT MAKES INSURANCE VALUABLE?

TURNING IRAs INTO INCOME

LONGEVITY ANNUITIES TO MAXIMIZE SPENDING

ROBUSTNESS ANALYSIS

CONCLUSION

APPENDIX 7A: PUBLIC POLICY CONSIDERATIONS

ACKNOWLEDGMENTS

NOTES

REFERENCES

CHAPTER 8 - A SUSTAINABLE SPENDING RATE WITHOUT SIMULATION

THE RETIREMENT FINANCES TRIANGLE

STOCHASTIC PRESENT VALUE OF SPENDING

ANALYTIC FORMULA FOR SUSTAINABLE SPENDING

MAIN RESULT: EXPONENTIAL RECIPROCAL GAMMA

NUMERICAL EXAMPLES

EFFECTS OF INVESTMENT STRATEGIES

CONCLUSION AND NEXT STEPS

ACKNOWLEDGMENTS

NOTES

REFERENCES

CHAPTER 9 - ASSET ALLOCATION WITHOUT UNOBSERVABLE PARAMETERS

CONVENTIONAL USE OF CRRA UTILITY

SHORTFALL-PROBABILITY MINIMIZATION

RECONCILIATION OF METHODS

MODIFICATIONS FOR REALISTIC SITUATIONS

REEXAMINING THE ARGUMENTS

CONCLUSIONS

ACKNOWLEDGMENTS

NOTES

REFERENCES

PART II - INVESTMENT MANAGEMENT FOR TAXABLE PRIVATE CLIENTS

CHAPTER 10 - INVESTMENT MANAGEMENT FOR TAXABLE PRIVATE INVESTORS

FOREWORD

PREFACE

Organization and Topics

ACKNOWLEDGMENTS

PART I A CONCEPTUAL FRAMEWORK FOR HELPING PRIVATE INVESTORS

INTRODUCTION AND CHALLENGE

THEORY AND PRACTICE IN PRIVATE INVESTING

LIFE-CYCLE INVESTING

PART II PRIVATE WEALTH AND TAXATION

LIFESTYLE, WEALTH TRANSFER, AND ASSET CLASSES

OVERVIEW OF FEDERAL TAXATION OF INVESTMENTS

TECHNIQUES FOR IMPROVING AFTER-TAX INVESTMENT PERFORMANCE

PART III ORGANIZING MANAGEMENT FOR PRIVATE CLIENTS

INSTITUTIONAL MONEY MANAGEMENT AND THE HIGH-NET-WORTH INVESTOR

PORTFOLIO MANAGEMENT AS A MANUFACTURING PROCESS

PART IV SPECIAL TOPICS

INDIVIDUAL RETIREMENT PLANS AND LOCATION

ON CONCENTRATED RISK

ASSESSMENT AND BENCHMARKING FOR PRIVATE WEALTH

REVIEW OF SECTION SUMMARIES

APPENDIX 10A: MORE ON LOCATION

APPENDIX 10B: MORE ON CONCENTRATED RISK

NOTES

REFERENCES

CHAPTER 11 - CORE/SATELLITE STRATEGIES FOR THE HIGH-NET-WORTH INVESTOR

TRADITIONAL APPROACH TO PORTFOLIO STRUCTURE

CORE/SATELLITE STRATEGY

CONCLUSION

QUESTION AND ANSWER SESSION

CHAPTER 12 - THE HIGHER EQUITY RISK PREMIUM CREATED BY TAXATION

ACKNOWLEDGMENTS

NOTE

REFERENCES

CHAPTER 13 - TAX DEFERRAL AND TAX-LOSS HARVESTING

SHORT-TERM VS. LONG-TERM CAPITAL GAINS TAXES

ALGEBRA OF DEFERRED TAXES

SHORT DEFERRAL PERIODS ARE NOT WORTHWHILE

MITIGATING ESTATE TAXES

TAX-LOSS HARVESTING

CONCLUSIONS

QUESTION AND ANSWER SESSION

NOTES

CHAPTER 14 - TAX MANAGEMENT, LOSS HARVESTING, AND HIFO ACCOUNTING

PAST STUDIES

LOSS HARVESTING AND HIFO

MONTE CARLO SIMULATIONS

CONCLUSION

NOTES

REFERENCES

CHAPTER 15 - INVESTING WITH A TAX-EFFICIENT EYE

ACADEMIC FINDINGS

U.S. BOND STRATEGIES

S&P 500 INDEX STRATEGIES

TAX INEFFICIENCIES OF HEDGE FUNDS

CONSTRUCTIVE-SALE RULES

CONCLUSION

QUESTION AND ANSWER SESSION

NOTES

CHAPTER 16 - DIVERSIFYING CONCENTRATED HOLDINGS

EQUITY RISK MANAGEMENT

THE IMPETUS FOR HEDGING

COMMONLY USED STRATEGIES

COMPARING ALTERNATIVE STRATEGIES

CONCLUSION

QUESTION AND ANSWER SESSION

NOTES

CHAPTER 17 - HEDGING LOW-COST-BASIS STOCK

HEDGE OR MONETIZE

CUSTOMIZED ANALYSIS

CONCLUSION

QUESTION AND ANSWER SESSION

NOTES

PART III - TAX-EFFICIENT WEALTH ACCUMULATION

CHAPTER 18 - TAX-ADVANTAGED SAVINGS ACCOUNTS AND TAX-EFFICIENT WEALTH ACCUMULATION

FOREWORD

PREFACE

INTRODUCTION

CHOOSING BETWEEN TRADITIONAL IRAs AND ROTH IRAs: THE BASICS

EMPLOYER MATCHING AND CONVERTING A TRADITIONAL IRA TO A ROTH IRA

CHOOSING BETWEEN NONDEDUCTIBLE IRAS AND TAXABLE INVESTMENTS

VALUING TAX-SHELTERED ASSETS ON A TAXABLE EQUIVALENT

EARLY WITHDRAWAL PENALTIES AND BREAKEVEN TIME HORIZONS

ASSET LOCATION BETWEEN TAXABLE AND TAX-DEFERRED SAVINGS ACCOUNTS

IMPLICATIONS FOR FINANCIAL ANALYSTS

APPENDIX 18A: PROOF OF EQUIVALENCY FOR STANDARDIZED PRETAX AND AFTER-TAX INVESTMENTS

APPENDIX 18B: SIMPLIFICATION WHEN TAX SAVINGS ARE REINVESTED IN 401(k)

APPENDIX 18C: DERIVATION OF BREAKEVEN WITHDRAWAL TAX RATE FOR NONDEDUCTIBLE IRA

APPENDIX 18D: DERIVATION OF FUTURE VALUE INTEREST FACTOR OF A TAXABLE ANNUITY

APPENDIX 18E: BREAKEVEN INVESTMENT HORIZON FOR A TRADITIONAL IRA AND A ROTH IRA

NOTES

REFERENCES

CHAPTER 19 - AFTER-TAX ASSET ALLOCATION

LOGIC OF AFTER-TAX ASSET ALLOCATION

SHARING OF PRINCIPAL, RETURNS, AND RISK

ASSET LOCATION IN AN AFTER-TAX FRAMEWORK

CONCLUSION

NOTES

REFERENCES

CHAPTER 20 - WITHDRAWAL LOCATION WITH PROGRESSIVE TAX RATES

THE MODEL

RESIDUAL ACCUMULATIONS AND WITHDRAWAL SUSTAINABILITY

CONCLUSION

APPENDIX 20A: ALGORITHMS FOR WITHDRAWAL STRATEGIES

NOTES

REFERENCES

PART IV - AFTER-TAX PERFORMANCE MEASUREMENT

CHAPTER 21 - AFTER-TAX PERFORMANCE EVALUATION

WHY THE AFTER-TAX FOCUS

FACTORS AFFECTING TAX EFFICIENCY

MEASURING AFTER-TAX PERFORMANCE

CONCLUSION

QUESTION AND ANSWER SESSION

CHAPTER 22 - TAXABLE BENCHMARKS: THE COMPLEXITY INCREASES

STANDARD BENCHMARK RULES

AIMR AFTER-TAX STANDARDS

IMPORTANCE OF THE CAPITAL GAIN REALIZATION RATE

CONVERTING A STANDARD PRETAX BENCHMARK

SHADOW PORTFOLIOS

CONCLUSION

QUESTION AND ANSWER SESSION

NOTE

CHAPTER 23 - EXPLAINING AFTER-TAX MUTUAL FUND PERFORMANCE

DATA

METHODOLOGY

RESULTS

CONCLUSIONS AND IMPLICATIONS

ACKNOWLEDGMENTS

APPENDIX 23A: CONSTRUCTION OF TAX-ADJUSTED RETURNS

NOTES

REFERENCES

ABOUT THE CONTRIBUTORS

INDEX

CFA Institute Investment Perspectives Series is a thematically organized compilation of high-quality content developed to address the needs of serious investment professionals. The content builds on issues accepted by the profession in the CFA Institute Global Body of Investment Knowledge and explores less established concepts on the frontiers of investment knowledge. These books tap into a vast store of knowledge of prominent thought leaders who have focused their energies on solving complex problems facing the financial community.

CFA Institute is the global association for investment professionals. It administers the CFA® and CIPM curriculum and exam programs worldwide; publishes research; conducts professional development programs; and sets voluntary, ethics-based professional and performance-reporting standards for the investment industry. CFA Institute has more than 95,000 members, who include the world’s 82,000 CFA charterholders, in 134 countries and territories, as well as 135 affiliated professional societies in 56 countries and territories.

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To carry out its work, the Research Foundation funds and publishes new research, supports the creation of literature reviews, sponsors workshops and seminars, and delivers online webcasts and audiocasts. Recent efforts from the Research Foundation have addressed a wide array of topics, ranging from private wealth management to quantitative tools for portfolio management.

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Copyright © 2009 by CFA Institute. All rights reserved.

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Published simultaneously in Canada.

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eISBN : 978-0-470-48279-7

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FOREWORD

Industry reports are clear; globally, the ranks of the high-net-worth individual (HNWI) have grown faster than increases in economic output. India and the Pacific Rim have experienced the most pronounced growth. Although recent declines in asset prices will certainly temper HNWI growth, the secular trend of wealth creation that drives increases in the high-net-worth population remains intact. Additionally, all investors are being asked to assume greater responsibility for the management of their financial future, particularly as it relates to retirement planning.

As a result, the demand for wealth management services is growing immensely, and building a competitive private wealth management practice requires a program of education and training. Many organizations offer training of various levels of sophistication for advisers serving this market. We like to think the CFA Program, started in 1963, is chief among them.

The increasing demand for wealth management services has also increased the supply of educational materials in this area. Here again, CFA Institute has been at the forefront of developing content for practitioners—with this book being just one example.

Included are materials published by CFA Institute and the Research Foundation of CFA Institute that meet the highest standards for quality and relevance. And to help guide the reader, the 23 individual pieces are grouped in four sections that address different concerns in the private wealth area: life-cycle investing, investment management for taxable private clients, tax-advantaged savings accounts, and after-tax performance. Each area addresses issues that are as unique as the clients that private wealth managers serve. And each area highlights approaches for managing these unique needs.

Being a compilation of materials from the Research Foundation of CFA Institute, the Financial Analysts Journal, and CFA Institute Conference Proceedings Quarterly, this book taps into the vast store of knowledge of some of the most prominent thought leaders—ranging from Nobel Prize winners, to academics, to practitioners—in private wealth who have focused their energies on solving the complex problems facing individual investors. We are grateful these authors have found a fertile home for their ideas at CFA Institute and the Research Foundation of CFA Institute.

I am very pleased, therefore, to present Private Wealth: Wealth Management in Practice the first in our CFA Institute Investment Perspectives Series. I know you will find it a useful guide and resource in meeting the challenges of private wealth management.

ROBERT R. JOHNSON, CFADeputy CEO and Managing DirectorCFA Institute

INTRODUCTION

The management of private client assets is comprehensive and complex. Institutional asset managers often have focused mandates to manage a pool of financial assets (often in the same asset class or subasset class) for the benefit of an end investor, as in the case of a mutual fund manager or pension fund manager. The purview of the wealth manager, however, extends beyond a particular asset class or even financial assets in general. It encompasses a broad range of implied assets and liabilities in an individual’s or family’s comprehensive portfolio that affect the ultimate disposition of the financial assets.

For some investors, implied assets include the value embedded in a stream of social security or pension payments as they approach retirement. Conceptually, the value of these cash flows can be estimated and their risk described. For younger investors, estimating the value and describing the risk of their future earning stream may be significant. These assets are certainly not tradable. They nonetheless have value (often times relatively significant value) and are germane to overall life-cycle planning and asset allocation analysis.

Without a doubt, each solution is unique. It depends on individual goals, preexisting risk exposures and tolerances, and investment constraints—all of which are often correlated with the client’s wealth level. The fundamental wealth management process, however, is generally applicable even if the ultimate solutions and outcomes vary considerably by client. Moreover, optimal solutions derive from an understanding of the complex interactions between investments, taxes, estate planning, and other issues.

To illustrate how complex these interactions can become, consider an incredibly simple case. A 65-year-old single woman has just retired. She has no bequest motive and is extremely risk averse. She plans to spend the rest of her life residing in a rented apartment, reading, writing, painting, strolling on the beach, and traveling. Her only assets are her state-sponsored retirement benefits, a tax-deferred retirement account worth $1 million, and a taxable money market account worth $1 million. What is the safest investment strategy that she can pursue to maximize her spendable after-tax income for as long as she lives?

The risk to her standard of living posed by uncertain longevity and inflation can be addressed by annuitizing part of her wealth, and market risk can be minimized by investing in inflation-protected default-free bonds. But there is still the substantial risk of future tax increases. Should she invest in tax-exempt bonds to avoid uncertainty about tax increases? Conceptually, inflation-protected tax-exempt bonds or annuities are candidates for dealing with these risks, but they are not yet available as retail products. So, the wealth manager faces the problem of incomplete markets, an understanding of which lends insights for financial innovation.

Next, the wealth manager must assess how much risk the client can accept to accomplish her goals. But this decision depends in part on the tax characteristics of the investments, which influences the choice of accounts where those assets might be located. The choice of tax-deferred retirement accounts has estate planning implications and may affect how her state-sponsored retirement benefits are taxed as well.

This book is a thematically organized collection of some of the best wealth management thinking contained in the annals of CFA Institute and the Research Foundation of CFA Institute. Some of the material represents insightful guidance on common problems, such as managing concentrated stock positions. Other authors have built on classic conceptual frameworks of legendary thinkers, such as Paul Samuelson and Harry Markowitz, giving new application to their pioneering ideas and testifying to the power of adhering to fundamental principles. Still other authors have pushed the boundaries of traditional thinking by offering new paradigms and ways of thinking about the issues confronting the growing ranks of individuals and families that have accumulated wealth for which they bear ultimate management responsibility.

With the proper tools, opportunities for the wealth manager to add value abound. This book provides those tools. The skeleton of the book is organized around three chapters commissioned by the Research Foundation of CFA Institute. Each chapter develops an integrated framework with broad application. Selected articles from the Financial Analysts Journal and CFA Institute Conference Proceeding Quarterly are then used to either develop these themes more fully or extend the analysis in yet more practical ways.

Part I examines life-cycle investing. Robert Merton and Paul Samuelson set the stage with musings about the state of financial planning in general. In “The Future of Retirement Planning,” Dr. Merton discusses the forces that precipitated the shift toward defined-contribution retirement plans and predicts the evolution of innovative financial and insurance products that will manage individual risk and accommodate common behavioral tendencies. Dr. Samuelson argues that retirement risk can best be managed through a common pool of diversified securities in “Is Personal Finance a Science?”

With that backdrop, Roger Ibbotson; Moshe Milevsky; Peng Chen, CFA; and Kevin Zhu in their chapter “Lifetime Financial Advice: Human Capital, Asset Allocation, and Insurance” develop a framework to address the fundamental problem of life-cycle finance—allocating the value of one’s financial and implied assets over one’s lifespan. The problem involves the management of many risks (mortality risk and longevity risk not least among them) subject to constraints imposed by exogenous factors, such as the nature of one’s human capital.

The remaining works in Part I build on these concepts and introduce other possible solutions. Zvi Bodie, Jonathan Truessard, and Paul Willen, for example, propose a methodological framework to develop contracts that meet consumers’ life-cycle needs. Mark Warshawsky advocates life-care annuities, which combine a life annuity with long-term care insurance. The economic efficiency of this product stems from the correlation between mortality risk and healthy lifestyles, which effectively curbs the adverse selection problem that would arise if each product were sold separately. Jason Scott outlines the advantage of the longevity (or deferred) annuity, which efficiently manages longevity risk without the disadvantages of a traditional immediate annuity. Laurence Kotlikoff outlines problems with using spending targets in retirement planning. Moshe Milevsky and Chris Robinson derive a simple model to estimate sustainable spending rates without resorting to Monte Carlo analysis. Finally, Michael Stutzer develops an asset allocation model that reconciles expected utility maximization models with shortfall probability minimization models.

The second part addresses issues confronting high-net-worth investors. In the chapter “Investment Management for Taxable Private Investors,” Jarrod Wilcox, CFA; Jeffrey Horvitz; and Dan diBartolomeo develop a holistic framework that avoids many criticisms of modern portfolio theory while using computational techniques that investment professionals are familiar with. They pay particular attention to tax-efficient asset allocation and portfolio management techniques, such as tax-loss harvesting and concentrated stock management. They also develop a framework for implementation that allows the wealth management firm to address the problem of providing customized solutions to a heterogeneous clientele.

Robert Gordon, Jeffrey Horvitz, Scott Welch, Andrew Berkin, and Jia Ye develop the themes of tax-loss harvesting and managing low-basis stock positions further. Clifford Quisenberry, CFA, illustrates how some of these concepts manifest themselves in a core/satellite investment strategy, and Martin Leibowitz illustrates how taxes interact with inflation to increase the after-tax equity risk premium for taxable investors.

Part III develops an analytical framework and rules of thumb for the ubiquitous investor facing decisions involving tax-advantaged savings accounts, such as 401(k) plans and Roth IRAs. The model developed by Stephen Horan, CFA, in the chapter “Tax-Advantaged Savings Accounts and Tax-Efficient Wealth Accumulation” is applied to a wide range of decisions, such as choosing between different types of plans, Roth IRA conversions, asset location, and tax-efficient withdrawal strategies for investors facing progressive tax rates on taxable withdrawals. William Reichenstein, CFA, extends these concepts into an asset allocation setting.

Because investors can use only their after-tax wealth to fulfill their spending, dynastic, and philanthropic goals, performance evaluation tools that measure growth in after-tax wealth are important. In the final part, James Poterba and Lee Price, CFA, describe the issues and challenges involved in estimating after-tax performance and propose methodologies. James Peterson; Paul Pietranico, CFA; Mark Riepe, CFA; and Fran Xu, CFA; identify mutual fund characteristics that drive a fund’s tax drag, including portfolio risk, investment style, and recent net redemptions.

We are thrilled to present this resource to the wealth management community and hope it serves as the foundation for future innovation in financial products and analytical frameworks that address the needs of the growing population of individual investors.

Stephen M. Horan, CFAZvi Bodie

PART I

LIFE-CYCLE INVESTING

CHAPTER 1

THE FUTURE OF RETIREMENT PLANNING

Robert C. Merton

The next generation of retirement products will provide the user-friendliness and simplicity of defined-benefit plans, but they will come in the form of increasingly sophisticated defined-contribution plans. The tools and technology needed to design such products are available in the marketplace and need only be adapted to retirement applications.a

With the move to defined-contribution plans, we, the financial services industry, are asking individuals to make complex financial management decisions that they have not had to make in the past and that, for the most part, they are not adequately prepared to make. In addition, I believe we are presenting these decisions in formats that make them difficult for individuals—even those who are generally well educated—to resolve.

I will begin this presentation with a few remarks about defined-benefit retirement plans, particularly how they went wrong and what we can learn from their flaws. I will then discuss defined-contribution plans, which have become the de facto alternative to defined-benefit plans. Unfortunately, traditional defined-contribution plans have a number of features that prevent them from being the long-term answer for employer-sponsored retirement plans. Thus, I will discuss a next-generation solution deriving from defined-contribution plans. Finally, I will discuss financial management technology and the tools available today that can be used to address and help solve the shortcomings of current retirement products.

DEFINED-BENEFIT RETIREMENT PLANS

Most expert observers agree that corporate defined-benefit (DB) plans are on their way out. The trend in that direction was emphasized in particular when IBM announced in early 2006 that it intended to close its defined-benefit plan to both existing and new employees. IBM isan employee-centric, financially strong company with an overfunded DB plan, and yet the DB plan is being shut down. Some observers say that defined-benefit plans have become too expensive for the corporations to maintain; others say they are too risky. I think the simplest explanation for what happened to defined-benefit plans is that they were mispriced, not three or five years ago but from the outset.

For example, assume that the liabilities in a defined-benefit pension plan have the equivalent duration of 10 years and a risk-free rate of 5 percent. Assume, too, that the plan used a blended expected return on the asset portfolio of 9 percent, not risk adjusted (with assets including risky securities). If liabilities that should have been discounted at 5 percent with a 10-year life span are instead discounted at 9 percent, the result is two-thirds of the present value. Thus, for every $1.00 of cost a corporation is expecting from a plan, the cost is actually $1.50.

If a corporation is negotiating with its employees and it offers what it mistakenly believes is $1.00 of benefits that are really worth $1.50, then employees are likely to choose the benefits offered over cash, even if they do not know the actual value of the benefits. As an analogy, consider a corporate automobile perk that allows employees to choose either a Toyota Camry or a Bentley. Which will they choose? Will the outcome be random? I do not think so. Even if they have no idea of the actual cost of each, most people are likely to pick the $300,000 Bentley over a $30,000 Camry, and just so with generous benefits versus cash compensation.

From the very beginning, providers and sponsors should have recognized that the accounting treatment of these plans was systematically underpricing the cost of benefits. Because of this underpricing, I can say with confidence that we will not go through a cycle that brings us back to defined-benefit plans, at least not to plans with such a pricing structure. Defined-benefit plans have some admirable features, and they may be used again, but we will not return to them with these benefits at this price.