I blogged a couple of weeks ago on the DB demise because of what I was seeing my current work on DC annuities, triggered by an interesting e-mail discussion string between fellows of the American College of Employee Benefits Counsel.
But then the PBGC held a 35th anniversary forum shortly thereafter, extolling the idea of revitalizing the current DB system. I thought this made it an opportune time to further the discussion.
The December 7 Forum on DB plans seem to hit it mostly right in its calling the attention to the fundamental value of employers providing "guaranteed income for life" to employees. The National Institute on Retirement Security also reported on the meeting, noting the critical role of Defined Benefit Plans, calling them the "Real Deal." The NIRS has also published its vision with which one can hardly argue. Under a high quality retirement system retirement system:
- employers can offer affordable, high quality retirement benefits that help them achieve their human resources goals;
- employees can count on a secure source of retirement income that enables them to maintain a decent living standard after a lifetime of work;
- the public interest is well-served by retirement systems that are managed in ways that promote fiscal responsibility, economic growth, and responsible stewardship of retirement assets
But here’s where the problem lies. Juxtapose those statements with the following quote from "The Black Swan," by Nassim Nicholas Taleb, Random House, 2007:
"Consider the following sobering statistic.Of the five hundred largest U.S, Companies in 1957, only 74 were still part of that select group, the Standard and Poors 500, forty years later. Only a few had disappeared in merger; the rest either shrank or went bust." p.22
This where the PBGC, the NIRS and Pension Rights Center (which also presented at the conference) have it all wrong: the traditional DB plan does not, and will not, meet these laudable goals if you rely upon the private employer for the financial wherewithal to insure that the funding and fund management will be adequate. Plan sponsors can be terribly conflicted, with their own corporate financial needs creating economic pressure to engage in some sort dangerous "creative accounting" in the management of these plans- which we have all too often seen in the past. I am tempted to argue that public plans do not have this problem, and that they should get a "bye" on this concern. But think again. Many state and local governments are in serous trouble because of a disturbing lack of financial discipline, as they have not really had to "pay as you go" when promising very expensive benefits. Are not these promises really of the most cruel kind, when we find the money to pay for them really is not, nor ever can be, there?
The current DB system is premised on the notion that a private employer can more cost effectively provide this benefit. Logically, this cannot be true because of the lack of sensible pooling even in the largest employers. Some employers will be able to do so today because of their current demographics, but many cannot-and even those who can may find themselves in a bind in a decade or two. The only potential cost savings is in the profit charge on this guarantee issued by an insurer.
In effect, the system believes that it can do a better job at longevity risk management than regulated insurance companies, and to get that insurance for, in effect, free. When all is said and done, it is likely far from free. We are seeing the effect of the fallacy today, with only 19,000 DB plans now being covered by the PBGC.
So if the system REALLY needs a guaranteed lifetime benefit based upon employer sponsorship, one under which employers have the ability to choose the benefits (and thereby control the cost), but one under which the employees should not be exposed to the vagaries of foolish business decisions of their employers’ senior management, what IS the answer?
I truly believe the answer lies in a private insurance system which provides Annuity Transparency, in annuities purchased through the employer sponsored system. I’ll talk about this on my next blog. For now, though, its back to the ski slopes of Quebec….
A footnote, added 12/21: Gretchen Morgenson reports in the Sunday NY Times on a multi-billion dollar failure in the Alaska pension system, caused in large part by the alleged error of Mercer. Again, my point: non-regulated institutions are ill-equipped to manage DB plans, particularly large ones. Had Alaska purchased insurance, the risk of error would have be borne by a well capitalized, highly regulated expert organization.