I had just completed a fiduciary training session for a client’s Board in South Bend, IN, when one of the more senior board members pulled me aside to tell me a story. His father had been employed by Studebaker when it went under in 1963-and took its pension plan with it. As the story goes, and which I had shared earlier with the Board, the financially struggling automaker had borrowed money from its pension fund in order to keep the company afloat. The company did not steal the funds (it was fully obligated to repay the money back to the plan) but it was a transaction in which a “prudent fiduciary” would not have engaged. Indeed, it was only the influence of the corporate officers on the pension board which enabled the transaction.
History tells the rest: the company went belly-up, not only causing the loss of 4,000 jobs, but also their pensions. That board member discussed the horrible consequences suffered by the former employees and the community at the time. It is that bankruptcy, and loss of the pensions, which served as the “policy trigger” which resulted in the passage of ERISA some ten years later. ERISA would have prevented that disastrous loan which lead to eventual collapse of the retirement plan. It also introduced those important tools which are now central to the operation of plans like enhanced fiduciary standards, tougher minimum required funding standards, the prohibited transaction rules and-for DB plans-pension insurance.
As awful as the Studebaker collapse was, it does evidence the stark reality that the market virtually demands that companies (think “plan sponsors”…) either radically change or go out of business over time. Think about the following:
- No company on the original 1928 Dow Jones Industrial Average is part of the current DJIA.
- Of the five hundred largest U.S, Companies in 1957, only 74 were still part of that select group, the Standard and Poor’s 500, forty years later. Only a few had disappeared in merger; the rest either shrank or went bust. (from the “The Black Swan,” by Nassim Nicholas Taleb, Random House, 2007,” p. 22).
This all has incredible relevance in a market under which the “decumulation” of retirement benefits has shifted from defined benefit plans to defined contribution plans. I had written in 2009 that the demise of the DB plan was inevitable because of the rise and fall of plan sponsors. It is noteworthy that it is one thing to rely upon an employer’s current funding of the accumulation of the lifetime income benefit through its employer sponsored retirement plan; it is quite another to expect that same employer sponsored plan to actually provide the guaranteed retirement payout over the retiree’s lifetime.
This really is where DC lifetime income programs have the opportunity to provide an important advantage over the traditional DB plan. Unlike the DB benefit, the properly designed DC program does NOT require that the plan sponsor be around for the lifetime of the retiree-portability of the DC benefit is a critical differentiator. It also means that the retiree payouts are not dependent upon the employer’s design of the payout. The innovative programs being made available in the market today include features well beyond anything that could be offered in a traditional DB plan. This includes (but is by no means limited to) things like the elective, periodic purchase of a pension guarantees over time; the ability to access cash balances which are also funding the retirement income benefit; and a sort of equity participation which can raise lifetime income guarantees over time.
This “advantage” does, however, require that the design actually be able to protect these DC retirement accumulations which are to be paid out over the lifetime of the retiree. The protections need to be able to be provided even with the demise of the employers which had been used to fund the retirement benefit. It’s obvious that true “portability’ is a fundamental element, especially where there is no PBGC backing the benefit. There are a number of different ways in which these DC programs being offered in the market accomplish this, and there are some innovative methods being developed to address this issue as well. Not all of these methods are simple, and not all of them provide the same level of protection. Understanding how these protections work (and understanding where they may or may not be needed) is one key to the success of this process.