Since the signing of the Pension Protection Act, the aura of pessimism that continues to hang over the future of private-sector DB plans has been relieved in many quarters by bullish excitement over the potential that the DC plan provisions of the PPA may hold in store for the American workforce -- particularly for the majority of working Americans who are unprotected by any income floor in retirement other than Social Security.
This past month, your blogger has been struck by press reports that Big Labor seems to be moving to the front burner, for serious discussion, hybrid structures that in an earlier day might have been stored away in Labor's research drawer marked "Contingency Plans," to be opened only in the event of a general DB meltdown. Damon Silvers, one of Labor's staunchest advocates, has been quoted to concede that "[o]ur current [pure DB] system is failing," and urges moving away from it now because "[b]y the time [the failure] becomes apparent to the majority of employees, it will be too late." Silvers's own employer, the AFL-CIO, has formally announced principles of retirement income policy that embrace carefully structured DC plans. Reportedly, the SEIU also has in mind a hybrid plan model that employs individual, portable accounts but with pooled investment risk and primarily an annuity form of distribution at retirement.
Commentators on the pension scene view it as highly significant that these major unions, traditional supporters of DB plans, are looking at models that, while preserving some elements of those plans, aim to expand the role of DCs in building atop the Social Security floor to provide retirement income at an adequate "replacement" level. In this lexicon, adequacy translates to 70% of pre-retirement income.
Both within and beyond the labor camp, the bullish outlook on the future for DC plans rests on the most salient features of the PPA reforms: automatic enrollment, default investment options and, within the latter, managed accounts. These features were made all the more concrete by last week's DoL/EBSA release of the PPA regulations proposed as 29 CFR Part 2550 (Default Investment Alternatives Under Participant Directed Individual Account Plans) (71 Fed.Reg. 56806 (Sept. 27, 2006). Like so many works in the rule-making genre, the proposed rule itself occupies little more than four columns, or about 1.35 pages of FR text, preceded by more than 16 pages of the required preliminaries, which in this case put a lot of flesh on the barebones rules.
I especially commend for the serious attention of policy wonks the social research sources cited and summarized in midget font in many of the footnotes throughout these pages -- most often the product of outstanding scholars in the field of what an increasing number of institutions label Financial Gerontology. Among other issues, the sources deal empirically with the incidence of automatic enrollment, its impact on participation, and the percentage distribution of default investment options actually chosen under automatic enrollment plans today.
As one might expect, overall a clear majority of DC plan participants pick the most conservative options (fixed-income, no equity). The proposed rule clearly seeks to inject into the default investment choices a mix of asset classes consistent with capital preservation or long-term capital appreciation, or a blend of both, with age meant to be most often the driving factor in guides to the participant. The aim is to defeat mindless default investing that over the career of the employee "is not likely to generate sufficient savings for a secure retirement." 17 FR at 56806.
Readers will have direct access to summaries of the proposed rule in BNA and other commercial services as well as in CLE program materials.
Of greatest interest to me, with my practice focus on issues of shareholder rights and corporate governance, is the provision of proposed § 2550.404(c)-5(c)(4) of the rule which requires, for a default investment alternative to make the grade as a "qualified default investment alternative" (a "Q-DIA"?), that material provided to the plan relating to a participant's or beneficiary's investment in a Q-DIA, including prospectuses and proxy voting material, will be provided to the participant and beneficiary. Employing assumptions from other parts of other economic analyses in the preamble to the proposal, DoL makes the assumption that at any given time, 5.3% of the participants and beneficiaries in participant-directed individual account pension plans, or more than 2.3 million individuals, will have default investments that will call for providing them with these "pass-through" materials on a quarterly basis, certain of them on other occasions as well. This "paperwork," estimated to amount to 9,404,000 responses (distributions of these materials) to participants per year, obviously iimpose additional cost burdens but come with the territory.
From a shareholder perspective, I would guess that the proxy-voting materials among these distributions in the Q-DIA sector would turn out to be mostly those applicable to mutual funds under management by an investment manager or the fund groups themselves, and much less frequently those on voting individual company shares in the kind of professionally "managed account" that may equally qualify as a Q-DIA. It is questionable whether the union and Taft-Hartley funds that today attempt to exert their DB-plan-rooted "pension power" on director elections, executive compensation plans, and other proxy ballot items can make their proxy voting policies and worker education efforts felt at the beneficial owner level of participant-directed plans that go the Q-DIA route.
Over decades, the continuing decline, freezes and many ultimate terminations of DB plans in the private sector, combined with the widely hoped-for and expected robust growth in both pure DC and hybrid individual-account plans, with a heightened role for long-term equity allocations, will gradually result in fragmenting to a significant degree the "pension power" that labor constituencies have plied in their corporate affairs programs. This then may be one of the prices that Labor may pay for improvements in the American workers' retirement security system which depend on advancing and promoting the growth and heft of DC plans in that system.
By way of postscript, it warrants saying that the proposed rule, and all else that has been noted here, apply only to the ERISA-covered world. As charted in DoL's preamble, the rule does not apply to state, local, and/or tribal government plans. Attacks against traditional DB plans in that sector are both political and parochial and the inroads of DC plans, other than as supplemental to DBs, have been relatively slight.
It appears that labor is at least leaning in the right direction. It is unfortunate that the situation had to become so critical before consideration of viable alternatives could begin. The traditional DB plan design is not a failure -- just decades behind in meeting the real needs of all stakeholder groups, particularly given the uncertainty and volatility that now exists. Unfortunately, it may all be too little, too late in the private sector.
Hopefully, the public pension industry stakeholders will be much more timely in their response to the need for reforming public plans into alternate designs that provide meaningful protection for employees at affordable costs. No stakeholder group should be required to bear all of the risks, but each should bear an appropriate share. In fact, the two most important risks that the employees need protection against, mortality risk and investment risk, cost the employers practically nothing if properly handled.
However, the term "hybrid" can also cover a multitude of bad plan designs. Anyone looking for a plan design and administrative strategy that have been highly successful in a public multiple employer environment would be well served to check out the Texas County and District Retirement System.
Posted by: Ray Henry | October 06, 2006 at 02:15 PM
Has anyone suggested that the overwhelming majority of DC Plans will be able to provide an adequate retirement income to the average worker? Shouldn't there be a rule that says you have to tell participants "If you continue to invest at this rate, and earn 6%, at retirement you will be entitled to $___ per month for the average rest of your life." Once they see what a paltry sum it is, maybe DB plans won't be considered failures anymore.
DB plans are not a policy failure, it's only that the burdensome regulation (in most cases, reasonable regulation as well) leads many businesses to simply abandon them.
We've now put the investment risk on the employee, found out most don't know how to handle it (and invest it in fixed income), so we've created a "default" which is in what the employer should have invested in the first place.
Posted by: Ron Dean | October 05, 2006 at 05:49 PM