The Defined Benefit Plan System: What Does the Future Hold?

In the year 2005 we saw a national debate on the nation's most important defined benefit plan, Social Security. The nation overwhelmingly expressed its sentiment that the system of work-related, guaranteed lifetime benefits provided the security that people wanted for themselves, members of their family, and the nation as a whole.

But the private defined benefit plan system has been withering away without any great public debate. Whether for reasons of cost, competition, volatility or other business reason, employers have been steadily and increasingly choosing to move away from defined benefit plans. The recently enacted Pension Protection Act is not likely to reverse this trend, and in combination with new accounting rules, we are likely to see this trend accelerate. In their place, we have defined contribution plans that place the risk on the individual. These risks include the risk of not contributing, of not investing well, of prematurely tapping funds, and of taking a distribution that does not last a lifetime. These risks will affect millions of families, and my guess is that many more will have retirement incomes lower than previous generations.

Had this trend been brought up for public debate, how would the American public have responded? And should we change course, or is it too late? Perhaps more importantly, is the choice simply between retaining the old defined benefit plan system, and moving to 401(k)-type plans?

Most benefit professionals seem to believe that 401(k) plans simply shift too much risk onto employees, and simply are not going to provide the retirement security of the old defined benefit plan. But employers do not want to assume all the cost and risk associated with traditional defined benefit plans. But must a plan have the risk assumed entirely by the employer OR the employee? Are there not arrangements where part of the investment and volatility risk and/or longevity risk are better shared? Is there a next generation of pension plan on the horizon, one that better meets the needs of both employers and employees?

Unfortunately, these changes are happening largely outside the great public debate. We will need to address these private pension plan issues in the larger context of long-term retirement security if we are to get a better handle on the direction we want for this country.

And in the meantime, long live Social Security -- it may increasingly be all that most people have.

Comments

[Greg Jackson]

I agree with Frank. DB plans can be done in such a way to limit the liability. Perhaps you are an ERISA attorney who drafts documents for DB plans. When is the last time you drafted a DB plan for a non-union manufacturing facility in the US? What I see on the rise are ESOPs not DB plans. Sure you have the cash-balance plans gaining ground in the professional service sector. I am talking about the hourly working individual with a high school education on the shop floor. They are not concerned with what they will have in 20 years and their employer knows it. They will choose a $1 hour raise now versus $1,000 month pension in 20 years.

[Judy Mazo]

PS - I agreed with Sherwin's comment a little too soon. I support his point about the invaluable role of unions in the promotion of DB plans and the need for some comparably strong countervailing economic pressure. I disagree with his statement that unions are "doing a terrible job" in protecting retirement security at this point. They are trying to marshall the strength to protect it, and frankly, they deserve a lot of the credit for burying Bush's plans to eviscerate Social Security.

[Judy Mazo]

David, Sherwin and Frank are all right. A "great national debate" looks to be nearly politically impossible, because it would mean that participant groups (ahem, David) and employer groups would each have to yield something -- openly, on the record, not just at off-the-record policy discussions around conference tables.

In fact, the multiemployer provisions in PPA'06 do a little of what David asked -- they allow for cutbacks in protected benefits, like early retirement subsidies, when a plan is in extreme circumstances, instead of throwing all of the cost directly on the employers. This was a result of the kind of private sector leadership Frank is calling for, advanced by a union-employer-fund coalition. That coalition came about because no one element of the multiemployer community had enough clout to get what it really wanted.
In my opinion, by the way, DB/Ks are just a packaging mechanism, the (k) part doesn't fund the defined benefit and the two benefit types could just as easily (but not quite as efficiently) be separate plans. If we get to the point of having excludible employee contributions funding the DB - like 414(k) "pickup" programs for the public sector -- that might be a serious option, although the public sector is not exactly going through a renaissance on the DB side.

[Frank Cummings]

I take issue with Greg Jackson’s DB epitaph - “its dead and there is no fixing it.” It’s not really dead, and there sure is a way to fix it. All of these predictions of demise have the same underlying premise, which Jackson recites this way: “Does anyone really think a company is going to absorb this kind of liability for its employees? ” What he’s talking about, however, is the risk that a risky actuarial manipulation will generate an easy funding schedule up front, ending in an unmanageable and disastrous funding requirement in the end. But it doesn’t have to be done that way in the first place. A DB plan can be “fully funded” at the outset – even overfunded to some extent – and kept that way. And if the portfolio is well diversified (including a safe mix of equities and debt instruments), serious risk is avoided. And the annual cost of such a DB plan, in most demographics, is LESS than a substantial 401(k) plan. Most law firm qualified DB plans do it that way, without unreasonable burden or risk. In other words, some sponsors are reaping a shameful harvest now, but with the blinders off and conservative funding up front, DB is still the very best thing in many, if not most, circumstances.

[Mike Hughes]

Seems strange to me that not a single entry mentions DB-K Plans and the new Section 414(x) of the Internal Revenue Code. While not a "miracle cure" for the correctly observed slow death of DB plans, this new provision might allow them out of hospice care, beginning in 2010

[Greg Jackson]

Hold on folks, its dead and there is no fixing it. The decline of security in this country started back when the gold standard went away. Reagan boasted about a world economy. Well he got it. Does anyone really think a company is going to absorb this kind of liability for its employees? Heck no, because they don't know if they will be in business next year, much less 20 years from now. Wake up. Next to go is medical insurance. "Sorry but we just can't afford it". The reality is you have to take care of yourself. Save your own money or work until you die. Those are the two choices.

[Sherwin Kaplan]

In discussing the decline of traditional, private sector defined benefit plans, most discussions I have read seem to avoid the basic cause. These plans did not arise voluntarily, they were forced on most companies by strong unions. As the strength of unions declined, so did their ability to protect defined benefit plans. No government regulation or legislation will alter the fact that these plans will continue to decline until a countervailing economic force reverses the trend. This force clearly will not be organized labor which, to be honest, is doing a terrible job of defending these plans.

[Frank Cummings]

I doubt that “public debate” is really relevant. The public does not design private pension plans – employers do, or unions do, or they both do. Plan design is still a settlor function, and rightly so – subject only to such minimum mandatory features as may be turn up in ERISA and IRC amendments.

Whether the free market will provide decent retirement security for most employees has always been doubtful – a huge percentage of the workforce has always lacked decent retirement security. But if “the public” calls the tune for all private employers, the result will be an additional government-provided benefit for all – really just another layer of Social Security – and it’s not at all clear that the current safety nets (Social Security and Medicare) are strong enough, financially, to survive at their current levels.

I don’t disagree with the notion that the current trend is a recipe for disaster. But how to fix it? It will take some real leadership among the larger plan sponsors – private action, more than public debate.