If ever anything was ripe for a revolution in the employee benefits space, it would be the regulation of single employer defined benefit plans. For more than four decades, DB plans have been ruled rather tyrannically by ERISA and its voluminous subsequent regulations.
At the time ERISA was drafted, the chief concern of lawmakers was ensuring that pension promises made by employers to employees were 100% guaranteed. This seemed an appropriate goal for the era, considering the cutbacks participants had recently sustained from underfunded plan failures. Remember that 401(k) plans had yet to be invented, so DB was the only meaningful employer provided retirement benefit option available.
We now know that those full guarantees are incredibly expensive disincentives to employers. Skyrocketing Pension Benefit Guaranty Corporation premiums and the threat of forced funding of full guarantees during times of business hardship are serious impediments to DB sponsorship.
Medical insurers, recognizing the rapidly increasing incremental cost of coverage as levels approach 100%, have long used lower co-insurance levels (such as 80%) to strike a reasonable balance between protection and cost. Perhaps ERISA drafters should have taken a similar approach with DB pensions.
A new problem: lifetime income
But they didn’t, which has contributed to defined contribution becoming firmly established as the primary retirement benefit structure in the U.S. An entire generation of Americans has now passed through full careers with 401(k) as their primary source of retirement benefits. Many have only frozen DB pensions, or possibly none at all. The risk of some loss is now universally accepted as part of the retirement benefit contract.
As such, the key need of employees today is no longer the full guarantee of their pensions. (Those with no DB benefits may not even be familiar with the concept.) Rather, it is the availability of affordable and predictable lifetime income options to complement the pool of assets they have accumulated in their 401(k)s at an acceptable level of risk.
A number of DC-based solutions have come to market touting lifetime income. Many, however, are not widely used. This is because they generally require people to voluntarily hand over substantial sums of money they have spent their careers accumulating to purchase potentially complex annuities at prices perceived to be unattractive.
In its natural state, DB is better suited for providing lifetime income to rank-and-file employees. It delivers the advantages of longevity risk pooling and professional investment management without asking retirees to make stressful annuity purchase decisions. Unfortunately, the types of DB plans that employers would voluntarily implement — ones with design flexibility and risk sharing options to fit their needs — aren’t permitted under law as it exists today.
Henry Ford allegedly said that any customer can have a car painted any color they want so long as it’s black. ERISA essentially takes a similar position: You can have any kind of DB plan you want as long as the pension is 100% guaranteed … and normal retirement age is no later than 65 … and benefits accruals aren’t back-loaded … and eligibility begins at age 21 …
An entire room full of ideas exists to improve U.S. pensions, but ERISA only allows the use of the ones you can see through its keyhole.
Toiling under the ERISA yoke for so long has made employers and retirement providers incapable of even considering new DB plans. Designs that would make DB plan sponsorship more attractive are immediately discounted as impossible under the law. So promising ideas are quickly dropped, and the world tries valiantly to reconstruct DB lifetime retirement income solutions using only DC components.
You say you want a revolution?
With revolutionary change in the air and current regulations struggling to address today’s lifetime income needs, it seems that the beginnings of a grass roots movement may be in place. All interested parties have something to gain from loosening restrictions on DB plans, so they should be on the same side of this issue.
Employers want design flexibility to attract and retain talent, to facilitate dignified retirement of their employees, and to effectively share cost and risk. They are willing to make reasonable contributions but don’t want to take on irreversible or existential risk.
Employees want lifetime income to complement their pool of retirement savings, but they are hesitant to part with their accumulated wealth to get it. They have enough experience with risk that they are now willing to accept a pension with a partial guarantee over a non-existent fully guaranteed one. They are also willing to make tax deferred contributions toward their retirements, but are prohibited from doing so inside DB plans.
The government doesn’t want to take on more private pension risk, but needs help delivering lifetime income to retirees as the finances of Social Security get squeezed. Insuring a lower percentage (like 80) and allowing employers and employees to share the remaining risk would significantly reduce PBGC exposure while still encouraging lifetime income solutions in the private sector.
(Note: I am assuming these changes apply only to future benefit accruals; past DB benefits would continue to operate under current full guarantee rules.)
Identification and articulation are always easier than execution, but common ground apparently exists to open a dialogue on this important issue. Emboldened by the seismic changes of the past year, I will open the discussion by calling for the emancipation of pension design from obsolete and overly restrictive limitations.
If 2016 taught us anything, it is that the needs of stakeholders can’t be ignored indefinitely. Tone-deaf institutions can quickly be discarded, and the status quo isn’t as much of a sure thing as everyone thought.
If you agree, I encourage you to accept my invitation to join the defined benefit revolution. Demand plan design options outside the narrow constraints of current ERISA rules. The future of American lifetime income security may depend on it.
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