BNA Pension and Benefits Blog

I read the other day that 20% of the income of a typical medical office is spent on insurance claims administration. Then there's the insurance company cost of administering the claims, plus the cost of the darned ERISA lawyer who brings those class actions.  A billion here, a billion there, pretty soon it starts to add up (Thanks Ev Dirkson).  I read the other day that most of the Democratic candidates for Preident are not only afraid of suggesting single-payor health plans, but are afraid of suggesting expanding employer coverage.  In other words, despite everyone being miserable with the present system, it's become like the weather - everyone complains, no one can do anything about it.  Then I read that some were proposing that ERISA preemption of health care matters be lifted so that the states could be freed to try what the states are supposed to do -- experiment with different ideas so we can get a handle on a national solution.  But the ERISA wags say "no no no. National uniformity is far too important for big corporations.  After all, these corporations can't even keep up with the laws of the tens or hundreds of nations in which they do business so . . .  wait a minute, yes they can and do quite well at it."  And the wags win, because we don't want to upset big corporations.  So the most logical means of finding the answer is removed.  And we are left with nothing.

I think I'll stop reading.

In journalism theory, the headline is a literary genre unto itself. It's supposed to capsulize what follows it so that the reader's own unassisted, low-tech browser linking eyes and brain can discern in a flash whether he or she has an interest in reading more.  Ideally, the headline should also smack of some news value. Or create a sensation. Wuxtry! Wuxtry!

That thought passed me as I looked at my Philadelphia Inquirer business section on a slow-news Saturday this month to spot a business section article headlined "Fewer large firms offering traditional pension plans," picked up from AP.  Not exactly news, certainly not to anyone peeking into this blog.  It's sorta "duh" stuff, or as Yogi would put it, déjâ vu all over again.  But making allowances for that, I read on.

The really new news lay in quantifying "fewer" not just to characterize what has already taken place but what is expected to happen in 2008 and beyond within the top-tier of American industry, the Fortune 100.  We have been told before not to sell the Fortune 100 short on their continuing to maintain, among themselves, DB plans that cover significant numbers in their workforce.  But the trend has been clear. The new numbers, in a fresh survey released in May by Watson Wyatt Worldwide, Inc., are that of 89 DB plans maintained by the companies in the 1986 vintage, only 35 were still being offered in 2006, and in 2007, currently, it is already down to 31.  Explained another way, WWW found, the 10 firms that offered primary DC plans in 1986 had grown to 37 by 2005 and numbered 42 in 2006. And 27 of the firms that featured DB plans in 1986 had moved to "hybrids" from the single such plan 20 years before.

Misnomer as it now stands, the Pension Protection Act of 2007 is widely expected to accelerate still further the terminations or freezes of DB plans in favor of 401(k) plans. Further, provisions of the PPA now sanction certain cash-balance and other hybrid plans as forms to pass muster as DB plans under the IRC and the anti-discrimination laws that protect older workers.  A spokesman for the WWW consultancy indicated that other Fortune 100 companies are "strongly considering" hybrid and DC plans right now, raising expectations that those plans will be on the increase again in 2008.

These trends continue at a time when 401(k) plans are undergoing judicial scrutiny in class actions attacking plan service providers, including mutual funds and their contractual partners in revenue-sharing, for charging excessive and improper fees to plan participants. See 34 BPR 1043 (5-1-07).

Perhaps not as visible as multiple class actions are the implications of an increasing number of studies wiithin the financial and academic communities which are highlighting the "reverse multiplier" phenomenon that almost inheres in DC accounts funded by mutual funds. 

From Economics 101, we learned of the classic "mutliplier" in consumer purchasing power, where $1 of spending in, say, a retail purchase is then "re-spent" several times over as the retailer applies that revenue dollar, variously, to pay wages, add to or replace inventory, procure business services, and on and on, as parts of that one dollar are recycled over and over through the economy.

We are now learning more and more about a form of "reverse multiplier" -- in which the loss to savers that arises from the shortfall between (x) gross market returns from, say, equity mutual funds and (y) the net returns after all expenses are passed on to the fund participants translates to a mutliple of that shortfall in the percentage reduction of retirement payments obtained in annuitizing the final account balance.

Well-managed DB plans are more successful in moderating the "reverse multiplier" because of the economies inherent in scale and risk-pooling and the expertises employed that individual plan partiicipants almost invariably lack. These factors tend to shrink the shortfalls between gross and net returns during the accrual period, making possible more bang for the buck of single-sum present-value that can be converted to a guaranteed life income at retirement.

The metrics are beginning to pile up.  The co-authors of "The Performance of U.S. Pension Funds" headed by Professor Rob Bauer at the University of Maastricht recently found that individual investors give up 250 basis points per year in agency costs in a comparison between their mutual fund returns and pension fund (DB plan) portfolio returns. This fairly confirms the conclusions reached by John Bogle, the former CEO of the Vanguard Group, that mutual funds are far more expensive than traditional pension funds and that an annual shortfall of 250 basis points per year in equity mutual funds is to be expected.  Going further, Bogle has maintained that a similar shortfall, of around 225 points per year, would be experienced in mutual fund bond funds. 

In the stratosphere of advanced financial analysis, Keith Ambachtsheer has examined such studies in the real-world context of "pension delivery organizations,' including mutual funds, and suggests that, compared to DB plan participants, mutual fund participants incur a reduction of at least 1% per annum during their years of employment, with a resulting 20% loss in life income benefits. In "The Ideal Pension-Delivery Organization: Theory and Practice" presented in March 2007 at an Amsterdam conference, Ambachtsheer posits that a combination of fund governance improvements and mitigation of agency costs offers a potential for doubling the pension per dollar of retirement savings, versus the end-results to be expected from persistent agency conflicts and poor governance. Ambachtsheer's paper, available on the Internet, contains an extensive bibliography and a series of endnotes referencing studies for policy consideration in this area.

It's in this realm of the math of individual-account savings plan returns that the continued trend of replacing DB plans with DC plans should arouse the most serious dismay.  Post-PPA, the status quo begs for  truly revolutionary institutional change if financial security in retirement is to remain an achievable goal for the vast majority of American workers.

Abbott A. Leban

Any time a legislative body as large as that of the Texas House of Representatives passes a bill of greater import than the designation of a state flower (e.g., Yellow Rose) or nut (e.g., Pecan) by a unanimous vote (i.e., 140-0), you sense that something odd may be afoot.  As your blogger drafted, the New York Times last Friday (5/18) cast light on the recent passage of a bill in the Texas House that would reject GASB's rules governing disclosure of the cost of promised healthcare benefits for retired employees of the state and its political subdivisions.  (Mary Williams Walsh, "Auditing Rule Is Put at Risk by Texas Bill," NYT, 5/18/07, C1.)

Reportedly, the Texas Senate is expected to vote before Memorial Day on a "softened" version of the House bill which would permit the affected governmental units to adopt and apply the GASB rules but not require them to do so.

The Government Finance Officers Association (GFOA), which includes folks who manage and report on general-account public funds as well as benefit plans and other trust funds, have stirred up outright opposition to the adoption of the GASB rules on grounds which on their face seem Byzantine: the GFOA would rather have the public-sector entities adhere to the more stringent FASB rules which apply to the private sector but which, unlike the GASB rules, do not require "performance audits."

Whether the unanimity in the Texas House would have been breached in a compromise for a permissive-only approach to GASB, we cannot know.  One would think that at least a few votes, if not a majority, could be mustered against "local option," as in prohibiting or allowing the sale of alcohol.  However, if GFOA had its way, the FASB standards would be Texas's. Local finance officials would then have no choice but to bite the bullet on calculating and disclosing an actuarial cost estimate of their reporting units' accrued obligations to pay post-retirement healthcare benefits.

GASB or FASB, either would nevertheless greatly displease many local officials, such as the Travis County auditor, who oppose any rule which requires some calculation of the government's accrued obligations for "other [non-pension] post-employment benefits" (OPEBs).

To maintain, as the Travis County official has been quoted to say, that those obligations are "not measurable" because different actuaries at two different valuation dates previously furnished healthcare cost estimates as wide apart as $89 million and $320 million (although they later closely converged on numbers of similar magnitudes) is ostrich-like: it is not to deny that the significant millions involved are that much greater than zero.

In a practical world, there ought to be a way for that county government and others like it to be able to avoid or lessen the risk of having their current credit ratings promptly downgraded in the wake of disclosing astronomical numbers (in the context of their finances generally) with no funding plans in place. Public officials ought to be able to find midway courses between, on the one hand, drastic cuts in public services and employee payrolls and, on the other, huge hikes in any of those relatively few tax and other revenue sources that political subdivision units have control over.

In the immediate aftermath of the Enron era scandals, when most public pension funds had taken large hits to their funded status, the legislative tack taken in a number of states entailed the adoption of credible plans, instituting step-rate increases in employer contributions -- in some cases, accompanied by temporary, defeasible employee contribution increases.  These were calibrated to make funding progress while the equity markets regained public confidence and staged an expected comeback -- sooner or later. Those efforts are by now proving themselves effective.

Granted, trying to remedy a pension plan funding deficit is not as politically daunting a task as deciding to begin funding long-term benefit payouts from scratch.

Cities and counties which have not already begun that task could be -- and some are -- banking on a pipe dream: that someday very soon, through overarching Federal action, America will enjoy universal healthcare coverage.

But before new legislation can possibly be enacted and set on a path to implementation, which could occupy the entire term of the next adminstration, realistically Congress will have had to attack the long-term funding shortfalls under both Social Security and Medicare. The truly "universal" health coverage that many now yearn for will also need to address issues of co-existence with Medicare (including the Part D program instituted just last year) and, in time, the "universal" plan's transitioning into or possibly swallowing up at least the benefits side of present-day Medicare for Medicare eligibles.

Until then, state and local governments with retiree healthcare plans will be forced to fend for themselves in quandaries of their own making.  The present values of future benefit obligations created by plan sponsors have a reality of their own, an existence independent of rule-makers.

Abbott A. Leban

Insuring the employee’s risk

The benefit gambit currently in vogue is a new kind of risk-transfer.  Instead of having the employer assume the employee’s long term risk (by defined benefit pensions, and by comprehensive health benefits), the name of the game now seems to be: transfer the risk to the employee.  How?  First, by giving the employee a defined contribution 401(k) and letting the employee take the risk that it might not be sufficient for retirement; and second, by designing a health benefit plan where large components of the risk of health costs are transferred back to the employee, and giving the employee a Health Savings Account that may or may not be sufficient to cover that risk.  And so on.

What about insurance of these risks?  Where are the new insurance products (protection for employee’s medical “HSA-Gap”? Employees’ 401(k) inflation protection?) designed to absorb and mutualize the employees’ cost of these risks?  Why not provide that kind of insurance to employees, but through employers, on a group basis purchasable by employees through their own § 125 cafeteria?

This is a market in need of new insurance products.  The insurers have a well-established but perhaps obsolete habit of “selling” group products primarily to employers, designed to save money for employers and reduce the employer’s risk.  What new safe harbors or other law changes are needed to facilitate an insurance industry effort to reduce employees’ risks?  What new “suitability” issues are involved? Surely the need is there, and the need should make the market.