BNA Pension and Benefits Blog

            Several weeks ago, the ERISA Industry Committee (ERIC) published a new proposal for retirement savings in the United States billed as a “New Benefit Platform for Life Security.” 

            As the first prong, the proposal suggests that there be three types of retirement savings: (1) a defined benefit plan, called a “Guaranteed Benefit Plan,” (2) a defined contribution plan, called a “Retirement Savings Plan” and (3) a short-term security account.  These plans could be offered independently or in combination with one another to provide additional retirement resources beyond Social Security.

            The Program focuses on providing sufficient incentives to maintain and expand employer participation and encourage individuals to contribute to their own retirement security. If implemented, the program would significantly simplify the current system, ideally make it more equitable to employers and employees and expand participation.  The program contains several supplementary initiatives including educational financial planning services, a regulatory program to provide full disclosure of fees and expenses and pre-established limits on both before and after tax contributions for each of the three types of plans.

            While the New Benefit Platform for Life Security has much to recommend it, very little has been written about it and few in the benefits practitioner community seem to have noticed it.

            You can follow the links here to see a copy of the Core Structure for Life Security Plan (the “Summary”) and a longer version that spells out some of the details (see pages 13-17 of report, found in pages 23-27 of this document).

            What do you think of this proposal?  Might it be improved by requiring that employers of a certain size actually be required to offer all three types of plans in combination?

Much has been made of the fact that employers are increasingly turning to 401(k) plans rather than defined benefit plans. Employers are implementing a number of strategies to help employees achieve retirement security in this brave new world. Most of these strategies, such as automatic enrollment and automatic increases in participant deferrals, focus on the asset accumulation phase. At the BNA conference earlier this year on Redesigning Pension Plans and Executive Compensation, Henry Eickelberg of General Dynamics talked about an innovative program that a number of large employers negotiated to help their employees buy annuities at reasonable prices.

The employer group isn't offering the annuities in their qualified plans but instead is making them available to employees for both plan rollovers and direct investment. The annuities include both fixed annuities, with and without inflation protection, and variable annuities. The group negotiated low commissions (.5% on the fixed annuity product). The good news is that these annuities are not limited to the employer group but are available to the public so other employers can bring them to the attention of their employees and financial planners can consider them for their clients. You can check them out at on the website for the Elm Income Group.

Years ago, before the Department of Labor issued its guidance on purchasing the safest available annuity for participants in terminating plans, Interpretive Bulletin 95-1, I advised a client that the standard was "Would you purchase an annity for your mother (not your mother-in-law) from this carrier." So I was intrigued years later by an article that Ron Gebhardstbauer wrote for the Women's Institute on a Secure Retirement (WISER) on the advice he gave his mother at age 77. She began receiving the required minimum required distributions at age 70 1/2 and he determined  that she would do better with an annuity than with the annual payouts, with the added advantage that she wouldn't see her annual payouts decrease as she got older. (Ron is the Senior Pension Fellow for the American Academy of Actuaries and the former Chief Actuary for the PBGC, so he can readiy figure these things out, unlike the rest of us.) I recently checked with Ron and his mother is still enjoying her annuity in her mid-80s.

You may be able to find a better deal through your own plan. I compared the payout on a single-life annuity for a male age 70 from Elm for someone who has $100,000 to invest to the same annuity offered by the federal Thrift Savings Plan (TSP), the 401(k) plan for federal employees. The annual payout under the Elm annuity was slightly less ($814 compared with $834 from TSP). Similar results for a female beginning payouts at age 60 ($605 from TSP versus $664 from Elm). However, most employers don't offer annuities to their DC plan participants and, even if they do, they may not have rates as competitive as TSP. The Elm annuities are definitely worth checking out. And kudos to the employer group that made an effort to bargain these good rates for their employees.

I'd be interested in hearing about any other sources for annuities that offer better rates. With the increasing elimination and freezing of defined benefit plans, employees will need to engage in self-help on the payout side of the 401(k) ledger just as they have to do on the investment side.

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.

Real Retirement Security – What Would it Look Like?

    The massive PPA-2006 did a little to protect the security of one government agency.  But PPA  did almost nothing to protect the retirement security of those who need it the most.  These are the people who are unlikely to accumulate adequate retirement security without employer-sponsored or government-sponsored assistance – the very same middle income employees (Studebaker’s “losers”) who needed it the most 40 years ago just before ERISA’s enactment  (the “target group”).  Studebaker’s “losers” would be adequately protected by the PBGC under today’s law IF, as they did then, they had an adequate DB plan.  But they’d still be living in a dream world if, today, they thought their employer would have a DB plan much longer.

Consider the current status quo:

    DB Plans are freezing or dying or both.

    Without DB Plans, “early retirement” is less and less feasible.

    “Cash balance” hybrid plans?  Perhaps a useful way for an employer to capture an actuarial surplus, but hardly a substitute for the good old fashioned lifetime annuity.  Indeed, hardly even a favorable substitute for a garden variety DC plan or 401(k).

    DC Plans are replacing DB Plans, but hardly anyone thinks that a 401(k) plan by itself will provide retirement security for the middle class.  Why not?  Just “follow the money” – cashout after cashout to pay for tuition, mortgage debt, credit card debt, and so on.

    Employer-sponsored medical benefits?  The tilt away from sufficient full coverage is becoming a landslide,

    Employer-sponsored “lifetime” (vested) retirees’ medical benefits?  Forget it.

    Of course there’s Social Security, but its index is likely to be cut back. 

    And in the meantime, Medicare, or what’s left of it, will itself require greater and greater employee co–payments and premiums to control a seemingly-uncontrollable funding shortfall.  Where do the increased premiums come from?  They’re deducted from Social Security, which makes both of them less and less sufficient.

If there a “fix”?  What would it look like?

    On the pension side: How about “locking-in”?  – No cashouts.  No withdrawals before retirement age.  And all benefits in annuity form.  Objections?  Employees won’t contribute?  But then what’s the message – that employees won’t use 401(k)’s except for short-term savings?  Then why have a tax shelter for that in the first place? – it’s got nothing to do with retirement security.

    On the health benefit side: Well, just keep rearranging the desk chairs on the currently sinking Titanic, but don’t delude yourself into thinking it’s not sinking.  National Health is on the way.  You don’t like it?  Nobody does.  It’s not great.  It’s just inevitable.  (As a current beneficiary of Medicare, I can tell you that my “single payer” system is a lot better than most youngsters’ “managed care” coverage).  I don’t love it.  But I like it a lot better than what I had before age 65.

    On the Social Security side: There’s no free lunch.  It’s the safety net.  We’ll just have to pay for it.  “Third rail” of American politics?  I sure hope so.

    Overall, can retirement security be made more secure (or at least not less secure)?  Sure.  But to do that, politicians will need to persuade themselves and their constituencies that this will not be a painless cure.  It will just be better than the currently-threatened death by an thousand cuts.

The DB system continues to contract.  With new FASB disclosure rules and greater funding volatility under PPA, additional DB plan freezes can be anticipated.  Last year a number of healthy major companies announced plan freezes. 

Once a plan is frozen, it may present a number of long-term regulatory issues for the plan sponsor.  But perhaps more importantly, in a typical situation, a plan sponsor may look at continuing to sponsor a frozen DB plan as more of a required nuisance than something it is really interested in doing.  And, some of the factors that probably generated the freeze in the first place (e.g., FASB and funding volatility) continue even with a frozen plan.  We understand that many companies with frozen plans would prefer that they not have to continue sponsoring them, with all that that entails. 

Most of these companies are probably waiting until asset values can cover the costs of acquiring shared annuities.  However, the insured annuity market has limited capacity to date and, of course, represents an expensive alternative for a company that wants to rid itself of pension liabilities.

Recent press and other reports have indicated that a number of large Wall Street and other financial institutions have an interest in "acquiring" frozen plans at a lower cost to sponsors than insured annuities.  The plans would continue to be maintained by the acquiring institution which would assume all funding and other legal obligations for the plan.  The acquisition of the plan would occur through the vehicle of a business acquisition of a subsidiary of the employer sponsor.  The subsidiary would assume responsibility for the plan prior to the business acquisition.  Employer sponsors would have to contribute some cash or other assets to the business transaction representing the negotiated determination of any plan underfunding (although such amount would presumably be less than would be required to purchase insured annuities). These assets would be dedicated to the pension fund, but held in a "side-bar" non ERISA vehicle.

The benefit to plan participants would be the plan would remain subject to ERISA, carry the PBGC guarantees, and reflect enhanced security because of the additional dedicated assets as part of the business transaction.  The benefit to the historic plan sponsor is that it has rid itself of the plan in total and everything that goes with it in a responsible fashion.  Presumably, the acquiring institutions would make money through enhanced investment portfolio techniques which would allow it, over time, to not have to contribute the entire dedicated additional asset funds to the plans.  We understand that well-capitalized entities with significant capital dedicated solely to acquired plans would be involved in these transactions.  These tranasctions could apply to plans in whole or to just the terminated liabities of such (e.g. retirees and terminated vested).

The transactions would seem to be permissible under existing law if properly structured.  No doubt, PBGC would have a strong interest in assuring plan security and its own well-being. 

ERISA has served American workers relatively well over the past 30 plus years.  Millions of employees have achieved relative retirement security with significant pension and retiree health benefits.  Employers have presumably found employee benefit plans to be a generally positive means of attracting and retaining workers and easing them into dignified retirement in order to replenish the workforce (or sometimes downsize it).  However, the entire employee benefits system has become frayed at the edges, if not the core, and currently seems not to be serving either employers or employees well in many situations. 

ERISA has been constantly amended and Congress, the regulatory agencies and the courts have imposed many burdens that employers would prefer not to deal with.  And the business and economic landscape has changed dramatically over the years.  The DB system appears to be in its death-throes.  Even healthy, successful companies are freezing their plans.  And generous retiree health plans are already a thing of the past except for a relatively small union workforce in certain industries (and even there it is not sustainable). 

Accordingly, we need some alternative to the current system.  I suggest a program under which benefit programs are disassociated from employer sponsorship.  The plans could be developed and provided by major financial, administrative, insurance and other companies.  The programs could pretty much parallel the types of designs that are in use today, even though there would be complete portability and probably only account-based DB type programs under which an account balance could be used, at ultimate retirement, to acquire lifetime annuity benefits.  Employers would provide funding for the benefits which could be flexible from year to year and be subject to some nondiscrimination standards.  Individuals would supplement employer contributions with their own.  People without an employment and employment relationship would also participate in the system.  The current tax advantages for employee benefit plans could largely be preserved, but there would probably need to be a cap on the tax advantage healthcare premium (i.e. amount that either an employee could receive from an employer tax free or that an individual could pay himself/herself on a tax deductible basis- note below, I am proposing equality of access and treatment between employees and those and those not employed).  Presumably, these programs and the new sponsors would be subject to a uniform federal regulation generally similar to ERISA and employers would be permitted to either maintain their own ERISA plan or elect for the new non-sponsorship model.  Health benefits would probably need to be developed through community rating and regional plans somewhat analogous to Medicare part D (with some form of cross subsidy between local or regional plans based on age and experience demographics of each plan's participating pool).

The entire program would certainly be easier to establish for financial type benefits (e.g. 401(k), account based db, life and disability insurance) than it would be for active and retiree health coverage (because the latter would require other market force and legal changes).

The benefit to employers who are willing to continue to provide significant funding for benefits is that they would have little or no fiduciary responsibilities or other obligations associated with sponsorship and they would have no long-term financial commitment to the vagaries of pension funding or the cost spiral of healthcare.  The benefit to employees and others who would now gain access to a benefits system is complete portability, continued partial funding by employers, and equality of treatment of those working and those not working (who could fund their own benefits, or if deemed poor, could receive some government subsidy). 

This new benefit design would, of course, require legislative and regulatory changes and assumption by various companies in the financial and other industries of responsibility for new plan design, effective sponsorship, some financial risk (although that could be limited because DB benefits would presumably be account based and health benefits would be repriced each year as they now are), and fiduciary responsibilities. 

More Mandated Benefits?  Stop!  Think!

    ERISA regulates and mandates a system that is, above everything else, voluntary.  In my view, mandates have no place in it, not because they are not good objectives, but because they are not voluntary, not free, and inevitably counter-productive.

    Why not mandate?  Because mandates undermine the voluntary market - a market that produces for the employees of most participating employers a package of benefits that is better than anything a government could or would mandate .  The voluntary market is not universal (like Social Security or Medicare).  It is a result of business decisions to provide these benefits because they are good business.   Universal mandates (for example, so-called “Mandatory Universal Pensions” or “MUPs”) are always just a devious way of making private employers pay for a safety net that should be paid by taxes.  A mandate will always be minimal, like the minimum wage, because it is a national, universal, rock-bottom benefit.  That is not what private employee benefits are about.

    Why not mandate at the state level (like Maryland’s Pay or Play)?  Same reason, only worse: It’s not even a universal mandate.   It’s still ultra-minimal.  And it guts the private employee benefit system’s cornerstone – federal preemption.  It just balkanizes the system.

    But why not abandon federal preemption?  Take a look at 14(b) of the National Labor Relations Act (the so-called “right to work” provision).  The supporters of non-preemption are, these days, at the liberal end of the political spectrum – and there they are supporting the same theory as “right to work” laws (which they have always opposed).  Those who ignore past experience are condemned, of course, to repeat it.

    Once that preemption door is opened, what, inevitably, also comes through it?  How about these: Each new unpreempted state law will come with a new unpreempted state remedy (without which, of course, the state law is meaningless).  And that state remedy – bet on it – will come with compensatory and punitive damages – the very thing that ERISA preemption sought to head off. 

    What’s wrong with that?  If you don’t know, you won’t care, but it’s the death knell of the ingenuity and further development of the private voluntary system.  It just converts the floor into a ceiling.

    The moral to the story?  If you want to pass a federal benefits law (“National Health” for example), OK.  Go for it.  But do it as a governmental benefit with governmental financing and governmental control.  Don’t pretend it is or should be part of the private voluntary ERISA system.  In the private system, it’s pure poison.

A New Year’s Wish: Why Not Try More Beneficial Benefit Planning?

As the mountain of new-year, new-law, alerts and warnings mounts, wouldn’t it be nice if sponsors and their advisors paid a little more attention to the beneficial purposes of a benefit plan?

Of course, lawyers and actuaries cannot be expected to ignore the potential for problem-discovering, alert-related, problem-solving, business-generating, fee-generating professional work growing out of the new law, new FASB rules, new SEC rules, new regulations, and the like. The profit opportunities are too great to ignore.

But wouldn’t it be nice if we also helped our clients to remember the serious needs of their employees and the benefit-planning opportunities that are the real reason why these plans developed in the first place?

What, exactly, does that mean?

How about some of these now-controversial ideas: Maybe considering how NOT to terminate, or NOT to freeze? Or at least how NOT to completely freeze a defined benefit plan? Or how about even perhaps doing the unthinkable and establishing new (but modest) DB plans, while diminishing the cash-flow risks (e.g., using more conservative actuarial assumptions, methods, and benefit definitions, and eschewing unpredictable contingent event benefits, limiting new unfunded past service credits)? After all, the "normal cost" of DB plans is not often the land-mine or booby-trap – it’s the present value of unfunded accrued liability where the risk lies, and, with care, that risk can be diminished or even avoided.

And how about combining modest DB plans with 401(k) supplements (many proponents’ original idea behind 401(k) plans in the first place)?

And how about putting some new restraints on DC plan cashouts, so that lower-paid employees (those who need pensions the most) are not the ones with the most cashouts? After all, 401(k) plans were invented to be retirement plans, not mere receptacles for short-term savings.

And so on.

This isn’t rocket science. It’s a question of role definition(s). The temptation to view plan sponsorship and "settlor functions" as a cash opportunity for employers (stockholders) may be real and substantial. But in a world in which outside advisers have taken on such a large role, perhaps we professional should remember, at least, the advice of a famous lawyer and outside general counsel who once wrote that he considered one of the primary responsibilities of outside counsel to be this: on an appropriate occasion, when asked to opine on a proposal that would be lawful but perhaps completely shortsighted, to look your client in the eye and say (what inside lawyers might not feel free to say): "You are damned fools and should stop." (Sol Linowitz, The Betrayed Profession, p. 4 (New York, Charles Scribner’s Sons, 1994), p. 4, quoting lawyer, cabinet member, diplomat, and Nobel Prize winner Elihu Root, ).

It takes some guts for a professional to say it, and it takes some character for a client to pay heed to it, but what a New Year that would be.

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.

How could I overlook the possible impact of the shift in power in the Congress on Congressional oversight mission, and, in turn, the possible impact of Congressional oversight on the world of employee benefits?  If nothing else, we're less likely to see a resurrection of the Department of Energy's announcement that it would not reimburse contractors for defined benefit plan costs, or for the cost of more than a minimal health coverage package.

Where else do you think Congressional oversight might affect agencies' approach to benefit regulation?