Topic: Economics
Defined Benefit or 401K Discusses the current efforts to eliminate defined benefit pension plansby Ben Samuel
(centrist libertarian)
Friday, March 21, 2008
Defined Benefit Or 401K?
That "Greatest Generation" of Americans, those who struggled through the "Great Depression" and World War II, have mostly passed on now, and the great majority of Americans now alive have grown up in the Reagan Era, where deficits do not matter, and money can be infinitely printed and wantonly distributed. Our forebears, left a legacy of Social Security, Pensions, Buy, Build and Produce American, or generally, build a nation striving for the success of each of its participants, and a common good for all. It culminated in the creation of the great American middle class. The last three decades have been spent attempting to decouple us from such idealistic notions and pursuing a Darwinian ideal of survival of the fittest. We have now come to a point where the results of such direction are to be realized.
A great battleground for these ideas in conflict has been the effort to displace the defined benefit pension plan (DBP) with the 401 K plan (401). Both have their origins tied to the effort of government to encourage employers and employees to provide a means of sustenance for people who have passed their productive working years. Both require that employees divert a portion of their current compensation for future dispensation. The great divide between them is individual ownership and responsibility for the results of the 401, as opposed to collective ownership of the DBP with a safety net of an insured pension by the Pension Benefit Guaranty Corporation (PBGC). With many American companies becoming competitively outclassed in the global economy, many DBPs have fallen on hard times and do not have enough assets to pay their obligations to their current and prospective pensioners, forcing the PBGC to assume their obligations under pension insurance. The startling number of these occurrences has forced the PBGC, which is funded by premiums from participating plans, and underwritten by the taxpayer, to press for rule changes in actuarial valuation of existing plans.
Among the rule changes is limiting the actuary's growth assumption to the interest rate available on government issued debt obligations, currently around 5%. Most plans now in existence have contemplated asset growth between 7 and 8%. The effect of such change is to nearly double the assumed actuarial unfunded liability of participating plans, and force the cost of insurance to increase as well as the cost to preserve vested benefits. The prospect of rapidly expanding withdrawal liability for employers provides incentive for them to divest themselves of DBPs and encourage their employees to 401 K's, something for which they have no shared liability.
From a peak of about 250,000 DBPs in 1991, there are less than 80,000 available to employees today. Some conjecture suggests that companies purposefully underfunded their DBPs subsequent to the creation of the PBGC with passage of the Employee Retirement Income Security Act of 1974 (ERISA), effectively handing off their obligations to the government. Those of us old enough to remember the decade of the 70's can recall a decade long bear market in stocks, with interest rates rising into double digits for Government and corporate issued debt. Companies hungry for capital could justify reduced funding to DBPs because of a transition of investment to high yielding safe debt obligations providing greater growth than actuarially assumed. Indeed, many of the DBPs became overfunded or even superfunded having more assets than they could be obligated to spend, and during that time many of these funds significantly improved their benefits.
In 1987, with a change in chairmanship at the Federal Reserve from Paul Volcker to Alan Greenspan, a period of "easy money" emerged, with interest rates falling to levels never before seen in the American economy. Additionally, other significant events took place. A technological revolution began with the introduction of desktop computers and the internet, the Soviet Union dissolved ending seventy years of centralized economic planning and opening new developing markets in Eastern Europe and Southern Asia, China similarly converted its economic system. Interest in the stock markets reinvigorated as large institutional investors could no longer rely on high interest debt obligations for growth, and new emerging companies as well as existing companies saw the issuance of stock as a better means of obtaining needed capital to address distribution of their goods and services to the new opening markets. The iconic Dow Jones Industrial Average improved 600% over the ensuing twelve years, something unseen in 75 years of its history.
With all this change, illusions emerged. Money would always be cheap, and stocks could only go up. The American dream, saving for and owning a house, distorted to a practice of indebting oneself to extreme, using the house as a personal bank account, and never having to worry as the value of the house would only increase. A company did not have to plan for profitability, only for its sale and inevitable acquisition. Government could infinitely indebt itself and print more money to exhaust that debt. However muddled Amerithink became, more grounded players understood the liability of the DBP and found an environment to exploit and divest themselves from that liability. A workforce growing up in this environment found itself an easy mark, for the limited benefits of a DBP could not compete against the promise of a 401K which will make all its participants millionaires many times over. That is until reality bites.
The first earthquake struck in 2000 with the collapse of the Dot Com businesses. The NASDAQ stock market index has not yet recovered from the 60% debacle that occurred to that average. People working in those businesses for moderate incomes and huge promises extended in the form of stock and stock options had their dreams shattered as their perceived wealth was destroyed almost overnight. The collapse in all American markets at that time had its effect on the DBPs as well, as the value of their assets declined and their growth assumptions went unrealized for the ensuing 3 years. Cheap money was made cheaper in an effort to restore confidence, and companies returned to a bottom line mindset in the development of their businesses. American manufacture quickened its pace to produce out of country to exploit cheap labor. America became a debtor nation for the first time since the Revolutionary War.
In 2004, the stock markets seemed to go bullish again, and in 2007 the Dow Jones average surpassed its previous 2000 high-water mark of 12,000. Cheap money produced a rush on home equity credit and accelerated an increase in the perceived value of homes. Unremarked upon during this time was the declining value of the American Dollar against the currencies of other nations. From 2004 through 2007, the dollar devalued 60% against the Euro. The value of hindsight suggests the seeming bull market from 2004-2007 as an effort to revalue American Companies viz a viz the lost value of the dollar. A true bull market should have taken the Dow past 16,000. Did not come close, but it did project the illusion again of the value of a 401 plan as those portfolios seemed to reflate. The aftershock hit in August 2007 with the realization that extensive credit creation by both the American government and its citizenry had left America reliant upon the kindness of strangers to maintain the standards to which they had become accustomed. The Dow broke down another 14%, that inevitable rise in home values reversed, lenders stopped lending, and the government speeds up the printing presses in an effort to rekindle a monetary stimulus to again reverse the trend.
The jury remains out as to the effects of the government's efforts to overcome the current financial crisis. The initial response has not been encouraging. Headlines pervade with talk of recession. American companies are being sold to foreign buyers. America seems either unwilling or unable to produce for itself what it needs. The PBGC's instructions to actuaries concerning their valuations of DBPs suggest there is not a great deal of confidence that interest and market returns on investments going forward will of themselves produce results for adequately funding those plans. Those of us with DBPs will most likely need to go through a period of allocating more of our incomes to retain our current level of benefits, or reduce the level of benefits going forward. Those of us solely reliant upon the progress of our 401, have a different set of problems.
Individual responsibility for performance outcomes of 401 plans inevitably means that each participant will of necessity be his or her own financial planner. The ability to be successful is limited by the investment options provided by the employer and the limits on the amount one may invest yearly in such plans without tax consequence. These, and the choppy bounce of uncertain markets, will play a role in retirement planning for 401 holders as it will be exceedingly difficult to assess at what rate you may draw down on your accumulated assets to provide you a regular and recurring income at retirement. This will be especially true in the current economic climate whose length we cannot gauge.
The current administration in Washington, DC, came into office with a particular agenda. That was to break down the last remaining vestiges of the Roosevelt "New Deal." That "New Deal" was a collaborative strategy to take America forward, and DBPs grew from such collaboration. That is why the participants in those that remain today are mostly unionized employees in private sector and employees in the government sector. This administration has so bankrupted the government, it is doubtful that government will have the wherewithal to regulate anything in the future. In that sense, no plan for retirement can rest securely, but certainly those reliant upon individual ownership are most at risk.
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