What’s The Way Forward For The U.S. Retirement Industry?

There are many in our country that would love nothing more than to see public pension systems unwound. They often cite the burgeoning unfunded liabilities as their motivation for this action: protecting the taxpayer. In a recent blog post on Burypensions Blog (not much doubt where the author stands on this subject) he listed some data that had been extracted from a recent Fitch Report, and on the “evidence” it looks damning for states such as Illinois, NJ, Massachusetts, and Kentucky with estimated unfunded liabilities totaling $352 billion. The unfunded liabilities were calculated using a mark-to-market discount rate (2.14%) instead of the return on asset assumption that is permitted under GASB (average is roughly 7.5%).

The use of the defined benefit plan has been dramatically reduced in the private sector with roughly 120,000+ plans having been terminated since the mid-‘80s. There are currently about 23,000 DB plans still functioning that cover roughly 15% of the private sector and about 85% of the public sector. At one point in time, nearly 50% of the private sector was covered by a DB plan.

We would suggest that the issue isn’t the DB plan, but how they have been mismanaged. These plans function well when annual required contributions are made, benefits are calculated based on lifetime earnings (salaries), and not spiked with overtime, sick and vacation pay, etc., plans focus on their specific promise (liability) to drive asset allocation and investment structure decisions, and not managed to some artificial return on asset number that is primarily used to calculate contributions, but in doing so has added far more risk to the process with little reward to show.

I get that those in the private sector are naturally concerned about their lack of a retirement benefit and the potential growing cost to fund the retirement plan of someone else. This pension envy is understandable but misdirected. The incredible risk transfer that began to take place in the early ‘80s from corporate America funding and managing a retirement benefit to the individual employee being asked to now take on this responsibility with far fewer skills is crippling America’s retirement dream for most of us. This is a huge policy misstep that needs to be corrected, and fast!

What many fail to realize is that there is a great benefit (no pun intended) to the local economies where DB plan beneficiaries live, as they spend those monthly checks that they receive, which is a proven catalyst to economic activity and tax receipts at the federal level. Does it make sense to close DB plans that ensure a monthly compensation and use DC plans that don’t? Of course not!

So, what can be done? First, we need to support efforts to get the private sector workforce back into DB plans, whether at their companies (highly unlikely) or through a state or federal effort. Second, for those plans that remain open, we need to get sponsors and their consultants to adopt more of a liability focus to the day-to-day management. As previously stated, managing to the ROA has only injected more risk into the process with little certainty of success. Understanding the promise that has been made and managing to that promise should be the standard operating procedure. By doing so, one establishes a glide path to full funding, whether at 50% funded or 90%. The U.S. equity and bond markets have enjoyed long bull markets, but for how much longer? Despite this rosy market environment, funded ratios are stubbornly low, while contributions expense is growing rapidly – not a great combination.

DB plans need to be supported, as they are the only true retirement vehicle. The absence of DB plans will place a greater burden on an aging population that already has a significant percentage of their cohort living on Social Security wages only. Economic growth in the U.S. has been modest, at best, for the last 12 years. Can you imagine what it would look like if we had 10s of millions of “retirees” living exclusively on a Social Security benefit? Where would the economic activity come from?

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