Working Indiana - Working for Democracy and Justice

Traditionally, American pensions first took the form of annuities.  Through their pensions, workers were assured a steady, if limited, income for the remainder of their lives.  Employers were obliged to make certain there was sufficient money to fund retirement benefits.  When our post World War II experience uncovered deficiencies in the structure and funding of these schemes Congress enacted ERISA, the Employee Retirement Income Security Act, to fix them.  Even after ERISA, underfunding employee pensions continued to threaten the integrity of America’s voluntary retirement system until Congress acted again, in 2006, to tighten funding and reporting requirements.

In 2004 the Pension Benefit Guaranty Corporation [PBGC] reported that ten U.S. firms accounted for $11 billion in pension funding shortfalls. (PBGC “Pension Insurance Data Book, 2004)  The 2006 legislative reforms attempted to address this looming threat but, in fact, employers had already moved away from traditional pensions in favor of “individual account” plans.  Individual account plans most typically take the form of 401(k)s.  The name is derived from the tax code and the account was never intended, never designed, as a primary retirement vehicle.  In fact, historically, the 401(k) traces its roots to a supplement to the tax deferred investment vehicles available for upper and middle management.

The transition from traditional annuity-type pensions to 401(k)s removed the funding obligation and its burden from employers and shifted it downstream to employees.  Employers may, but need not, contribute to 401(k)s.  The timing of this forced migration was less than perfect, too.  It happens to coincide with an extended period of flattened wages and diminishing worker savings.  Expressed as a percentage of income, household debt has climbed from a bit over 10% in the early 80’s to more than 14.5% in 2004.  The Federal Reserve’s Survey of Consumer Finances indicates that in 2004, debt equaled or outstripped income for all but the top 10% of American households.  In effect, the culture told American workers to save up for their own retirement during decades when they saw few gains in earnings and none in savings.  It is not surprising, then, that the Vanguard Group (quoted by US News) reported that the “average” 50-something held less than $130,000 in his/her retirement account and that the “median” for all 401(k)s was only $53,400 for workers over 65 years old. [http://www.usnews.com/usnews/biztech/articles/060116/16intro.htm] But the fact that American workers were thrown into 401(k)s during a nearly perfect storm of adverse economic conditions is not the only flaw in America’s unplanned retirement system.

The PBGC was created to insure America’s private pension system.  Through insurance, workers were assured that underfunded and abandoned pensions would still pay out.  In contrast, there is no mandatory insurance for 401(k)s.  Until Congress acted in 2006, there was no requirement that a 401(k) Plan even provide investment advice to participants.  As a result, many loyal employees were overinvested in company stock.  When ENRON entered a black out period as its stock spiraled into the abyss its overinvested employees paid the supreme price.  Even though the Pension Protection Act now provides a means for extending investment advice to participants, a recent study by EBRI (the Employee Benefit Research Institute) found that 2/3ds of survey participants would probably not implement all of any investment advice and ten percent claimed they would ignore it completely.[http://www.ebri.org/pdf/briefspdf/EBRI_IB_04a-20079.pdf]  Empirical evidence suggests that they may be right.  Mutual Fund managers charge to outperform the market yet, in the long run studies show that they seldom can, a fact central to Gregory Baer and Gary Gensler’s 2003 book The Great Mutual Fund Trap,” and a fact about markets that has been known since the first edition of the now classic “A Random Walk Down Wall Street.”  Baer and Gensler recommend investing in index funds, not managed funds.  Yet, some 401(k) plans do not offer them and federal law does not require them.

Of all the shortcomings of 401(k)s perhaps the greatest is the lack of “risk pooling.”  Individual accounts are just that.  They are individual.  Where you get off the rollercoaster of the American stock market is a matter of individual circumstance and appetite for risk.  Even though employees may have the benefit of professional investment advice (at a cost, of course) they are each, individually, investing in (customarily) mutual funds.  Rather than sharing the risk of poor investment results with thousands or millions of fellow workers, participants in 401(k)s are on their own.  Funds that show a five or ten year history of decent profits may underperform for any given individual on the year he or she leaves the work force and continue to underperform for years thereafter.  In contrast, large public employee programs that continue to pay out traditional annuity type benefits have the considerable protection of pooling risks.  Although these pensions are suffering from an underfunding crisis, too, it arises as a result of governmental indifference to funding obligations, not to the lack of risk pooling.  In fact, the demise of traditional pensions is a result of American hostility to risk pooling in deference to a nostalgic or fundamentalist belief in free markets, a story told a few years ago by Malcolm Gladwell in the New Yorker. [http://www.newyorker.com/archive/2006/08/28/060828fa_fact?currentPage=all]  Gladwell recounts the story of Richard Gosser, president of a UAW local in Toledo.  Gosser proposed a $0.10 per hour regional contribution to a pooled pension fund only to meet with a “terrified” response by Toledo employers who immediately formed a trade association to squelch the idea.  The result: traditional American pensions were victims of “dependency ratios,” forced to face rolling shortfalls as fewer workers labored to produce sales supporting an ever growing, dependent, population of retirees.

Second only to the lack of risk pooling, 401(k)s are subject to limitations imposed upon them by the quality of choices made available to participants.  One study of 401(k)s, for example, concluded that the choices available to participants were so poorly designed that, in 62% of the Plans studied, the difference in “terminal wealth” between an adequately designed Plan and the Plans under study was a whopping 300%. [Elton, Gruber, and Blake, “The Adequacy of Investment Choices offered by 401(k) Plans” retrievable at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=567122#PaperDownload]  Thus, even those workers fortunate enough to be able to participate to the fullest in their company’s 401(k) may find their efforts unrewarded because, simply, the universe of choices available to them in terms of investment potential is inadequate.

Finally, there is the vexing matter of insurance.  Recall that ERISA required employers to pay a surcharge for insurance, through the PBGC, so that workers were assured that a lifetime’s work would, indeed, be rewarded with a pension.  The balance in a worker’s 401(k) plan is at risk in two ways: first, the firm that manages a worker’s money is not required to maintain insurance.  Second, shortfalls are not insured against.  Workers have been forced to become “investors” against their will and to accept all of the risk with no relief if they—or their paid advisors—have chosen badly. 

The 401(k) was not meant to be America’s retirement vehicle of choice.  It places the risks of underperformance on individual workers and has no insurance against losses.  In matters of investment losses Courts have proven reluctant to blame employers.  For example, the 7^th Circuit Court of Appeals rejected the complaints of a 401(k) participant in Jenkins v Yager 444 F.3d 916 (7^th Cir, 2006).  There, Ms. Jenkins complained that the choices available in her 401(k) resulted in aggregate losses of $700,000.00.  ERISA allows employees to assume the risk of poor investment results in 401(k)s under § 404 but only if plans meet some conditions imposed by the DOL [29 C.F.R.§ 2550.404c-1(b)(2)(c)].  Although the DOL requires 401(k)s to have, at minimum, at least three investment options and to permit participants to select among available options at least once every three months and although Ms. Jenkins Plan didn’t meet these requirements, the Court of Appeals interpreted the DOL requirements as a “safe harbor,” meaning that employers need not worry about losses imposed on their employees if they met these minimums.  Employers did not, however, become responsible for investment losses if they did not meet these minimum design requirements.  Since the employer claimed he selected the choices because he was taking a “long view” and since he said he browsed the materials forwarded him by the funds, he had satisfied his obligations under ERISA and Ms. Jenkins (and her fellow employees) was left with her loss.