No, Pensions Aren’t All Collapsing, and We Don’t Need To Scrap Them

Max B. Sawicky January 25, 2018

(Design by Rachel K. Dooley)

This piece is a response to In These Times’ Feb­ru­ary 2018 cov­er sto­ry by Doug Hen­wood and Liza Feath­er­stone, Wall Street Isn’t the Answer to the Pen­sion Cri­sis. Expand­ing Social Secu­ri­ty Is.”

My good friends Doug Hen­wood and Liza Feath­er­stone, the Nick and Nora Charles of the Brook­lyn lefty scene, have writ­ten a high­ly ques­tion­able analy­sis of pub­lic employ­ee pen­sion funds. So I’m going to ques­tion it. Their charge is that Wall Street is ruin­ing the pen­sions that pro­vide retire­ment secu­ri­ty for mil­lions of Americans.

First, some cru­cial con­text. For many years now, what are called defined ben­e­fit (DB) pen­sions have been under attack from the Right. A DB pen­sion takes in con­tri­bu­tions from the work­er and her employ­er and stash­es them in a col­lec­tive fund that is then invest­ed. When the work­er retires, the fund pro­vides the work­er with annu­ity pay­ments and pos­si­bly health insur­ance sub­si­dies. Ben­e­fits typ­i­cal­ly are cal­cu­lat­ed based on the worker’s years of ser­vice and some aver­age of annu­al wages over their lifetime.

DB pen­sions were (often suc­cess­ful­ly) sought after by trade unions in the mid-20th cen­tu­ry. Over the past 40 years, how­ev­er, the rise of aus­ter­i­ty poli­cies has includ­ed efforts by employ­ers to scale back or com­plete­ly elim­i­nate DB plans. Giv­en the shrink­age of pri­vate sec­tor union­iza­tion, many pen­sion pro­grams that remain are held for employ­ees of state and local gov­ern­ments. (Some­times they also remain a perk for upper-ech­e­lon employ­ees in non-union pri­vate-sec­tor companies.)

You could think of these pen­sions as retire­ment insur­ance. For as long as the work­er sur­vives, he or she is assured a basic income. Some pen­sion schemes include ben­e­fits for a sur­viv­ing spouse as well. For many pub­lic employ­ees, the pen­sions were estab­lished as sub­sti­tutes for Social Secu­ri­ty. This means if some­thing hap­pens to the pen­sion, there is no Social Secu­ri­ty backstop.

The Right doesn’t like DB pen­sions for sev­er­al rea­sons. The sim­plest is that they want to dri­ve down wages and ben­e­fits of all types. Anoth­er is that these plans have been the fruits of hard-fought union orga­niz­ing and bar­gain­ing, so attack­ing them is anoth­er way to attack union­iza­tion. And final­ly, they are bas­tions of pub­lic employ­ee com­pen­sa­tion. Attack­ing the plans is anoth­er way to attack the pub­lic sector.

The attacks are not framed as ways to cut the pay of work­ers. Instead, the Right crit­i­cizes pen­sion plans as head­ing for bank­rupt­cy, much as they have (incor­rect­ly) crit­i­cized Social Secu­ri­ty. The objec­tive of the attacks is to trans­form DB plans into what are called Defined Con­tri­bu­tion” (DC) plans. Indi­vid­ual Retire­ment Accounts and 401(k) plans are types of DC schemes. The work­er decides how much to con­tribute and how the mon­ey is invested.

Both DB and DC plan assets are invest­ed in the stock mar­ket, and both (with excep­tions) enjoy defer­ral of income tax­es. The huge dif­fer­ence is that under DB plans, the ben­e­fits are guar­an­teed. It is up to the fund man­agers to make sure enough mon­ey will be avail­able to pay them. Under DC plans, the amount avail­able depends on the worker’s invest­ment decisions.

In short, you, the work­er, have the oppor­tu­ni­ty to screw your­self, by not con­tribut­ing enough or by choos­ing bad invest­ments. Most peo­ple are not well qual­i­fied to man­age invest­ments. Smart peo­ple — ahem — can make stu­pid mis­takes, too.

Broad­ly speak­ing, the trans­for­ma­tion of DB into DC plans (or into no plan at all), shifts the risk of a bar­ren retire­ment from Cap­i­tal to Labor. Social Secu­ri­ty pro­vides only a lim­it­ed back­stop to DB or DC plans — it’s sim­ply a low­er pay­out. That’s not to say DB plans are per­fect. They have been sub­ject to abuse by employ­ers or unions admin­is­ter­ing the funds. Mon­ey has been stolen or invest­ed in dubi­ous schemes.

One of the most noto­ri­ous cas­es was the Mafia loot­ing of a Team­sters fund; they didn’t do much bet­ter with the finan­cial mar­kets: As a Mar­ket­watch head­line attests, the Team­sters pen­sion dis­ap­peared more quick­ly under Wall Street than the mob.” So Hen­wood and Featherstone’s warn­ings about Wall Street ought not to be dis­count­ed out of hand. 

Yet for all their short­com­ings, DB plans are still going to be bet­ter for most peo­ple than DC plans, for the rea­sons men­tioned above.

A Dan­ger­ous Argument

Now comes the dynam­ic duo of Hen­wood and Feath­er­stone to tell us it’s true, DB plans are going broke. This has been the mantra of con­ser­v­a­tive Uni­ver­si­ty of Chica­go econ­o­mists. That doesn’t make it untrue, but it does make it sus­pi­cious. In this case, sus­pi­cion is well founded.

The sta­tus of a fund — whether it will have enough mon­ey to pay out ben­e­fits — can be a very com­pli­cat­ed, uncer­tain cal­cu­la­tion. It hinges on pro­jec­tions of future employ­ment, retire­ment behav­ior, mor­tal­i­ty and invest­ment returns over extend­ed peri­ods — basi­cal­ly, the typ­i­cal length of a worker’s career, in the neigh­bor­hood of 30 years or more. Actu­ar­ies do this kind of research so that insur­ance com­pa­nies can fig­ure out how much to charge you.

To esti­mate a fund’s assets in the future, one must stip­u­late expect­ed invest­ment returns. This is where the big argu­ment lies. If a fund is invest­ed in very safe U.S. Trea­sury bonds, returns will be in the neigh­bor­hood of 2 per­cent. Over extend­ed peri­ods, going back decades, stock mar­ket returns have aver­aged 6 or 7 per­cent. A fund that looks to be in good shape with 6 per­cent returns can look utter­ly bank­rupt with an assump­tion of 2 per­cent. Some on the Right would like to estab­lish rules requir­ing funds to assume 2 per­cent. That would put a host of pen­sion plans under the gun imme­di­ate­ly. They would have to ask for high­er con­tri­bu­tions from work­ers, reduce ben­e­fits or close up shop. All three have been tak­ing place.

Hen­wood and Feath­er­stone are right that the stock mar­ket is not an ade­quate guar­an­tor of retire­ment secu­ri­ty. As New School eco­nom­ics pro­fes­sor Tere­sa Ghi­lar­duc­ci has writ­ten, the shift from DB to DC plans as a nation­al strat­e­gy for retire­ment secu­ri­ty has been a huge flop. Hen­wood and Feath­er­stone pro­pose an expan­sion of Social Secu­ri­ty as an alter­na­tive. I think pur­su­ing this line of argu­ment is mis­tak­en on sev­er­al grounds.

First of all, we don’t need the frag­ile state of DB or DC plans to jus­ti­fy an expan­sion of Social Secu­ri­ty. That’s all that most peo­ple have to begin with, and as things stand it isn’t enough. Social Secu­ri­ty should be expand­ed in any case.

Sec­ond, there is no rea­son for a DB plan to assume rock-bot­tom invest­ment returns, as Hen­wood and Feath­er­stone want us to. For some­body start­ing out in a career, their chief ally, besides decent pay, is time. If you have to fund your own retire­ment, you would be crazy not to buy rel­a­tive­ly risky stock in your youth. (Diver­si­fied, low-cost equi­ty funds, to be spe­cif­ic, not indi­vid­ual com­pa­nies.) Over the long term, by the time you retire, you’re bound to be in bet­ter finan­cial shape. (Yes, as with all aver­ages, some­times the thir­ty-year growth will be low­er and some­times high­er than 6 or 7 per­cent. But that’s no rea­son to switch from the stock mar­ket to 2‑percent Trea­sury bonds.)

Third, DB plans are under the gun, and Hen­wood and Featherstone’s piece cre­ates an open­ing for the Right while offer­ing an alter­na­tive that’s unlike­ly to be polit­i­cal­ly viable any­time soon. The chief attack line is the same one endorsed in the arti­cle, that the funds are bank­rupt. (But again, by and large they’re not bank­rupt, unless you adopt extreme low-end assump­tions.) Those whose funds are dis­man­tled will not be bestowed with a love­ly Social Secu­ri­ty ben­e­fit in rec­om­pense, as Hen­wood and Feath­er­stone advo­cate. They’ll be set adrift in their own risky IRA, with very lim­it­ed abil­i­ty to man­age it well.

With­out doubt, some funds are in very bad shape. For decades, the Gov­ern­ment Account­abil­i­ty Office has been fol­low­ing this issue. You will find my name in a few of their reports. The upshot of our find­ings has been that most funds are rea­son­ably healthy, and the 2 per­cent solu­tion — that is, assum­ing 2 per­cent returns when cal­cu­lat­ing pay­out — is unnecessary.

In social-demo­c­ra­t­ic nations with big rev­enue sys­tems, the larg­er pub­lic pen­sion funds can afford those very con­ser­v­a­tive assump­tions about invest­ment returns. Just as a very wealthy per­son is liable to keep a decent chunk of wealth in assets that are high­ly unlike­ly to lose val­ue. In very well run plans in Cana­da, we found that uncon­ven­tion­al invest­ments, risky projects that would be flash­ing alarm bells for an Amer­i­can plan, have worked out well.

Alas, the U.S. is not blessed with these advan­tages. Our pub­lic sec­tor is vul­ner­a­ble to dys­func­tion. There are some bank­rupt plans. Take Illi­nois, for instance. Please. But the blame for these crises doesn’t lie with stock mar­kets, and the solu­tion isn’t scrap­ping the plans. Instead, it’s state and local gov­ern­ments that must start actu­al­ly pay­ing ade­quate con­tri­bu­tions into the funds, if they are to become healthy. Work­ers will be depen­dent on their DB plans for as long as they are avail­able. Big Social Secu­ri­ty is not com­ing to the res­cue for at least the near- and medium-term.

If we were design­ing social wel­fare ben­e­fits from scratch, we would be well advised to avoid employ­er-based health insur­ance or pen­sion plans that depend on stock mar­ket invest­ments. In the mean­time, how­ev­er, these ben­e­fits deserve the staunchest defense. Anoth­er world is pos­si­ble, but it is not yet around the corner.

Max B. Saw­icky is an econ­o­mist and writer based in Vir­ginia. He pre­vi­ous­ly worked for 18 years at the Eco­nom­ic Pol­i­cy Insti­tute in Wash­ing­ton, D.C.
Limited Time:

SUBSCRIBE TO IN THESE TIMES MAGAZINE FOR JUST $1 A MONTH