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

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-20^th 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.