Fitting a Square Retirement Peg Into a Round Hole

I just don't get it. We knew what they were and honestly, they may have been well defined before then, but in 1974, Congress saw fit to codify defined benefit plans (DB) and defined contribution plans (DC) in ERISA. At the time, there was no Section 401(k) in the Internal Revenue Code.

It was also pretty clear back then. Pension plans were required to offer annuity options. Plans that were not pension plans (mostly profit sharing plans) were not required to offer annuity options. And ERISA said it was good.

In a profit sharing plan, a participant's accrued benefit was his or her account balance, generally. In a pension plan, generally, a participant's accrued benefit was the amount of his or her annuity. And ERISA said it was good.

But, time went by and despite ERISA saying things were good, Congress decided to tinker. And, as a group, Congress has few tools in its bag of tricks that exceed its ability to tinker. It usually works like this. Representative A introduces a bill and she has just enough votes locked up that she can almost get it through the House. And, Representative B comes to her with an idea and says that if you'll just add this one [stupid] provision, I'll vote with you and I can drag C, D, E, F, G, and H along.

That's how the sausage is made in the tinkering factory.

So, once upon a time, we had this round retirement hole (the structure that ERISA gave us) and it was good. It worked pretty well. The evidence of that is that people who spent a good part of their careers under the structure developed in ERISA have generally retired and if they planned at all well, their retirements are not at all bad compared to their working lifetimes.

But, as Congress saw fit to tinker with the rules, it found ways, among others, through bills known as Pension Protection Act[s] to convince employers to get rid of pensions. That's right, Pension Protection Acts killed pensions.

Irony.

So, through Pension Protection Acts, workers were suddenly left with nothing but account balances and through improved awareness of health risks and better medical care, they were also left with longer life spans. Those account balances that were perfectly sufficient to get them to the age 75 or so that was their life expectancy at birth had no chance of getting them to their new life expectancy that was closer to 85.

Now what?

The hue and cry was for annuities. And, thus Congress began to tinker again. How could they possibly fit this square account balance peg into the round annuity hole. So, Congress explored ideas for annuities in DC plans.

But, you see that if you offer actuarially equivalent annuities from a DC plan, then you have gains and losses and that would essentially be a DB plan. If you offer insurance company provided annuities (and recall that insurance companies are in business to make money), then you have too small of an annuity.

Oh the ignominy of the square peg.

We had a perfectly good system. It came with perfectly good benefits and for most plans, perfectly good actuarial assumptions and methods.

And Congress broke it. And after all these years, despite taking file and rasp and hammer to the square peg, the round hole remains empty.

Congress, there are smart people who do not sit in your chambers. Give us your objectives and let us find you a solution. We'll make that peg round and Americans will be able to look forward to their golden years again.

ERISA will once again say it is good.

Who Put the Dagger in the Heart of Defined Benefit

What happened to defined benefit (DB) plans? We, at least those of us who can remember those times, saw a rise of them from the passage of ERISA in 1974 until the Tax Reform Act of 1986 (TRA86). They were viewed as an affordable way for companies to provide an excellent retirement benefit to their employees, especially ones that showed loyalty to those companies. In fact, most current retirees who have been retired for at least 10 years retired in part because they had those DB plans. And, companies that sponsored them and did so responsibly did not go out of business because of them.

Unfortunately, the number of DB plans has dwindled significantly. There was not a single killer, though. The list is long. It includes:

• Congress
• The Pension Benefit Guaranty Corporation (PBGC)
• The global economy
• The e-commerce economy
• The temporary worker for hire economy
• The Financial Accounting Standards Board (FASB)
• The Securities and Exchange Commission (SEC)

Congress

What did Congress do that was so bad? Frankly, that crew of 535 individuals that changes in makeup from time to time did a lot. Between them, they rarely have anyone among them that knows much about DB plans. And, today, because their staffers who give them what they think is excellent guidance tend to be young, the advice that they actually get is colored by propaganda of the last 30 years or so. 

Nevertheless, Congress passed laws ... lots of them. And, lots of them included DB provision and each one was worse than the last. More than anything, though, because Congress intermingled retirement policy with tax policy so intimately, it eliminated plan sponsors' ability to fund DB plans responsibly.

Back in 1987, just one year after passage of TRA86, Congress, in its infinite wisdom, decided that the status quo, having existed for about a year, needed change. Included in that necessary change was limiting the amount that companies could contribute (and deduct on their tax returns) to DB plans. We were switched from a regime that was sound actuarially to one that never was and never will be.

Think about. Suppose you agree to pay someone an amount in the future. Shouldn't you be setting aside money regularly to pay for those future benefits? Of course, you should. And, DB funding used to be based on funding methods that allocated costs intelligently to the past, present, and future. But OBRA 87 began the path to dismantling those methods as Congress thought it better that DB deductions would be limited so that it could spend more money elsewhere. Thus was limited the ability of companies to responsibly fund their plans. And, as a result, as interest rates fell and there were a few significant downturns in equity markets, DB plans became [often] severely underfunded. Finally, the way these regimes worked, companies had no room to make deductible pension contributions in years that they could afford to, but were required to make large contributions in years that they could not afford them.

PBGC

For those that don't know, the PBGC is a corporation, run under the auspices of the Department of Labor, that was established by ERISA to protect the pensions of participants in corporate DB plans. The PBGC was and is funded by premiums paid by plan sponsors. 

While the purpose of the PBGC has always been to protect pensions, it has behaved over the last 30 years or so as if pensions should be in place to protect the PBGC. To the PBGC's policymakers, nothing would be a greater tragedy than the PBGC projecting that it would run out of money.

So, the PBGC lobbied Congress. And, with that lobbying, the PBGC got increased ability to intervene in business and in corporate transactions. It got increased premiums. It got even high premiums for underfunded DB plans, often ones to which the sponsors wanted to make contributions when business was good, but were precluded from doing so.

What happened?

The PBGC tried to commit suicide.

You see, as the PBGC helped to make DB plans less attractive for employers, employers froze entry to or terminated DB plans. This meant that there were fewer participants in DB plans on whom premiums were paid to the PBGC. Companies that couldn't terminate DB plans were the ones that had plans that were so underfunded that they didn't have enough money to fully fund them. Often, the PBGC had to assume responsibility for those plans. So, as the PBGC incurred more liabilities, it also got less premium revenue. It's awfully tough to run  a business that way.

Various Economies

As the US economy has become more global, more electronic, and more temporary, DB plans have lost some of their appeal, When a company was competing primarily with other US companies, providing excellent retirement benefits was important to attracting and retaining good employees. But, non-US companies didn't have to do that and as competition from offshore became fierce, retirement benefits became less of an issue.

And, as employers began to show less loyalty to their employees and were less worried about retaining them, retirement benefits lost some of their appeal. The prophecy was somewhat self-fulfilling; as retirement benefits lost some appeal, they continued to lose appeal.

FASB

Accounting for DB plans use to be more cash based than accrual based. In 1985, the FASB gave us Standards Number 87 and 88 that instructed companies how to account for DB plans. Previous to then, companies used Accounting Principles Bulletin (APB) 8, under which most companies expensed as part of P&L their cash contributions. The FASB saw this as incorrect.

So, we moved from a regime under which pension expense was somewhat controllable (a company by building up a surplus in good times could contribute less in bad times and thereby have some control over their pension expense) to one that had components that became quite volatile as the economy did. CFOs abhor volatility and thus had one more reason to not want DB plans.

SEC

The SEC didn't get deeply involved in pensions until recent times. But, when they did, they got them all wrong.

Primarily, the SEC's involvement with pensions has been in corporate proxies. For the last 10 or more years, companies have been required to provide as part of their proxy materials a table of Summary Annual Compensation for (generally) their top five paid employees. Included in compensation is the increase in actuarial present value from one year to the next of defined benefit pensions both qualified and nonqualified. 

Often times, that increase is largely due to a decrease in underlying discount rates or more recently, to a change in mortality assumptions. Yes, according to SEC rules, when the Society of Actuaries publishes a new, more up-to-date mortality table, that represents compensation to executives. And, of course, the media loves to look at those numbers as if someone had written checks for those amounts in those years to those executives. And, some investors look at those numbers and want to use them to explain how the companies in which they invest overpay their executives. (This is not to say that they don't overpay their executives, but when a large piece of the overpayment is simply due to year over year changes in actuarial assumptions, the logic is bad.) 

There are better ways. Actuaries understand them. And, actuaries, in some cases, have tried to explain them to the SEC. But, the SEC has chosen to listen more to attorneys, accountants, lobbyists, and unions. They carry more sway and are more emotional about this issue, but generally speaking, they don't get it.

I'll write about a better way in another post soon.

But, in the meantime, now you know where the dagger came from. DB plans use to allow people to look forward to retirement. For most, they don't anymore.

Qualified Retirement Plans Are Not a Congressional Toy

I was at the Southern Employee Benefits Conference Annual Educational event yesterday. One of the speakers had just returned from a conference in Washington where there were a number of presenters who are staffers on The (Capitol) Hill. Reports are that staffers from both parties strongly implied that tax-favored status of 401(k) and other qualified retirement plans may be in jeopardy.

In short, this is bad -- really bad.

The eventual ability of many Americans to retire in the recently traditional sense is already in jeopardy. Various surveys that I have seen say that the majority of Americans in the workforce have no savings outside of their qualified retirement plans and for most, those are 401(k) plans only. If Congress were to eliminate some or all of the tax breaks associated with them, I fear that those savings would disappear as well for many people. All but those who had the ability and foresight to save and invest on their own would be left to find sources of income until they reached their deathbeds.

That is bad -- really bad.

I don't think I have ranted too much for a while, but this topic is always good for one.

When Congress looks at issues that have tax effects, they break them into two categories -- tax revenues and tax expenditures. Anything that causes the government to collect less money in taxes is a tax expenditure.

Therein lies the rub. Most things that Congress can do for the country cost money. If Congress chooses to send a bill to the President that provides for some improvement that was not previously planned, it needs to pay for those costs. It often chooses to do so through reductions in tax expenditures.

According to IRS publications, the two largest current tax expenditures are for employer-provided health insurance and for employer-provided retirement plans. Health insurance is a sacred cow. It's not going away unless or until we have a single-payer system. Retirement does not appear to be so sacred.

And, retirement always seems to be a good revenue raiser, at least the way that the Congressional Budget Office (CBO) scores bills. The CBO looks at 10-year costs or revenues. So, Congress needs money to pay for a highway bill -- they reduce required contributions to defined benefit plans. That cuts tax expenditures ... in the short run.

As I have said many times, Congress should not intermingle tax policy and public policy. Ever!

Sadly, Congress does not listen to me. All of my readers know that Congress should listen to me, at least on these issues, but alas, they are not so wise.

So, we are left with a Congress that makes changes to employee benefit plans in the most interesting places. Here are a few that will either refresh your memory or leave you scratching your head or both:

• The Uruguay Round Agreements that led to the formation of the World Trade Organization
• HATFA, the 2014 highway funding bill
• Several defense appropriations acts
• Any number of omnibus budget reconciliation acts (OBRAs)
• KETRA, the Katrina Emergency Tax Relief Act of 2005
• SBJPA, the Small Business Jobs Protection Act

If Congress wants to eliminate the tax breaks for qualified plans, it should do so by eliminating the federal income tax. If Congress chooses not to do that, don't mess with them.

Public Enemy #1

Suppose I told you that I had a business idea for you that had profits (written as +) and costs (written as -) that went like this:

• 2010: + 100 billion
• 2011: + 200 billion
• 2012 : + 250 billion
• 2013: + 250 billion
• 2014: + 250 billion
• 2015: + 250 billion
• 2016: + 150 billion
• 2017: + 50 billion
• 2018: - 50 billion
• 2019: - 200 billion
• 2020 --> : - 200 billion or more every year

How would you "score" this business? Personally, I would say that if we went in to that business, it would be time to get out by 2017. The Congressional Budget Office (CBO), not because they are stupid (they are, in fact, a bunch of very smart people), but because they have a set of rules given to them by Congress that they must follow, would tell you that this business (or law) actually saves the country lots of money.

How can that be? Look at their rules. Time value of money is not part of the rules. So, one dollar in 2010 is the same as one dollar in 2012 is the same as one dollar in 2019. And, the scoring for a bill ends after 10 years. So (and my intent here is not to be political, but instead to make a point) construction of bills and therefore laws becomes a jury-rigged process. Every major bill that goes to the House Ways and Means Committee seems to save money early on and not start to cost money until close to Year 10. Hmmm? Does that make such a bill a budget-neutral, or even budget-positive bill? I don't think so. But the author of the bill will tell you how it will save the country money while neglecting to tell you that the same bill will saddle future generations with mountains of debt.

Where did the numbers above come from? I made them up. Where could they have come from? They could have come from the Affordable Care Act (PPACA), or Health Care Reform, if you prefer. There is a law where the savings are front-loaded, but once the program starts to cost the country money, it never is projected to stop costing money. Yet, the authors of the law say it saves the country money. And, they use the non-partisan CBO as ammunition to prove it. 

The CBO says PPACA will save us money. And, by their estimates, which I believe to be as valid as any others, it is expected to save us money ... over a 10-year time horizon. But, what happens after 10 years? Hmmm! It costs money every year after Year 10. So, if instead of scoring over 10 years, CBO rules asked them to score over 20 years, then proponents of the law could not say that PPACA saves the country money.

Does the public know this? Generally not. Does Congress know this? I think that some in Congress do, and some probably do not. Now you do.

To my mind, these rules are lunacy. We are in the computer age. If the CBO can do a 10-year projection, it can also do a projection for 25 years, 50 years, 100 years. It's not the CBO's fault, though. They have rules. But, to my mind, those CBO rules, foist upon them by Congress are Public Enemy #1.

What do you think?

Will the Super-Congress Kill Your Benefits?

If you haven't been hiding under a rock, you know that Congress reached a budget/debt deal last week that was signed into law by the President. Well, they sort of reached a sort of deal.

They increased the debt limit by more than $2 trillion and they cut spending by about $2.5 trillion. Except that they didn't. You see roughly $1.5 trillion of that savings is yet to be decided. The dreaded Super-Congress (three each of Senate Democrats, House Republicans, Senate Republicans, and House Democrats) is charged with coming up with a plan to find that other piddling amount. If they can't do it by November 23 of this year, then the nuclear option kicks in (stop your wishful thinking, nothing inside the Beltway will be nuked). In oversimplified terms,  the nuclear option will make pre-specified cuts adding to roughly $1.5 trillion. And, those pre-specified cuts will come to a large extent to each party's sacred cows -- defense spending and entitlement spending.

So, somewhere between November 22 and November 23, the Super-Congress will miraculously reach agreement. Remember, you heard it here first.

Thus far, we know the names of 9 of the 12 members of the Super-Congress (the 3 House Democrats are yet to be named). Perhaps more important, we know the names of the co-Chairs: Senator Patty Murray (D-WA) and Representative Jeb Hensarling (R-TX). To say that there is common ground between these two is roughly akin to saying that Kennedy and Kruschev were best friends. I'll let you guess on the details.

So, why am I writing about this in a blog that is usually devoted to benefits and compensation? I'll get to that soon, but I am glad that you asked.

As the Super-Congress gets named, various members have deigned to give interviews to the media. The Democrats say that entitlements need to stay as they are and that the wealthy need to pay more taxes. The Republicans say that the defense budget is critical and that new taxes are not on the table.

Where they agree, though, is that we have too many tax loopholes. Their may not be agreement on what constitutes a loophole, but you can't have everything.

I don't recall where, but I read somewhere that the three largest tax expenditures are these (in no particular order):

• The mortgage interest deduction
• The employer deduction for health benefits for employees
• The combination of the employer deduction for retirement benefits for employees and the tax-free build-up of assets in trusts for qualified retirement plans

The first one, in my opinion, is a goner. Not in its entirety, but above some limit, there will be no tax deduction for mortgage interest. And, there will be no deduction for interest on any but a primary residence. Again, in my opinion, as this has been floated before without tremendous resistance, this seems obvious.

The other two, they are in serious trouble. And, if either or both suffer, so will you, the American worker.

Let's use an example to illustrate. Suppose your cash compensation is $100,000 per year. Let's estimate then that the total cost of your employment to your employer (before tax deductions) is $140,000 (this number may be high or low, but it's not a bad representation). Presently, your employer gets a tax deduction for virtually every dollar of that. So, assuming a 35% marginal tax rate, that means that after $49,000 in tax deductions, you cost your employer $91,000 per year.

Are you with me?

Again, in very round figures, suppose your health and retirement benefits cost your employer $15,000 per year (before the effects of tax deductions). At 35%, the deductions for that will be $5,250. So, eliminating these deductions will cost your employer $5,250 (with respect to your employment). Do you think you are going to continue to get the same benefits? Think again. For most of you, the answer is no, or perhaps it's NO!

Your employer is going to cut its contribution to your benefits to save that $5,250. So, the value of your employment package will decrease by about $5,000 on a baseline of $140,000. That's a little more than 3.5%. Oh, you don't think that sounds like much? In this economy, how long does it take you to get a 3,5% pay increase? For many of you, that could be two or three years.

So, how can this happen. Well, the Republicans will swear up and down that this is not a tax increase and they will tell you that they have held to their pledge to not increase taxes. The Democrats will fight hard to ensure that this change does not apply to the lowest paid workers and that its effect progressively increases as a worker's pay increases, probably phasing in completely somewhere around $150,000 of cash compensation.

And, the chosen twelve will shake hands and know that they have saved their sacred cows, and each side will go back to its constituency and say that it has won. Don't believe them for a second. The losers will be you and me. The losers will be the American workers who "get up every morning to the alarm clock's warning, take the 8:15 into the city" (I know, Bachman-Turner Overdrive was a Canadian band, but the lyrics fit).

Remember, you read it here first. 

With Regard to Benefits and Compensation, Whither Goeth the 112th Congress?

We, the people, have recently elected a new Congress. Unless you have been hiding under a rock, or perhaps a pile of rocks, you know that the Republicans have taken control of the House of Representatives and that the Democratic majority in the Senate is probably subject to filibuster on any issue with which the Republican leadership has really significant disagreement. Finally, the Republicans seem particularly united on what they consider to be their key issues.

So, the general thoughts are that Health Care Reform will get repealed, retirement legislation will be more employer and less union friendly, and compensation restrictions will largely be gone. Hold on! We don't have a Republican President. The Republicans in Congress can say all they like and they can try for all they want, but likely the best they can do during the 112th Congress is to try to work with the Democrat Party to reach happy compromise.

Current thoughts include these:

• The Republicans will use their majority in the House and their filibuster ability in the Senate to block funding for enforcement of Health Care Reform. While this sounds good to those who would like to see Health Care Reform disappear, my opinion is that doing this will alienate many swing voters and guarantee a Democrat return to majority in the 2012 elections.
• George Miller, Chair (until January) of the House Health, Education and Labor Subcommittee, will not have the influence that he has had with a Democrat majority. His personal agenda, focused on what some would consider over-disclosure to participants, is likely to fall by the wayside. Thus, all disclosure projects in the next two years will need to come through the DOL rather than through Congress.
• As a group, the Republican Party tends to intervene much less in corporate compensation decisions than the Democrat Party, but this is a hot button for the President. Don't expect the President to give in on this one, he has referred to Wall Street "fat cats" enough times that we can be sure that he will not sign any bill that lifts restrictions on executive pay.
• Where marginal tax rates will be in 2011 will influence benefits decisions. I have my suspicion that the EGTRRA (Bush) tax cuts will remain for all taxpayers through 2012, but I sure wouldn't bet my life on it.

So, whither goeth Congress on benefits and compensation issues in the short term? I think the answer may be nowhere.