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American Retirement Increasingly Rides the Market
By Mark Sappenfield, The Christian Science Monitor
February 16, 2005
Bush's approach on privatization is a system that's been building in the private sector since the 1990s, punctuated by the likes of IBM closing fully paid plans to new
workers and steering them instead toward personal accounts. States,
too, have been moving toward systems that expose retirees to
stock-market risk but cost the employer less. Michigan has a program in
place. California and as many as seven other states may follow suit.
The debate over personal accounts in Social Security, in short, is
being shaped in part by broad changes in the nation's retirement
landscape, not just by perceptions of the federal program's health.
This debate pits the popularity that 401(k) style plans enjoy with many
Americans against the worries of many others that their retirement
security is eroding on more than one front.
Some of the factors driving the trend in states and businesses are
different from those in the Social Security debate. Yet the momentum
for change, from governors' mansions to the corporate boardroom, speaks
to a broad reevaluation of whether the generous network of pension
systems evolved generations ago can and should survive amid modern
economic pressures.
"It's a question of retirement-income policy for the whole country,"
says Donald Segal of the American Academy of Actuaries' pension
practice council.
In the 1990s, with workers becoming increasingly mobile and the stock
market setting new records, many state and private employees came to
believe that they could manage their retirement money better than their
pension fund, which favored workers who stay with one employer for many
years. Six states responded with pension plans that offered optional
personal accounts or hybrids of personal accounts and traditional paid
benefits. Michigan went so far as to close its old plan for all new
employees.
States remain eager to move more people toward stock-market accounts.
The reason is simple: to save money. But in today's more tepid stock
climate, workers aren't necessarily eager to invest. In Florida, 4
percent of workers who have a choice are enrolled in private accounts.
Unlike Social Security, which is funded by workers' and employers'
contributions, state and business pensions are funded in large part by
state investments in the stock market During the past 15 years, the
percentage of state pension assets invested in stocks has risen from 40
to 60 percent.
The shift has made pension plans more vulnerable to the vacillations of
Wall Street. For employers, private accounts are seen as a way to
lessen that uncertainty - and cap their obligations in an era when
life-spans are increasing and baby boomers are poised to retire.
That's because traditional pensions, known as defined-benefit plans,
guarantee employees a certain retirement income, regardless of how
stocks perform. If they nosedive, as happened recently, then the state
must make up the difference.
By contrast, with private accounts, also called defined-contribution
plans, the employer pays a set amount into an employee's retirement
account, and the employee invests in any one of a dozen or so
portfolios approved by the state - leaving the employee on the hook if
stocks fall.
"It's a cost-saving mechanism," says John Ehrhardt of Milliman, an
actuarial consulting firm in New York. "States need predictability in
their cost structures."
For states already wrestling with billion-dollar deficits, the new
pension burden can be significant. In California, the state paid $160
million to the California Public Employees' Retirement System in 2000.
This year, it is expected to pay $2.6 billion. That led Gov. Arnold
Schwarzenegger to propose a solution like Michigan's: All new public
employees go to a private-account system. Seven other states from
Virginia to Alaska are either considering bills on the issue or are
conducting studies.
The same forces are at work in business. Some 13 percent of firms
surveyed by Aon Consulting in 2003 had instituted a freeze on their
defined-benefit plans during the previous two years and 6 percent more
were considering the step. It's not that companies are eager to abandon
the old benefit system. That system "is the most efficient way to
provide benefits," says Mr. Ehrhardt, suggesting it's often difficult
for employers, as well as workers, to keep tabs on personal accounts.
But many firms believe they have no choice. The unprecedented drop of
both stock prices and interest rates led some financial officers to
embrace private accounts as a hedge against future downturns. Moreover,
many old-line companies with aging workforces are finding it hard to
compete with newer companies, which often keep costs down with 401(k)s.
In Michigan, some people eye plans like Governor Schwarzenegger's
warily. "A lot of people don't have the expertise [to invest wisely],
and defined-contribution plans are not a cure for everything," says
Michael Reaves of the Michigan Association of Public Employee
Retirement Systems.
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