man hand holding paper with ERISA on it September 2019 marks the 45th anniversary of PresidentGerald Ford signing the Employee Retirement Income Security Act,commonly called ERISA. Does it need to be changed to takeon the next 45 years? (Photo: Shutterstock)

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September 2019 marks the 45th anniversary of President GeraldFord signing the Employee Retirement Income Security Act, commonlycalled ERISA. Of course, the issue of retirement income security isas relevant as ever, particularly given questions about thelong-term sustainability of current SocialSecurity benefit levels.

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We can use this occasion to review the issues that thelegislation was intended to address, how the environment haschanged over the past 45 years, and potential changes to bolsterretirement security for the next 45 years.

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Historical perspective

The American Express Company is generally credited with settingup the first U.S. private pension plan in 1875. Shortly thereafter,utilities, banking and manufacturing companies also began toprovide pensions.

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But it was during the period from the start of World War IIthrough the Korean War – in part due to wage-price controls thatprevented pay increases but permitted improved fringe benefitprograms, high tax rates, and union interest – when many privatesector employers introduced pension plans as a form ofcompensation. As a result, the number of workers covered underprivate sector pension plans went from 4 million in 1940 toover 17 million by 1958.

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But the growth in these programs was not without problems.Before ERISA was enacted, pensions were lightly regulated and therewas little recourse for workers if organizations failed to deliveron their pension guarantees. For example, a U.S. Senate report published in fall 1973 indicated atleast a quarter of all employees participated in plans that did notvest benefits until retirement, regardless of service.

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And it was perfectly legal for an employer – even those not infinancial difficulty – to terminate a pension plan without fundingall vested benefits. Another major concern was the mismanagementand embezzlement of pension funds, particularly those benefitingcollectively bargained workers. In 1965, the Senate conducted ahigh-profile investigation of union pension funds being transferredoverseas for "medical research" to foundations controlled by theplan trustees without disclosure to the planparticipants.  (Film buffs may recall the scene in "TheGodfather Part II" when a fictionalized version of the gangsterMeyer Lansky brags that his Cuban hotels were in part financed byTeamsters pension funds.)

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Studebaker

The incident many cite as highlighting the need for pensionreform involved the December 1963 shutdown of the Studebaker auto plant in SouthBend, Indiana, laying off over 4,000 workers.  Soon afterthe plant closed, Studebaker terminated the retirement plan forhourly workers, and the plan defaulted on itsobligations.  Eventually, an agreement was finalized wherevested participants age 40-59 receiving on average only 15% oftheir accrued benefits; workers under age 40 received nothingregardless of service.

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Starting in the mid 1950s and throughout the 1960s, Congressgradually granted the U.S. government more enforcement power overprivate pensions. But in the wake of Studebaker and other scandals,there were calls for stronger action to be taken.

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ERISA and its aftermath

In February 1972, the U.S. Senate Labor Committee published areport which cited the following key "deficiencies" in privatepension plans: inadequate vesting provisions, inadequate funding,loss of portability of earned benefits on relocation, plansunderfunded at plan termination, abuses by employers andfiduciaries, and inadequate information for employee participants.The final ERISA legislation of 1974 attempted to address many ofthese issues, including establishing a pension insurance systemfunded by employer premiums.

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At its core, ERISA was intended to help secure the promiseemployers made – in the form of defined benefit programs – toprovide a percentage of an employee's compensation duringretirement. But by 2019, the employer "promise" that ERISA wasseeking to secure back in 1974 has now largely disappeared.

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Instead, defined contribution plans are now the sole workplaceretirement benefit offered to most employees; it is up to eachindividual to save and invest for their retirement. So, if the keygoal of the original ERISA legislation – securing employer providedpensions – is irrelevant to today's worker, what now?

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Where do we go from here?

Forty-five years after the passage of ERISA with employer-basedretirement programs now primarily in the form of definedcontribution plans, the most important limitations of this systeminclude:

  •         Inadequatesavings: One 2019 study estimates over 40% of all U.S.households where the head of the household is now between 35-64will run short of the retirement income needed to cover averageexpenses and healthcare costs.
  •         High cost: Defined contribution planssponsored by smaller companies don't enjoy the economies of scaleof larger plans and pay substantially more in total plan fees,usually at least 1% of assets. These costs often reduce employeereturns as they are incorporated into the total expense ratios ofplan investments.
  •         Overly complicated: When you review theevolution of different defined contribution (DC) programs issuedunder the tax code (e.g., 401(a), 401(k), 403(b), 457(b)), youquickly realize there has been no master plan in putting themtogether. Then consider personal retirement programs like IRAs,SEPs, Keoghs, etc. and it can boggle the mind. All these provisionsadd cost and complexity to the system without seeming to bolsterretirement security.
  •         Too centered on the employer plan: Thecurrent U.S. employer retirement plan system is partly an outgrowthof the wage-price controls imposed during World War II thatencouraged employers to provide compensation increases throughfringe benefit programs such as pension plans. But the regulatoryregime imposed by ERISA in order to help secure these benefits(including non-discrimination testing, audits, legal documents,disclosures, etc.) substantially increases compliance costs anddiscourages smaller employers from even offering programs.Furthermore, employees in the "gig economy" frequently aren'teligible for an employer-sponsored plan.
  •         Decreasedprotection against longevity risk: The average Americanlife expectancy increased from 71.9 in 1974 to78.5 in 2017. At the same time, the move from DB to DC plans hasmeant that the average participant has less protection againstoutliving their assets as lump sum payments have replaced lifeannuities as their plan's default form of distribution.
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Rethinking retirement legislation for the 21st century

In aggregate, these issues suggest any overhaul of the currentprivate pension system needs to deliver a simpler, less expensivesystem that encourages increased overall savings rates. It is hardto see how simply tweaking the existing ERISA legislation willproduce that, as it was built around forcing individual employersto secure their pension commitments through a series of regulatoryrequirements.

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Perhaps we need to envision a system that recognizesindividuals, rather than employers, as the key driver of retirementsecurity.

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One potential starting point would be adapting the U.S.government's Thrift Savings Plan for civil service and militaryemployees. It is already a multi-employer plan, doesn't have tofile financial statements, has incredibly low administrative costs,is not subject to litigation, and allows employees to contribute tothe same account across different jobs.

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Expanding this type of program to the private sector could evengo further by allowing self-employed workers to establish accountsas well. And the program could restrict any employer contributionsto the use of certain safe harbor formulas, eliminating the needfor non-discrimination testing.

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The U.S. government's role could be limited to ensuring promisedcontributions are deposited, as occurs for Social Securitycontributions with private sector providers competing for accountsusing a standard design, comparable to how Medicare supplementplans are now offered.

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Addressing inadequate savings

This approach could lead to a much simpler, cheaper system. Bypooling tens of millions of employee accounts together, evenworkers at smaller companies would enjoy low investment andadministrative fees. Standardizing plan terms and options wouldmake it simpler for the average worker to understand. And the plancould offer the lowest possible cost life annuities give thepopulation size.

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What it wouldn't do of course is address inadequate savingslevels by employees or lack of employer contributions. But supposethe U.S. government assumed virtually all the administrative dutiesfor this program in return for some level of minimum employercontribution (say 1% of pay) that would be required ofparticipating plans. (Employers could of course contribute moreusing one of the same harbor formulas. Or even decide to remainwithin the existing system.) How many employers would turn downthis trade?

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Revamp instead of upgrading

ERISA was enacted when the average worker's dream was spendingtheir career with one company and retiring with a gold watch and acomfortable pension.

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Perhaps that is the best sign that a new system – whether basedon the ideas above or something different – is needed to betterreflect today's economy rather than updating a system which haslong outlived its original goals.

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Alan Vorchheimer, Principal, Wealth Practice atBuck can be reachedat [email protected].

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