September 2019 marks the 45th anniversary of President Gerald Ford signing the Employee Retirement Income Security Act, commonly called ERISA. Of course, the issue of retirement income security is as relevant as ever, particularly given questions about the long-term sustainability of current Social Security benefit levels.

We can use this occasion to review the issues that the legislation was intended to address, how the environment has changed over the past 45 years, and potential changes to bolster retirement security for the next 45 years.

Historical perspective

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

But it was during the period from the start of World War II through the Korean War – in part due to wage-price controls that prevented pay increases but permitted improved fringe benefit programs, high tax rates, and union interest – when many private sector employers introduced pension plans as a form of compensation. As a result, the number of workers covered under private sector pension plans went from 4 million in 1940 to over 17 million by 1958.

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

And it was perfectly legal for an employer – even those not in financial difficulty – to terminate a pension plan without funding all vested benefits. Another major concern was the mismanagement and embezzlement of pension funds, particularly those benefiting collectively bargained workers. In 1965, the Senate conducted a high-profile investigation of union pension funds being transferred overseas for "medical research" to foundations controlled by the plan trustees without disclosure to the plan participants. (Film buffs may recall the scene in "The Godfather Part II" when a fictionalized version of the gangster Meyer Lansky brags that his Cuban hotels were in part financed by Teamsters pension funds.)

Studebaker

The incident many cite as highlighting the need for pension reform involved the December 1963 shutdown of the Studebaker auto plant in South Bend, Indiana, laying off over 4,000 workers. Soon after the plant closed, Studebaker terminated the retirement plan for hourly workers, and the plan defaulted on its obligations. Eventually, an agreement was finalized where vested participants age 40-59 receiving on average only 15% of their accrued benefits; workers under age 40 received nothing regardless of service.

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

ERISA and its aftermath

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

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

Instead, defined contribution plans are now the sole workplace retirement benefit offered to most employees; it is up to each individual to save and invest for their retirement. So, if the key goal of the original ERISA legislation – securing employer provided pensions – is irrelevant to today's worker, what now?

Where do we go from here?

Forty-five years after the passage of ERISA with employer-based retirement programs now primarily in the form of defined contribution plans, the most important limitations of this system include:

Inadequate savings: One 2019 study estimates over 40% of all U.S. households where the head of the household is now between 35-64 will run short of the retirement income needed to cover average expenses and healthcare costs.
High cost: Defined contribution plans sponsored by smaller companies don't enjoy the economies of scale of larger plans and pay substantially more in total plan fees, usually at least 1% of assets. These costs often reduce employee returns as they are incorporated into the total expense ratios of plan investments.
Overly complicated: When you review the evolution of different defined contribution (DC) programs issued under the tax code (e.g., 401(a), 401(k), 403(b), 457(b)), you quickly realize there has been no master plan in putting them together. Then consider personal retirement programs like IRAs, SEPs, Keoghs, etc. and it can boggle the mind. All these provisions add cost and complexity to the system without seeming to bolster retirement security.
Too centered on the employer plan: The current U.S. employer retirement plan system is partly an outgrowth of the wage-price controls imposed during World War II that encouraged employers to provide compensation increases through fringe benefit programs such as pension plans. But the regulatory regime imposed by ERISA in order to help secure these benefits (including non-discrimination testing, audits, legal documents, disclosures, etc.) substantially increases compliance costs and discourages smaller employers from even offering programs. Furthermore, employees in the "gig economy" frequently aren't eligible for an employer-sponsored plan.
Decreased protection against longevity risk: The average American life expectancy increased from 71.9 in 1974 to 78.5 in 2017. At the same time, the move from DB to DC plans has meant that the average participant has less protection against outliving their assets as lump sum payments have replaced life annuities as their plan's default form of distribution.

Rethinking retirement legislation for the 21st century

In aggregate, these issues suggest any overhaul of the current private pension system needs to deliver a simpler, less expensive system that encourages increased overall savings rates. It is hard to see how simply tweaking the existing ERISA legislation will produce that, as it was built around forcing individual employers to secure their pension commitments through a series of regulatory requirements.

Perhaps we need to envision a system that recognizes individuals, rather than employers, as the key driver of retirement security.

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

Expanding this type of program to the private sector could even go further by allowing self-employed workers to establish accounts as well. And the program could restrict any employer contributions to the use of certain safe harbor formulas, eliminating the need for non-discrimination testing.

The U.S. government's role could be limited to ensuring promised contributions are deposited, as occurs for Social Security contributions with private sector providers competing for accounts using a standard design, comparable to how Medicare supplement plans are now offered.

Addressing inadequate savings

This approach could lead to a much simpler, cheaper system. By pooling tens of millions of employee accounts together, even workers at smaller companies would enjoy low investment and administrative fees. Standardizing plan terms and options would make it simpler for the average worker to understand. And the plan could offer the lowest possible cost life annuities give the population size.

What it wouldn't do of course is address inadequate savings levels by employees or lack of employer contributions. But suppose the U.S. government assumed virtually all the administrative duties for this program in return for some level of minimum employer contribution (say 1% of pay) that would be required of participating plans. (Employers could of course contribute more using one of the same harbor formulas. Or even decide to remain within the existing system.) How many employers would turn down this trade?

Revamp instead of upgrading

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

Perhaps that is the best sign that a new system – whether based on the ideas above or something different – is needed to better reflect today's economy rather than updating a system which has long outlived its original goals.

Alan Vorchheimer, Principal, Wealth Practice at Buck can be reached at Alan.Vorchheimer@buck.com.

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ERISA at 45: Where do we go from here?

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