This week marks the 30th anniversary of the signing of the Employee Retirement Income Security Act, the purpose of which is encapsulated in its name.
That is, ERISA was to make the retirement income of private-sector employees secure.
In one sense, it has been a huge success. In another, it has been a terrible failure. Unfortunately, little but a government mandate that all private companies offer employees fully funded defined benefit plans with full portability can repair the damage to the retirement income security of private-sector employees.
Let's consider the successes of ERISA.
First, by imposing relatively short vesting periods, ERISA ensured that more employees would eventually earn at least some pension benefit from companies for which they worked for long periods.
Second, by setting high standards of fiduciary behavior, and requiring trustees to make sure assets were invested solely in the interests of beneficiaries for the purpose of paying benefits, the law ended self-dealing by corporate pension sponsors and made the promised pensions more secure.
Third, by requiring that companies fund their unfunded past-service liabilities over 30 years, ERISA ensured that companies contributed significant sums to their pension funds so there were assets to back the promises.
Fourth, ERISA called for the establishment of the Pension Benefit Guaranty Corp. to provide backup insurance to pay the pensions of those whose companies might fail before the pension promises were fully funded.
Now let's consider the failures.
First, because of compromises lawmakers made to both employers and unions to get agreement on the law, the funding rules were too loose. Thirty-year funding for salaried plans and 40 years for negotiated plans were both too long. These compromises made pension benefits — dollars of compensation to be paid in the future — appear far less expensive than dollars paid in wages today. As result, employers promised pension benefits that were too rich, that they would not be able to afford without a miracle in the capital markets. These promises have come home to roost in the steel industry, are coming home in the airline industry, and will likely come home to the auto industry.
Second, ERISA allowed too much freedom in assumptions underpinning the funding of the benefits, contributing to underfunding.
Third, the existence of the PBGC further encouraged corporate executives to be cavalier about pension benefits and their funding, while encouraging union leaders to negotiate higher pensions. If the gamble failed, the PBGC would pick up the pieces.
Fourth, ERISA provided no incentive for corporations to establish or maintain defined benefit plans, and no significant disincentive for the termination of such plans. As a result, the number of corporate defined benefit plans has dropped to about 27,000 today from a peak of 112,000.
As a result of these failures, while the retirement benefits of those still covered by defined benefit plans are more secure than they would have been without ERISA, the retirement benefits of all other private-sector employees are less secure.
That's because those employees now are covered by 401(k) plans, if they have retirement benefits at all, and 401(k) plans pass most of the funding responsibility and all of the investment risk on to the employees.
To a certain extent, government actions after ERISA helped destroy private-sector defined benefit plans. Changes in the definition of the full-funding standard made funds vulnerable to a bear market, digging funding holes from which companies could ill-afford to climb, for example.
It's too late now for minor repairs to ERISA and the whole private retirement system. A major overhaul is required.
In fact, Congress and the next administration should examine the provision of retirement income in this country from top to bottom, from Social Security to corporate retirement plans to public employee plans.
They should ask the following questions: What is the best mix between a government-sponsored plan and employer-sponsored plans in terms of economic efficiency and social equity? What is the optimum structure for the government plan and employer-sponsored plans? The retirement system in this country cannot be fixed by piecemeal action any more. A new system must be built from the ground up.
