A long history of reaction

The history of U.S. pension legislation over the last four decades is largely one of playing catch-up.

“Congress typically waits until there is some crisis,” said Phyllis Borzi, assistant secretary for the Employee Benefits Security Administration at the Department of Labor. “One of the beauties of the marketplace is that things change. The problem with government is that we tend to be more reactive than visionary, and Congress is 18 times more like that than anybody.”

Just ask the 11,000 employees of the Studebaker-Packard Corp., which in 1963 reneged on its defined benefit pension promises, leaving more than half with little or no retirement benefit. The lack of protection for private-sector workers shocked Congress into action, but it took more than a decade to come up with the solution, which came in the form of the Employee Retirement Income Security Act of 1974. The watershed law signed Sept. 4, less than a year after the first issue of Pensions & Investments, laid the ground rules for defined benefit plan sponsors on participation, funding, vesting, reporting, fiduciary duties and financial disclosure. The law also created a safety net for workers — the Pension Benefit Guaranty Corp.

Then there were the employees of Enron Corp., who were urged to keep adding company stock in their defined contribution plans. In 2001, asset values crashed as Enron executives sold their shares while the company slid into bankruptcy. That helped to raise awareness of the issue of company stock in retirement plans and led to several rounds of defined contribution reforms, but it was too late for Enron workers.

Massive industry upheaval in the airline and steel industries in the early 21st century also shook up what had been until then a rather sleepy PBGC, transforming an agency handling 73 defined benefit plan terminations in 2000 into one facing 186 terminations in 2002, all of which led to a whopping $23.3 billion deficit by 2004.

Another case of delayed reaction came in 1986, when Congress added a financial distress test for employers seeking to terminate their plans. “It's clear that Congress was trying to create a financial safety net, but from the beginning the program was not structured correctly,” said Ms. Borzi of EBSA. “Congress struggled in the '70s, '80s, '90s and even today over how to structure a system that does not encourage gaming and dumping.” Disagreement over how employers calculated their funding levels, plus bipartisan concern over the PBGC deficits that could have hurt taxpayers created the climate for the next big pension legislation, the Pension Protection Act of 2006.

The PPA provisions for shorter, seven-year amortization periods for measuring liabilities and more conservative interest rates for calculating them pleased accountants, CEOs and politicians pushing mark-to-mark accounting, but proved to be a tipping point for defined benefit plan sponsors, which started freezing or closing plans at an unprecedented rate, or at least seriously considering it. “It was the difference between a snapshot and a motion picture, which did contribute to a lot of additional volatility that caused concern to balance sheets,” said Drexel University law professor Norman Stein. With short amortization periods and new discount rates, “the legislation suffered from a kind of schizophrenia” that has since spilled over to the public sector, he said.

“It really put a lot more plans at risk,” said Diane Oakley, executive director of the National Institute on Retirement Security, Washington. As a congressional policy aide during the PPA debate, she said many people worried that the law was going too far and would drive more sponsors to terminate their defined benefit plans and send more plans to the PBGC. “The idea was to get more money into the plans, but the business response was to close the plans,” said a committee policy aide with the Senate Health, Education, Labor and Pensions Committee who asked not to be identified.

The 2008 recession brought its own reminder of how market forces and legislative action can work at cross-purposes. “The law of unintended consequences is alive and well, especially when talking about government,” said Dallas Salisbury, president and CEO of the Employee Benefit Research Institute, also of Washington. He noted that the PPA was mainly about protecting the PBGC. “All of the things that it so dramatically influenced on the defined benefit side could almost be described as accidental.”

The PPA was better for defined contribution plans. It codified earlier tax changes that encouraged automatic enrollment in 401(k) plans and made it easier for 401(k) sponsors to offer investment advice to participants. “What we saw in automatic enrollment is what I think is the perfect model for the role of government. They provided some legal reassurance to encourage this behavior,” said Edward Ferrigno, vice president for Washington affairs for the Plan Sponsor Council of America.

While ERISA and PPA were massive efforts, there were lots of smaller legislative changes over the last 40 years that often came through the tax-writing committees, beginning with the Revenue Act of 1978, where Section 401(k) established qualified deferred compensation plans, and clarification regulations in 1981. “Some of the pieces that really changed things were not big things at the time,” said Alicia Munnell, director of the Center for Retirement Research at Boston College.

Another tax bill in 1984 added non-discrimination testing of 401(k) plans, but it was the Tax Reform Act of 1986, which established faster vesting schedules, raised contribution limits, and further tightened non-discrimination testing that “set the groundwork for the explosion of defined contribution,” said Mr. Salisbury of EBRI.

While the tax code was used to prevent abuse of employees' retirement assets by employers, many see the history of pension legislation as a story about lawmakers' search for tax revenue, which could be increased by reducing some tax exemptions for retirement contributions or benefits. “Every time they wanted to raise money, they whacked the retirement system,” said David Wray, past president of PSCA.

Ms. Munnell agreed. “ERISA was trying to do a lot of good things, but it had a lot of demands,” she said.

Over the years, several other pieces of legislation were aimed at preventing abuses, including a 1980 multiemployer pension plan law that created withdrawal liability to discourage employers from leaving their fellow sponsors holding the bag. The 1984 Retirement Equity Act helped protect women by mandating spousal consent for workers to waive survivor benefits, among other things. It also created a coalition of pension advocates, said Mr. Stein of Drexel University. “There was a political element to that that has carried forward to this day.”

The difficulty of getting additional and timely fixes has shifted a lot of responsibilities for filling in the broad strokes of ERISA to regulators, including those at the Labor Department and the Internal Revenue Service, where some efforts have been more successful than others.

“Congress is good at big concepts and not the fine detail,” said Bradford Campbell, a partner in the Washington law office of Drinker Biddle & Reath LLP, who served as a top official in the Employee Benefits Security Administration during the implementation of PPA. “The one downside is that Congress has more checks and balances. Unless the regulatory agency is making process mistakes, they have a great deal of regulatory latitude. If it's in good faith, it works well.”

Right after the passage of ERISA “it was chaos,” said Ms. Borzi, who was a key House pension aide from 1977 to 1995. A concerted effort by officials from the DOL, IRS and the Securities and Exchange Commission during the Carter administration to give plan sponsors and providers a single set of operating parameters helped.

“You have this delicate balance of providing some benefits while at the same time making sure they aren't ripping off the participants or the taxpayers,” said Karen Ferguson, director of the Pension Rights Center, an advocacy group in Washington. “Regardless of politics, the agencies try to continue that balance.”

Employers have also gotten more proactive about regulation in the last 20 years, said Aliya Wong, executive director of retirement policy for the U.S. Chamber of Commerce in Washington. “I think as employers are seeing more money going into the plans, they want to see it being spent wisely, and are trying to prevent more burden,” she said. “A great example of that is (developing rules for) electronic delivery, where employers said "make it workable,'” Ms. Wong added.

One “deregulation” regulation that had a big impact on retirement plan investing came in 1979, with the “prudent man” rule, which opened up investment options by removing the fear of investment risk-taking that had existed in the absence of clear direction on the issue. The rule, which said that a fiduciary must act with the “care, skill, prudence and diligence” of any prudent man in a similar capacity, led to what became known as the “prudent investor” rule for assets that may be too risky for large allocations but beneficial for a diversified portfolio. Many credit the rules with increasing private equity investment by both corporate and public pension funds.

Less successful was the way agencies handled exemptions to prohibited transactions rules. While they “generally worked well,” said Scott Macey, president and CEO of The ERISA Industry Council in Washington, “they should recognize a little more flexibility. The rules have encouraged too much litigation” in cases where sponsors did not mimic specific examples that had already been sanctioned.

“The nature of government regulation for better or worse is that even when it is intended to create flexibility, it doesn't because it is read literally by the lawyers. The Catch-22 is it ends up stifling innovation,” said EBRI's Mr. Salisbury.

Another ERISA provision, 404(c), which allows participants to direct their defined contribution investments, “really changed the dynamic,” said Ms. Borzi, particularly as demographics changed and defined benefit plans saw increased volatility. She sees that provision as creating an opening for defined contribution plan service providers and consultants to get much more involved, but worries that DC plan participants will need more help with financial literacy.

The changing landscape from defined benefit to defined contribution “has required companies to rethink and the government to rethink its job,” said PBGC Director Joshua Gotbaum. ”Our job is to encourage defined benefit plans. Part of our job, as the economics of the world changes, is to ask what companies can afford. We understand why companies have had to change their retirement programs, but we encourage them to do so in a way that preserves retirement security,” he said. “We regulated DB plans more intensely than we did DC plans. I think that differential is a continuing incentive for companies to not offer DB.”

As defined benefit plans continue their downward trend, leaving a gap so far unfilled by DC plans, the discussion is now shifting to ways to tackle lifetime income instead of lump-sum distributions, which Mr. Gotbaum said “are like cigarettes. They're not illegal and many people like them, (but) they are bad for you. They are the opposite of retirement security.”

David Levine, an ERISA lawyer with Groom Law Group in Washington, thinks the search for guaranteed income is part of a 40-year, pre-ERISA full circle back toward individual responsibility that could bring a resurgence in annuities, along with new asset allocation models that include professional money management.

Sen. Tom Harkin, D-Iowa, chairman of the Senate HELP Committee, said: “The world has changed, and we are facing a real retirement crisis.” He is hoping that later this year Congress will consider his proposal for a universal access pension program with professional investment managers and reduced employer demands.

Another back-to-the-future moment may well come as EBSA officials work to update the fiduciary standard created in ERISA. “I think that was a critical concept, and I think Congress got it right,” said Ms. Borzi. “I am the first to admit that the Department of Labor got it wrong” with regulations implementing the law that allowed for exclusions. “At least 35 years have gone by, and business models have grown up without any inclination to really go back to the first principles,” she said. “It's a functional definition. It is all about reducing conflict of interest.”

If EBSA officials prevail in their mission to revert to a tighter fiduciary standard, “it is probably the most significant regulatory bookend of anything that's happened” since the passage of ERISA, said Mr. Salisbury.n