Pushing a poisoned elixir

Risk & Insurance, May, 2005 by Len Strazewski

Security and risk are usually considered to be mutually exclusive, but the Bush Administration's two latest retirement policy proposals are built on the idea of injecting more risk to create greater security over the long term.

Both proposals are popular with retirement-industry lobbies, but generally controversial because they challenge some traditional retirement funding values, most notably, the "three-legged stool" idea of a secure personal retirement.

The stool concept--used to train the previous generation of human resource directors, employee benefit managers and employees--is that retirement security is built on three sources of retirement assets: private employer pensions, personal savings and investments, and Social Security.

The two new proposals, targeting private pensions and Social Security, squeeze some of the legs closer together than ever before.

In January, Labor Secretary Elaine Chao introduced the administration's plan to reform the single-employer defined benefit pension system with changes in the accepted funding formula and higher Pension Benefit Guaranty Corp. insurance premiums.

The plan is designed to reduce the steady flow of pension plan terminations and the resulting burden on the PBGC.

Specifically, the proposal calls for a new government-determined method for measuring pension liabilities based on a formula linked to corporate bond rates and present earned benefits. The formula would replace actuarial calculations that are based on projected benefit levels and anticipated investment returns.

The proposal also allows plans to adjust their assumptions according to their risk of termination, as a way of preventing forced termination. "At-risk" pension plans may be allowed to use a higher rate of return based on higher-risk junk bonds while financially stable plans would be required to use projections on more conservative investment grade bonds.

According to an analysis by PricewaterhouseCoopers in Washington, the plan would measure funding more directly on the market costs of providing benefits and allow assumptions to be modified based on the financial health of the plan sponsor rather than an objective measure.

Underfunded plans would also be restricted from increasing benefits and may even be prevented from offering lump sum payouts. PBGC flat rate insurance premiums would also increase from $19 per participant per year to $30 per participant per year.

The proposal has already been popular with the retirement industry lobby. James A. Klein, president of the American Benefits Council in Washington lauded the proposal as the first step in dealing with a retirement plan crisis.

However, the proposal comes at a time when the administration is also promoting a major change to Social Security, which would also inject more investment market risk.

The Social Security proposals, also designed to reduce the financial burden on the responsible agency, calls for a portion of Social Security contributions to be invested in individual accounts managed by participants, and most likely, investment in private equity markets.

The plan would also restrict future cost-of-living increases.

The proposal's similarity to defined contribution retirement plans sponsored by employers has made it popular with employers, but unpopular among Congressional Democrats who say the greater investment risk born by participants does not provide greater security.

LEN STRAZEWSKI, a professor and benefits expert, is a regular columnist for Risk & Insurance[R]. He can be reached at riskletters@lrp.com.