Securing Your Future With a Defined Benefit Plan (Part 2 of 2)
The Value and Necessity of Pension Plans
By Thomas L. White, Police Trustee
The Great Recession of 2007-2009 has placed many pension plans under the microscope of public inquiry and has put into question whether they should be continued or ended in lieu of Defined Contribution (DC) plans. In the previous article I wrote for the newsletter I addressed the history of DC plans and ERISA and described why they occurred and what the intention was for their creation. Now I would like to dig a little deeper into them to help describe where Defined Benefit (DB) plans fit into the formula. To do this I would to take you back to the early 1960's and look at what happened to the Packard Corporation and the infamous failure of the car maker known as Studebaker.
A Brief Background
After World War II the strength of the American consumer returned and the two things Americans love to do (at least in the late 1940's and 1950's) were to make babies and drive cars, so America created a lot of them. Meanwhile, Britain, Germany and Japan were repairing their war torn economies and didn't make headway into the automobile market until the late 1960's and early 1970's. After the war ended the Big Three automobile makers, General Motors, Ford, and Chrysler were the kings of the automobile market, however, a second tier of auto maker enjoyed it's heyday in the 1950's and that included the Packard Corporation and the Studebaker Corporation. By the end of the 1950's this second tier of automobile makers were losing out to the Big Three and this meant consolidation through mergers and acquisitions. One of these was the merger between the Packard Corporation and the Studebaker Corporation. At this point let me do a quick primer of this merger.
“The Most Glorious Story of Failure in the Business”
One aspect of why the Big Three were successful was by creating economies of scale; they could make lots and lots of cars which reduces the cost per unit of car. The second tier of auto makers could not match this economy of scale and started losing money, lots of money. That meant mergers and acquisitions were going to take place. When Packard and Studebaker merged in a "shotgun wedding in October 1954" they were losing money by the boatloads and Studebaker was pretty much broke. When joined together this merger created one giant money losing organization. Studebaker failed in December of 1963 and an excellent chronicle of its failure was written by James Wooten in his article "The Most Glorious Story of Failure in the Business". [2] But the real story is what happened after the failure. Back in the forties and fifties most workers received pensions and the workers at Studebaker were no exception, so when the company failed the workers lost their pension benefits, and back then the Pension Benefit Guaranty Corporation (PBGC) did not exist to recover any benefits lost. The unions (who were also in their heyday at this time) went crazy, and as you can imagine requested government intervention to save their workers benefits, but in doing so, they also opened up a Pandora's Box because now the politicians gained legislative access to the pension plans. This was done by the forbearer of the PBGC with the creation of the Federal Reinsurance of Private Pensions Act of 1964. This act in and of itself was worthless to the average worker who lost their benefits, but it opened the door for Congress. Over the next decade legislation continued to be enacted until its culmination in the Employee Retirement Income Security Act of 1974 or "ERISA". This is the reason why ERISA was created, and in my prior article I described what ERISA was created to do.
Going Forward into an Unstable New World
Through the 1970’s pension plans continued to grow until 1983 when they reached their peak. Since then both private and public pension plans have had a steady decline until legislation enacted under the guise of pension protection effectively ended the viability of private pension plans. This legislation is known as the Pension Protection Act of 2006. How did we get here? In an article written by Janice Kay McClendon entitled "The Death Knell of Traditional Defined Benefit Plans: Avoiding A Race to the 401(k) Bottom" she cites four factors for the movement away from DB plans and these are: (1) Industry changes, (2) demographic shifts, (3) Economic considerations, and (4) a two-tier compensation system. [2] The first three factors really are about the changing climate in private business in changing from an American business system defined by the progress from the Industrial Revolution to the Information/Communication Age. The fourth factor in the article explores the inequality of pay between management and the workers. She highlights this by two examples; the first is the pay differential in 2003 between the CEO who was paid 400 times what the average worker earns. In another example she pointed out that the top five executives in publicly traded firms earned $260 billion in total compensation from 1993-2002. [1]
Why Pensions Are Important
Pensions have a long history in America and go back to the creation of our country when the soldiers who fought in the revolutionary war were awarded pensions for their service to their country. Since then pension plans have been vital to the life of the community because they add so much back into the community through income, stability, knowledge, growth, wealth, and vitality. Income is added to the community because when a pensioner retires that steady payment will flow into the community in good times and bad. That pensioner also left an open position that will need to be filled by a new employee who is now earning an income to be spent in the community. You might think it works the same way for 401k accounts, but it does not because the pensioner receives a check from an account that is still accumulating contributions from the members and the organization, while also earning returns. When someone retires with just a 401k that account will continue to earn returns, but it no longer will receive contributions and therefore has an accelerated depletion cycle. Knowledge is added by the national and international awareness that a pension fund brings to the community. Pension funds do not live in a vacuum, but must bring in experts from around the country and around the world to explore new economic and investment horizons, which is then often shared in the local community with pension fund investments. This is also where the growth and wealth are created by a pension fund. For example, DPFP pension fund is invested in the new LBJ Tollway currently being constructed along the northern loop of this highway. This has brought many hundreds of jobs and will ensure the fifth heaviest traveled highway in the U.S. will effectively, efficiently, and safely move traffic for the next fifty years thereby generating more growth opportunities for Dallas. Also, DPFP has invested hundreds of millions of dollars in commercial and residential properties within the City of Dallas, such as Museum Tower which leads to more growth and wealth created by the spending of these residents and the property taxes paid by these properties. The investments, projects, and knowledge brought into the area lends itself to continually creating an exciting vitality in the City of Dallas and helps to ensure a strong and solid city where people will want to live and raise their families.
Flying at 30,000 feet
Lastly, I think it is important to take a look at how pension plans impact the economy in a macro view from 30,000 feet. I learned personally about the Great Depression and World War II from my father who lived and served during that time and he told many stories of the sacrifice, the pain of unemployment, and the frustrations of the people around him. I also learned of the courage, fortitude, strength, and knowledge of the people who we can refer to as the Greatest Generation. Pensions of the past were created to reward service to your government and were created out of necessity, but this created the greatest economy ever known by mankind. By 1981, over 60% of workers had access to some type of DB plan. After 1981 and coincidental to the Reagan-Bush Era, the number of participants has fallen off dramatically to where today only 18% have access to a DB plan. During this time the U.S. has had a number of recessions (which in the due course of a capitalistic system is a normal event) and the time to recover from a recession has taken longer and longer. While several factors play into the recovery of the economy, one of the largest is the ability for the American consumer to spend money. Consumer spending generates about 70% of GDP and I fear that as pensions go by the wayside, the ability of our country to recover from future recessions/depression will considerably weaken. The reason for this is straightforward, as the economy slumps into a recession, 401k balances will slump; leading consumers to feel poorer and this will lead to retrenchment and put even more recessionary stress on the economy. If this trend continues it will come to the point where the U.S. will be solely dependent upon foreign countries and their economies to pull us out of the next recession or depression. In discarding DB plans for the average American worker, we are creating an economy that one day in the future our fate will not be decided by us, but by foreigners. I bring this up to make this point, during a recession/depression much like the one experienced from 2007 to 2009, pensioners received their same monthly pension checks and maintained their same buying power because they are unaffected by job loss or underemployment and the associated drop in income. However, for those relying on their 401k balances to maintain their lifestyle, their buying power will drop as the economy drops and will not have the purchasing power to revive a flagging economy. One last point: during tough times as we have seen these last few years, a 401k is a piggy bank for those who lose their jobs, but it also destroys the future. The power of a 401k is longevity, but leakage (I mentioned this in the first article) invalidates this thesis. There is a dearth of studies in the academic literature regarding the future disparities of purchasing power of present and future pensioners opposed to with those who have 401k accounts solely as retirement plan.
Action is Needed
For those of us who have DB plans, action is required to maintain these plans in the tough economic times we face today; we are facing many political and financial headwinds in these challenging years. But I want to issue a challenge to you. Become involved in the process of recovering DB plans for the private and public sector. The National Conference on Public Employee Retirement Systems (NCPERS) has put forth a plan called Secure Choice to help out fellow workers in the private sector. Change will only occur when people take action, when you take action, so please get involved in your local community, your union and in the upcoming elections to protect your pensions. Don’t sit on the fence or on the sidelines because one day someone may come up to you and ask you what you did to protect your pension? You can honestly answer them that you did your part. We only go around once in this world and I simply ask you to become more than the heroes you are today, but to become the heroes of tomorrow and help start the process to bring back what is fair for everyone.
Citations:
McClendon, Janice Kay. (2007) The Death Knell of Traditional Defined Benefit Plans: Avoiding A Race To The 401(K) Bottom. Temple Law Review, Vol. 80, p.809-845.
Wooten, James A. (2001) ‘The Most Glorious Story of Failure in the Business’. The Studebaker-Packard Corporation and the Origins of ERISA. Buffalo Law Review,
Vol. 49, p. 683-739. http://ssrn.com/abstract=290812 or http://dx.doi.org/10.2139/ssrn.290812
