So What Else Is New In DC?

 In journalism theory, the headline is a literary genre unto itself. It's supposed to capsulize what follows it so that the reader's own unassisted, low-tech browser linking eyes and brain can discern in a flash whether he or she has an interest in reading more. Ideally, the headline should also smack of some news value. Or create a sensation. Wuxtry! Wuxtry!

That thought passed me as I looked at my Philadelphia Inquirer business section on a slow-news Saturday this month to spot a business section article headlined "Fewer large firms offering traditional pension plans," picked up from AP. Not exactly news, certainly not to anyone peeking into this blog. It's sorta "duh" stuff, or as Yogi would put it, déjâ vu all over again. But making allowances for that, I read on.

The really new news lay in quantifying "fewer" not just to characterize what has already taken place but what is expected to happen in 2008 and beyond within the top-tier of American industry, the Fortune 100. We have been told before not to sell the Fortune 100 short on their continuing to maintain, among themselves, DB plans that cover significant numbers in their workforce. But the trend has been clear. The new numbers, in a fresh survey released in May by Watson Wyatt Worldwide, Inc., are that of 89 DB plans maintained by the companies in the 1986 vintage, only 35 were still being offered in 2006, and in 2007, currently, it is already down to 31. Explained another way, WWW found, the 10 firms that offered primary DC plans in 1986 had grown to 37 by 2005 and numbered 42 in 2006. And 27 of the firms that featured DB plans in 1986 had moved to "hybrids" from the single such plan 20 years before.

Misnomer as it now stands, the Pension Protection Act of 2007 is widely expected to accelerate still further the terminations or freezes of DB plans in favor of 401(k) plans. Further, provisions of the PPA now sanction certain cash-balance and other hybrid plans as forms to pass muster as DB plans under the IRC and the anti-discrimination laws that protect older workers. A spokesman for the WWW consultancy indicated that other Fortune 100 companies are "strongly considering" hybrid and DC plans right now, raising expectations that those plans will be on the increase again in 2008.

These trends continue at a time when 401(k) plans are undergoing judicial scrutiny in class actions attacking plan service providers, including mutual funds and their contractual partners in revenue-sharing, for charging excessive and improper fees to plan participants. See 34 BPR 1043 (5-1-07).

Perhaps not as visible as multiple class actions are the implications of an increasing number of studies wiithin the financial and academic communities which are highlighting the "reverse multiplier" phenomenon that almost inheres in DC accounts funded by mutual funds.

From Economics 101, we learned of the classic "mutliplier" in consumer purchasing power, where $1 of spending in, say, a retail purchase is then "re-spent" several times over as the retailer applies that revenue dollar, variously, to pay wages, add to or replace inventory, procure business services, and on and on, as parts of that one dollar are recycled over and over through the economy.

We are now learning more and more about a form of "reverse multiplier" -- in which the loss to savers that arises from the shortfall between (x) gross market returns from, say, equity mutual funds and (y) the net returns after all expenses are passed on to the fund participants translates to a mutliple of that shortfall in the percentage reduction of retirement payments obtained in annuitizing the final account balance.

Well-managed DB plans are more successful in moderating the "reverse multiplier" because of the economies inherent in scale and risk-pooling and the expertises employed that individual plan partiicipants almost invariably lack. These factors tend to shrink the shortfalls between gross and net returns during the accrual period, making possible more bang for the buck of single-sum present-value that can be converted to a guaranteed life income at retirement.

The metrics are beginning to pile up. The co-authors of "The Performance of U.S. Pension Funds" headed by Professor Rob Bauer at the University of Maastricht recently found that individual investors give up 250 basis points per year in agency costs in a comparison between their mutual fund returns and pension fund (DB plan) portfolio returns. This fairly confirms the conclusions reached by John Bogle, the former CEO of the Vanguard Group, that mutual funds are far more expensive than traditional pension funds and that an annual shortfall of 250 basis points per year in equity mutual funds is to be expected. Going further, Bogle has maintained that a similar shortfall, of around 225 points per year, would be experienced in mutual fund bond funds.

In the stratosphere of advanced financial analysis, Keith Ambachtsheer has examined such studies in the real-world context of "pension delivery organizations,' including mutual funds, and suggests that, compared to DB plan participants, mutual fund participants incur a reduction of at least 1% per annum during their years of employment, with a resulting 20% loss in life income benefits. In "The Ideal Pension-Delivery Organization: Theory and Practice" presented in March 2007 at an Amsterdam conference, Ambachtsheer posits that a combination of fund governance improvements and mitigation of agency costs offers a potential for doubling the pension per dollar of retirement savings, versus the end-results to be expected from persistent agency conflicts and poor governance. Ambachtsheer's paper, available on the Internet, contains an extensive bibliography and a series of endnotes referencing studies for policy consideration in this area.

It's in this realm of the math of individual-account savings plan returns that the continued trend of replacing DB plans with DC plans should arouse the most serious dismay. Post-PPA, the status quo begs for truly revolutionary institutional change if financial security in retirement is to remain an achievable goal for the vast majority of American workers.

Abbott A. Leban