Business Page – Feburary 08, 2004

A question of pensions

Introduction

If many of our private sector employers were to have their way, they would dramatically alter their pension schemes from a defined benefit (DB) to a defined contribution (DC) scheme. In so doing they would be following many in the developed world and more especially the USA where the number of active members in defined contributions schemes has increased from 13 million in 1978 to over 50 million in 2000, while those in defined benefits schemes have fallen from 29 million to 22.5 million over the same period. It is true that certainly in respect of the USA, this trend has partly been driven by that country’s tax and pensions laws, but employers there and elsewhere have found DC schemes attractive because of the reduced costs and risks to them, which in fact are shifted to their employees. Making the issue more complicated is the fact that certain features of the DC schemes are attractive to the workers.

In the USA the changing landscape is generating intense debate and there have been a few isolated cases where some schemes have reverted to defined benefits. This has been due in part to pressure from employees and the extensive analytical work done by the academic community, but also in part to the fact that employers are finding that the overall benefit of the defined contribution scheme is not as great as theory would have suggested. This apparently is because the US plans may include not only pensions, which are a long-term benefit, but also short-term benefits including medical benefits, the cost of which continues to escalate at an alarming rate.

Shifting the responsibility

In Guyana, there is no such debate, and except in matters pertaining to the National Insurance Scheme, pension and health schemes are often seen as a private matter between the employer and the employee. This is dangerously wrong and brings with it several costly public interest risks. Inevitably in most employer/employee relationships, the balance of strength lies with the employer - whether it is in respect of access and control over information, negotiating strength, influence over the independent advisors such as actuaries and fund administrators, or, to put it bluntly, the employer’s ability to call the shots.

The employee or his representative often faces a dilemma when the employer warns, sometimes with no justification, that pressing for desired benefits may adversely affect the company’s long-term survival. This is a very effective ploy, and more often than not employers in the private  sector get their way even if  the workforce is de-motivated because of feeling cheated.

One perhaps extreme case took place recently in Guyana when an employer faced with a deficit in the company’s pension scheme avoided the deficit by offering the employees the termination of the scheme in exchange for immediate payment of the cash value of their benefits. In a situation where the employee is living hand-to-mouth, cash now is always the first choice, and sadly, the employees accepted the offer with the union leader apparently unable to exert any leadership influence on this unfortunate development.

Regrettably, this is not the only such incident where workers  have been left at the mercy of employers, or where they have had benefits withdrawn or reduced. The introduction of the NIS in 1969 saw employees having to pay contributions of about 1/3 towards benefits which had hitherto been financed entirely by the employer. More recently, we have seen many pension schemes altered to the detriment of the worker, notwithstanding clauses in their scheme which specify that any change to the scheme should not place the worker in a less favorable position. Interpreted correctly, this suggests that whatever change there is should not adversely affect the interest of the worker. Why then is there such an interest by employers in changing their benefit schemes from a defined benefit to a defined contribution?

Differences of money

There is no doubt that there are significant differences between defined benefits and defined contribution schemes. In a defined benefit scheme the benefits are set out in the scheme or plan which would provide, for example, that the pension benefit at the retirement age would be set at say the average monthly salary earned by the employee in the last three years of employment.  With a defined contribution scheme, the level of the contribution is fixed but the benefit varies according to the returns on the investments.

Since the funds of the DC plans effectively belong to the employee, he usually has a say in how those funds are invested, but he also bears the risk from the poor performance of those investments even if they are invested in the company. On its collapse in December 2001 Enron, once America’s seventh-biggest company, it was found that over half of its employees’ pensions assets had been invested in the company itself. Subsequent research found that this was not a unique situation, and in fact at several top American companies, including General Electric, there was even heavier investment in their own company than at Enron. For those companies considering a move from DB to DC, this must surely be a matter for attention.

This column does not wish to suggest that DC plans do not have their virtues, or that given the choice employees would always prefer DB plans. It is convinced, however, that employers almost always seek to act in their short-term self-interest. At the same time workers must realize that the long-term survival of the employer is in everyone’s interest.

Some of the virtues often associated with DC schemes are:

* Portability - DC plans offer portability which is crucial for shorter-term employees, including those who do not plan to work right through to retirement. However, it is also true that a worker often changes jobs because of the real or perceived deficiencies in remuneration and other conditions at the employer. In fact DC may actually promote shorter tenure as workers seek to cash in on their share of the investment.

* Cost control - Controlling costs is a significant factor in the decision by the employer on the better option. As the financial statements of several of our public companies show, DB schemes can build up substantial deficits for which the employer is responsible.  Part of the problem has been the rather optimistic assumptions made by the actuaries in determining the longer-term obligations of the scheme, and the considerable lag in having periodic actuarial reviews. Thankfully, 2-3 year reviews are now far more common than the five years which was not uncommon in the past. Of course DC schemes do not require such valuations which under DB schemes would be borne by the employer.

* Access to savings - DC plans allow terminating employees to access their savings prior to retirement, and most allow lump-sum payments upon retirement. If these distributions are poorly invested or spent, the individual could be left without adequate retirement income.

On the other hand, the case for DB plans seems extremely strong. Without a doubt, it is better public policy. The basic purpose of a retirement system is to provide a secure and predictable level of income for former employees after retirement. DB plans do this. However, for lower-paid employees unable to make substantial contributions, they receive correspondingly less benefits as do those who outlive their retirement benefit. The only recourse would be to stay employed if there are such opportunities, or to fall back on the public system which is itself short of resources.

Business Page considers that the interest of the worker is better served by DB schemes, as such plans provide guaranteed income security to workers for their retirement; do not expose employees to investment risk; do not make retirement benefits dependent on employees’ ability to contribute (or, in the case of the US, save in 401k) and provide automatic cost-of-living adjustments. It is argued as well that they are not inflexible and can allow for portability with shorter vesting periods, reciprocity agreements, and buybacks for prior or related service.

Despite the apparent virtues of DCs relative to DBs to the employer, DBs are not without merit, as they encourage a stable workforce of persons with a guaranteed income-replacement.  Employers benefit from the favorable investment performance of pooled pension fund assets, but DCs do not solve deeper budget constraints and may actually exacerbate a morale problem.

Conclusion

Pension and related matters are not the private business of the employer and the employee only. They are public interest issues in which the state and the rest of society have an interest. This article has referred to one case where workers were lured into converting a DB to a DC scheme by the simple method of giving back the accumulated savings which in fact belonged to the workers. This was not good public policy and should not have been allowed.

There should be clear guidelines to guide any attempt at future conversions, and the workers’ representatives need to be more alert to the issues involved. Perhaps the Ministry of Labour and the TUC would want to take the initiative.

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