Back to Portfolio for the Future™

Does the Defined-Contribution Broom Still Sweep All Before It?

July 14, 2014

broomThe New York Times froze the pension benefits for non-union employees, and we were determined that they would not do likewise for Guild employees.”  

Those are the words of Bill O’Meara, President of The Newspaper Guild of New York. We were discussing the background of the labor negotiations between the Guild and The New York Times in 2012, and how the outcome of those talks, now ratified so to speak by the Internal Revenue Service, may be a straw in the wind for a revival of defined-benefits plans (though in a re-jiggered form).

To some, “defined benefits funds,” the traditional arrangements whereby an employee’s retirement benefits are independent of the performance of the fund whence they are to be paid, seem almost as bygone and quaint these days as words like “whereby” and “whence.”

Passé Since the ‘90s

In the U.S. in particular, the assets under management by the alternative, defined contributions plans (where liability equals fund value) passed the AUM within DB plans back in the 1990s. The difference has widened steadily since then, in boom times and in bust.

The reasons for the switch aren’t mysterious. There was a time, after all, not too long ago, when organized labor was a much more formidable force, both in private industries and among municipalities, in the U.S. than it is at present. And secure pension plans were a common negotiating demand of this formidable force. Furthermore, managers both of corporations and of municipalities found that they could give ground on pensions, often in return for concessions elsewhere because, after all, they thereby received bargaining leverage today in return for liabilities decades away.

In 1949, for example, UAW leader Walter Reuther demanded a “noncontributory” pension for his members. Chrysler in particular balked at this, and the union kept its members out of Chrysler plants for 100 days. Chrysler relented, and promised an “actuarially sound” pension.

Douglas Fraser, who was active in the UAW already and who would become its president thirty years later, reminisced once about how this notion of actuarial soundness was a “new expression” to the rank and file. But after the strike of 100 days, they took the phrase at face value and went back to work, pension promise in hand.

Anyway, those days are gone. But….

The work force has never regarded DC as anything other than a makeshift, and in markets where labor is tight the appeal of retirement security is a powerful bidding tool even if one accepts as fact the disappearance of Reuther and his ilk.

“This was one of the three biggest issues in our negotiations with The Times leading to the 2012 agreement,” said O’Meara, “along with wages and health care.”

Certainly the DB system has tax benefits, both for the recipient and for the employer. Contributions to a plan on behalf of a particular employee/taxpayer are made on a pre-tax basis. This essentially defers the tax event, the recipient will pay taxes on the benefits (if he is otherwise subject to taxation at the time) when he receives them.

Also, the employers’ contributions to an employees’ trust or annuity are considered “ordinary and necessary” business expenses, and are deductible as such.

The Guild and The Times agreed to a new system that they call an Adjustable Pension Plan, or APP, contingent on IRS approval (they received “positive signals” from the IRS and Treasury officials while negotiations were still underway). That is, they agreed that if the IRS agreed that APP was a defined benefits plan, allowing the treatment just described, then the plan as discussed would move forward.

Had the plan not received final IRS approval, the benefits part of the contract would have reverted to a DC plan, and this would have been yet another exhibition of how DC is sweeping all before it. But the IRS did approve, and that broom is for now back in its closet.

“The IRS deliberation wasn’t a matter of public notice and comment,” O’Meara said. “There was no rule or regulations change involved, simply an analysis to determine the APP as set out satisfied the existing rules. They’ve decided that it does.”

Above the Defined Floor

The idea is that employees/retirees will receive a defined floor, payments they can count on month after month for the rest of their lives, and with PBGC insurances. Above that floor, outcomes can vary depending on how well the plan’s portfolio performs.

As O’Meara put it, this allows employers “greater flexibility than the older, traditional DB plans did.”

He has hopes that the APP will have greater significance than simply a resolution of the issues before the Times and the Guild, that it will be a valuable template for other managements and unions going forward.

If that happens, it will of course affect the alternative investment industry, which will have to make its pitch to the managers of these variable-DB institutions.