I’d like to start what is likely to be a series of columns on the possibility that we are or may be moving to a provider-based retirement benefit system.
What problems might be solved by such a change? And what challenges might be created? I want to begin with a consideration of our current system and the employer’s role in it. And I want to begin that discussion with a consideration of what “employee benefits” actually are.
“If we were to apply the unmodified, uncurbed, rules of the micro-cosmos (i.e., of the small band or troop, or of, say, our families) to the macro-cosmos (our wider civilization), as our instincts and sentimental yearnings often make us wish to do, we would destroy it. Yet if we were always to apply the rules of the extended order to our more intimate groupings, we would crush them. So, we must learn to live in two sorts of world at once.”— F.A. Hayek, The Fatal Conceit
“I just don’t want my employees thinking that their jobs depend on performance. What sort of place is that to call home?” — Michael Scott, Regional Manager, Dunder Mifflin Paper Co.
The Office: A Transactional Macro-Cosmos or a Place to Call Home?
What are retirement benefits? Are they just another sort of compensation? Or are they something more—a sort of glue that helps hold the office (or shop or warehouse) together?
That’s a complicated question that depends on what sort of employer (or what sort of employer-employee relationship) we’re talking about, and what sort of benefit (e.g., disability vs. stock options) we’re talking about.
Different Sorts of Firms
It’s obvious that there are all sorts of employers out there, existing on a continuum between Hayek’s macro-cosmic “transactional” office and Michael Scott’s office-as-family. And it’s not just about size. There are family businesses that do see their employees as (extended) family members, where decisions about what sorts of benefits to provide are based on “sentimental yearnings.” And there are family businesses that are motivated solely by cost and associated tax benefits.
There are large corporations for which “taking care of our people” is a high value and others (say, a big brokerage or sales organization) where everyone is expected to “eat what you kill,” and benefits are seen as just another version of cash.
Different Sorts of Benefits
Certain benefits—medical being perhaps the best example—are inherently unrelated to pay and thus are (at most) an ambiguous sort of “compensation.” The lower-paid employee and the higher-paid employee often get the same coverage when they get sick. They may even go to the same doctor. And the benefit provided to a married employee with five children is typically worth a lot more than the one provided to a single person, even if they’re doing the same job for the same cash pay.
Retirement benefits aren’t like that. They are pay-related. Both employers and employees understand that. And I believe that the emergence of DC plans has been a response to that intuition: retirement benefits are about pay and money and many participants (and employers) prefer that that money be delivered via a transparent and transactional, cash- and account-based plan.
Let’s stay with this issue of DB vs. DC and the “family” (or paternalistic) vision vs. the transactional vision for a bit.
In a traditional DB plan, a 55-year-old gets a significantly more valuable benefit than a 35-year-old, even if they are both doing the same job. The complexity (“non-transparency”) of DB benefits can hide this effect, but most employees still get it. In a DC plan (typically) these two employees (typically) get the same benefit. And that seems more fair.
DB vs. DC, Workforce Management and Culture
There are, of course, employers that continue to provide traditional DB benefits. The design has some utility, e.g., in attracting mid-career hires. And its backloaded benefits do (often) provide an incentive for employees to remain with the employer. That may be a feature where retaining experienced workers is important. But it may also be a bug—causing employees to stay at a job after they’ve lost interest in the mission.
But those “workforce management” features of DB plans are, I think, less important than (for lack of a better word) “culture.” Does the firm “take care of our people” or scrupulously just “pay employees what they are worth?”
I don’t think there’s any right or wrong to any of this. Different employers and different employees have different styles and different expectations from work. There are successful “family” firms. And there are successful transactional firms.
My sense, nevertheless, is that the arc of the retirement benefits universe is bending toward the transparent and transactional. Hence the dominance of account-based plans, most significantly, the 401(k) plan.
The Role of the Employer in a DC Universe
In this context—a DC universe—the question naturally arises: Do we really need an employer at the center of it? The employer might, for example, set certain basic variables, such as the matching contribution rate. But the most difficult jobs in running one of these plans, it turns out—the thing that employers keep getting sued over—are “monitoring” (as the Supreme Court puts it) the fund menu and negotiating the deal with the recordkeeper.
Those aren’t inherently part of an employer’s skill set. Management is (or should be) good at running its core business: making widgets. Why does it also have to hire an investment staff, who in turn (often) hires an outside expert, to figure out what funds should be offered in its 401(k) plan? When the main reason to have a 401(k) plan is to deliver a (somewhat complicated) set of tax incentives for retirement saving—something we as a society have decided is a good thing. And the employer got picked to deliver these benefits because it manages payroll.
Other than the size of the match, perhaps, there aren’t a lot of workforce management incentives here. It’s not really credible that an employer’s ability to create a really great 401(k) plan fund menu is going to have a significant effect on, e.g., its ability to recruit.
I just want to emphasize: I’m talking about employers that are delivering a pay-related, cash benefit via an account-based plan. Indeed, a 401(k) plan allows an employee to save nothing at all, if in his or her judgment that is the right decision. Or to save 25% of pay—whichever he or she prefers. I would argue that this is not an employer whose primary concern with respect to retirement benefits is to “take care of our people” paternalistically. Rather, its concern is to provide its employees with the tools they need to take care of themselves—with maybe a nudge (i.e., defaults) in the right direction.
Why not let someone else—like a provider—do the very difficult job of managing the plan’s fund menu? And administration—recordkeeping, 5500, etc.?
But Wait…
That all makes sense from the employer’s point of view. But it raises a new set of questions: Do we simply adapt our current provider infrastructure to this new employer-less situation—kind of in the way the Affordable Care Act adapted to the installed health insurance business model? In that case, who will do the job that employers do in the current system—monitoring the fund menu and checking the fairness of the provider’s deal?
Or should we think about something that looks like single-payer, e.g., the proposals to reinvent our retirement system as part of the Thrift Savings Plan (TSP)—sort of a “TSP for all”? In which case, how might putting everyone’s nest egg in one investment basket affect our capital markets?
I will take up those questions in a subsequent column.
Michael P. Barry is a senior consultant at October Three and President of O3 Plan Advisory Services LLC, which provides retirement plan regulatory analysis targeted at plan sponsors and those who provide services to them.
Opinions expressed are those of the author, and do not necessarily reflect the views of NAPA or its members.
