A paper from the Laura and John Arnold Foundation and the TIAA-CREF Institute is sparking a fresh look at the essential elements of state-of-the-art retirement plans. Titled “Equivalent Cost for Equivalent Benefits: Primary DC Plans in the Public Sector” and written by Josh McGee, vice president of public accountability for the Arnold Foundation, and Paul Yakoboski, senior economist with the TIAA-CREF Institute, the paper is the latest shot across the bow in the long-raging defined-benefit-plan versus defined-contribution-plan battle. But for those who have not yet reviewed the paper for themselves, there is some bad news: It has been unceremoniously yanked from the institute’s website.
Ever since the 2008–’09 financial crisis, defenders of public defined benefit plans have been coping with a hailstorm of criticism from well-funded pension detractors. The crisis, which exposed the precarious financial position of some public funds, breathed new life into pension critics’ mission to weaken, if not destroy, the traditional retirement benefits of public employees like firefighters and teachers.
These pension critics have been aided in their cause by two other groups: private sector workers who suddenly found themselves without work in the crisis (or, at the least, with depleted 401(k) retirement savings accounts) and began to question why the teacher next door should receive pensions while they had none; and the mutual fund industry, which has gained enormously from the growth in 401(k) plans.
McGee teamed up with the New York City–headquartered TIAA-CREF Institute, the research arm of the giant asset manager, to argue against a 2008 study by the National Institute on Retirement Security (NIRS) that found that defined contribution, 401(k)-style savings plans deliver inferior benefits to traditional pensions. The TIAA-CREF paper argues that a best-practice defined contribution retirement plan can deliver superior results to traditional defined benefit pensions. TIAA-CREF, which manages $542 billion in assets, has been providing retirement plans to the higher-education market for nearly 100 years.
McGee and Yakoboski agree that traditional 401(k), defined contribution plans are unable to compete with the cost advantages of defined benefit plans. They assert that there are best-practice defined contribution plans that were not described in the 2008 NIRS study but that provide “a viable, sustainable option for providing retirement security to workers.” The authors contend that the NIRS study, in leaving out best-practice defined contribution plans, “can be inappropriate and misleading when the dominant design looks very little like the ideal and does not accomplish the core aim of retirement income security.” The TIAA-CREF brief provides a list of seven best practices that include mandatory participation or automatic enrollment; adequate contribution rates; and a limited set of professionally managed, low-cost, pooled investments. (Yakoboski, at first willing to speak with Institutional Investor, withdrew his participation in this article without explanation.)
NIRS executive director Diane Oakley was quick to respond to the recent attack on her organization’s study. “The only way to get best practice in DC is to take away employee flexibility and choice,” she says. But that is an oxymoron, she points out, as those plans are all about employees selecting from a menu of investment options, monitoring them and controlling their contribution amounts and withdrawals. “Best practice does not really exist,” Oakley adds.
To further her case, Oakley points to defined benefit plans’ higher investment returns, ability to maintain an optimally balanced investment portfolio for a wide age cohort and pooling longevity risks with large numbers of individual participants.
The response to the TIAA-CREF paper from other pension observers has been mixed. David Madland, director of the American Worker Project at the moderately liberal Washington–based think tank Center for American Progress, published a paper, “American Retirement Savings Could Be Much Better,” with his CAP colleague senior fellow Rowland Davis in August 2013. In it they argue that personal savings vehicles like 401(k)s are “unnecessarily costly and needlessly risky.” Their solution: a new pension model like the center’s proposed Secure, Accessible, Flexible, and Efficient (SAFE) retirement plan that combines the best elements of defined benefit and defined contribution plans.
“There are definitely best practices in DC plans, and most can be improved to provide better outcomes,” notes Madland. “But even with the improvements, you don’t get the defined benefit quality.” He questions why the TIAA-CREF paper lacks any illustration of how its plan achieves a good retirement benefit outcome. He also asks why someone would write this kind of paper. His conclusion: “Some people don’t like social insurance, and they believe people shouldn’t have it.”
A longtime advocate for social insurance, Teresa Ghilarducci, an economics professor at the Schwartz Center for Economic Policy Analysis at the New School for Social Research, comments, “There are many innovations in America, so any DC plans that become more like DB plans will be better because the DB model is better.” Ghilarducci, who has designed her own model of government-administered Guaranteed Retirement Account plans, to augment Social Security, has for the past decade pushed for better retirement benefits for the U.S. workforce. Although she notes that defined benefit plans must be structured in a way to reduce employer risk exposure — the clear advantage of defined contribution plans — she views defined benefit plans as the gold standard to be aimed for in any new pension model. “There are many ways to do that in DB,” she explains.
Robert Clark, who is a pension fund expert, and has written for the TIAA-CREF Institute, has a somewhat different take. An economics professor at the Poole College of Management at North Carolina State University in Raleigh, Clark believes in choice when it comes to retirement benefits. “There’s no question you can design a bad DC plan,” he notes. He argues that well-structured defined contribution plans are needed to mitigate the effects of “mobility risk” for an increasingly transient workforce. Perhaps even more interesting, Clark says he chose for himself ?the North Carolina Optional Retirement Plan (ORP) defined contribution plan over participation in the North Carolina Retirement Systems because he liked the plan’s portability.
Clark, who considers his North Carolina ORP a model of best practices, points out the other factors that make it appealing: a committee to oversee the investment benefit providers (including TIAA-CREF, Fidelity Investments and Lincoln Financial Group), an annuity option, low fees and a whopping 13 percent combined employer-employee contribution rate.
From the discourse among McGee, Yakoboski and others, the push will remain to develop viable and sustainable alternatives to both the classic pension and retirement savings vehicles.
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