Parking a link: Collective DC plans? (UPDATED)

Last updated on: August 16, 2016 at 9:52 am by Jane the Actuary

Parking a link: Collective DC plans? (UPDATED) 2016-08-16T09:52:19-06:00 Jane the Actuary

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I came across this report on collective DC plans (following the model of the Netherlands?), originally linked to by The Agenda, a blog on the National Review Online which I read occasionally. Anyone read about this? For the moment I’m just parking this link here to look at in detail more later. (I have some materials on the collective DC plans in the Netherlands at work which I keep meaning to pull up — that’s the direction they’re headed with many companies moving from traditional DB to this “collective DC” structure.)

UPDATE:

So now I’ve read the report. On the whole, I think many of the ideas are credible.

The “collective” plan is not intended to be government- or union-run. The risk that investment return will take a back seat to politically-favored investments should be as much a non-issue as for an ordinary mutual fund, because these plans ought to be run at the same remove from government.

Such a plan should also be at no greater risk of nationalization of funds than a mutual fund.

The fundamental idea builds off the mutual fund concept, and off the concept of an annuity. Like a mutual fund, pooling of funds reduces expenses and allows greater diversification. Like an annuity, pooling of longevity risk eliminates the worry of outliving one’s funds.

The authors of this study promote significant savings relative to traditional 401(k) plans in terms of the amount of retirement benefit available for the money, due to
* reduced plan expenses, by further increasing economies of scale due to larger plans than typically the case currently,
* professionally managed investments (it’s long been known that, for instance, large corporate pension funds, have, on average, a significantly higher return than 401(k) funds),
* benefits due to smoothing of investment gains and losses, decreasing the need for the individual saver to build a “cushion”, and
* the ability to annuitize at a more favorable rate than through a traditional individual annuity, through group rates, allowing for a greater retirement income at a given level of account balance than if a 4% rule-of-thumb or “preserve the principal” approach were followed.

The plan provides for account growth based on smoothed investment returns, and annuitization at retirement. Employers participate through payroll deduction, and it moves with you through various employers. I believe the balance is intended to be portable — that is, one can move from one provider to another — but I imagine that the money is locked in rather than spendable for pre-retirement needs (which seems to be another way the plan makes retirement savings “cheaper”, by reducing leakage). The smoothed investment returns minimizes the risk of losing value, but the funds/annuities aren’t guaranteed in the way that an immediate annuity is. Whether an employer is expected to make their own contributions isn’t specified, though perhaps I read too quickly.

The modelling looks credible, though I haven’t studied the assumptions and methodology in depth.

Here are my concerns with this plan:

First of all, the name is awful. Please, just say no to clever acronyms! Supposedly the plan the CAP promotes is a “Secure, Accessible, Flexible, and Efficient, or SAFE, Retirement Plan” — does this really tell you anything about what this plan is all about? “Secure” — well, it isn’t guaranteed. “Accessible” — well, there’s easy access to begin savings, but the money itself isn’t accessible until retirement. Flexible? No, not really. The plan administrators would have to follow a precise approach to funding and smoothing in order to avoid favoring one group over another (e.g., retirees vs. younger or older workers). This is a “Pooled Retirement Plan,” not a “SAFE plan.”

Second, there’s no sense in this report of how to get from here to there. The authors envision non-profit Retirement Plan boards, who contract with professional money managers. I can easily envision the same companies as currently manage 401(k) plans for employers, the benefits outsourcing companies, expanding into pooled retirement plans, but where would the non-profit boards come from? I don’t see what entities would come into existence. Perhaps they envision the UAW and SEIU finding a new line of business, and skimming a little off the top, but who else? And what value would they add?

What would really be needed is a framework and a governing body and enabling legislation, that spells out under what conditions a company could offer such an annuity-like product while exposing the participating employee to more risk than an annuity and without the same requirement for establishing reserves as with an annuity.

The report also envisions mandatory auto-enrollment (with an opt-out option), and auto-escalation, though the report doesn’t suggest specific contribution levels. The difficultly is that the Social Security formula has a very progressive formula (90% on the first tranche of pay, 35% on the second, and 15% on the third), which means there is no simple answer to the question of what the “right” amount of savings is. A very low earner needs to save less as a percentage of pay than a high earner, when Social Security benefits are taken into account.

In the Netherlands, where “collective DC” plans are common, and the source of much of the research this report cites, the Social Security formula is entirely different — it’s a flat amount per person, less for an individual who lives with another (married, partnered, roommates, sisters, it doesn’t matter) but with no relation to income. In such a system, the employer pension contributions generally are made on pay above a given annual threshold, with the intention that the employer-provided retirement benefit covers pay above the Social Security benefit only.

In this sense, such a pooled retirement plan, if based on pay above a threshold, would dovetail nicely with various conservative proposals, such as the Biggs’s AEI proposal, or the Heritage proposal. I would very much like to see people concerned about the future sustainability of our retirement system, from the left and the right, come together in legislation that transforms Social Security into a Dutch-style flat benefit and a complementary private pooled retirement plan system, and it is one of my great frustrations that numerous entities and individuals have crafted proposals such as this, but that there’s never been, so far as I know, a substantial effort at coming together to develop legislation which moves us forward.

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