Freezing pension plans and then health care?

The big business news of the week is IBM's abandonment of its conventional pension plan so that, going forward, its employees will bear the investment risk previously assumed by the employer-promisor of what had been a defined benefit plan. Viewed over the long term, we have seen a shift from no employer-provided pensions to defined benefit plans (promising retirement income, often in a manner based on final employment income and years of service) and now, apparently, to defined contribution plans (employer promises certain matching payments, perhaps, but employee bears risk of performance). Some of this evolution can be attributed to tax law (or perhaps itself caused changes in tax law); employment places with no pension plans sacrificed an obvious tax benefit, defined benefit plans allowed employers to benefit from appreciated investments and their favored tax treatment, and (now) defined contribution plans make use of 401(k) and other vehicles. But it is not entirely clear why employees would rather bear the risk of poor investment returns. In principle, the more attractive a pension plan is to employees, the lower the wage they need to be paid, so that employers ought simply to provide the best or the most tax-favored plan as viewed by a majority of, or in some industries perhaps marginal, employees. Some easy answers to the question of why we see some changes in the absence of legal change are that wages are sticky or that employees (especially young ones) underestimate the value of pension contributions or that they do not expect pension plans to be solvent when their retirement dates arrive or that they do not expect to stick around at their current jobs.

Might health care be next? For most of our history, employees could not get the same tax benefits if they took taxable wages and paid for their own medical care or health insurance.  Employer-provided health care, or health insurance, thus had a huge advantage.  The advantage is arguably smaller for retirees, and we have indeed found a lesser inclination to provide health care for retirees, and there have been recent employer withdrawals from the provision of this retirement benefit. Employer provided health care might also be more efficient - or less so. More efficient to the extent that a group can bargain with health care providers, but less efficient because of moral hazard. It might, for example, be efficient to have individuals pay for their own health care and then join groups (through insurance companies or employers) for catastrophic and expensive care. But the deductibility of health care costs when employer-provided, makes this less attractive than it might otherwise be.

Returning to retirement plans, even if tax law gives individual savers all the advantages it offers them through employer-provided plans, there is the fear that many individuals will simply save much less than they would have, or were forced to, through employers' defined benefit plans. Over time this might build up a stronger interest group, or voting bloc, in favor of more generous social security payments (and higher taxes). It might also bring about mandatory retirement savings plans, at the workplace or at home. Eventually, it is likely to bring about increased regulation of private firms that manage retirement accounts, as is currently occurring in Chile. At their core, then, pensions, health care, child care, and a number of other goods and services need to be thought of in a deep way (perhaps through explicit collective decisionmaking) as properly belonging in one of three sectors: government,employment, or household. Libertarians tend to like the last, but it is hard to get far from questions of government regulation (of insurance companies, say, and through tax incentives) once large numbers of individuals and organizations see where their interests lie.

Comments

[John Lederer]

"But it is not entirely clear why employees would rather bear the risk of poor investment returns."

An unenumerated possibility is that would like the benefits of good investment results.

[Matt Parker]

In health care, it's probably less about the long-term financial implications of defined contribution (a.k.a. consumer-directed health plans) and more about an employee's comfort with being a payor instead of a beneficiary. As with riskier, but portable and potentially more lucrative retirement accounts, thes plans should begin to be more attractive to employees as they become more comfortable with their role as health care consumers.

Defined contribution plans really became appealing after the advent of the likes of CNBC, Bloomberg, MotleyFool.com, etc., became popular sources of the kind of information professional market participants use to make relatively informed decisions about what investments to make. In other words, regardless of the tax consequences, unless an individual can ACT as an informed consumer, he/she will remain a passive recipient of a low-risk, low-yield benefit.

So too with health care. Until consumers become as proficient with -- and plan sponsors begin providing -- health care decision support tools like Rxaminer (www.rxaminer.com) and DestinationRx (www.destinationrx.com), the popularity of defined contribution health plans will remain low.

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[Michael Machen]

This is all part of the 'great risk shift' as discussed in the New Yorker recently by Gladwell and Surowiecki, among others. Since benefits are not something typically negotiated by employees (when was the last time your 401k match was negotiable?) there is gradual erosion of those benefits in the face of rising costs and overseas competition from companies that do not bear these costs due to government healthcare and pension systems. We see this in the shift from defined benefit to defined contribution in the pension world, and as HSA accounts (tax free flex-spending plans coupled with high-deductible health insurance) in the health care arena. All of this is heading one way: government assumption of health care and retiree benefits. The question for those who prefer individual assumption of the risk is what happens when middle and upper class retirees poorly manage their retirement and are destitute? Government will step in, and is in the best position to group the risk.

[Small Businesses For Sale]

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