Traditional Pension Research Articles

What Do We Know About the Risk of Individual Account Pensions? Evidence from Industrialized Countries

The traditional way by which rich countries assure old-age income security is through mandatory, publicly financed pensions. Most national systems provide defined-benefit pensions in which a worker's benefit is calculated based on years of coverage under the program and average wages while contributing to the system. Traditional systems are designed to replace a predictable and stable percentage of workers' average earnings over their later careers. Excessive pension commitments have pushed many pay-as-you-go pension programs toward insolvency, however. One reform option is to scale back traditional pensions gradually and replace them with pensions financed out of individual investment accounts. A presidential commission recently outlined three reform plans to reduce benefits under the U.S. Social Security system and replace them with annuities financed out of retirement savings accounts (President's Commission to Strengthen Social Security, 2002). This paper examines evidence on the likely success of individual accounts in providing retirement income. I use historical and simulated data on financial-market performance to evaluate the market risks facing contributors to a system that is based on individual investment accounts. The paper estimates the hypothetical pensions that workers in five industrialized countries could have obtained based on historical data. The empirical magnitude of retirement income risks is shown to be quite large, almost certainly larger than would be tolerated in most rich democracies.

Replicating Default Risk in a Defined-Benefit Plan

A stock-bonus plan with a provision to permit diversification can come close to replicating the classic default risks in defined-benefit pension plans. The diversification formula is a function of a worker's service in the company and the particular features of the defined-benefit (DB) plan that are being reproduced. The diversifiable stock-bonus (DSB) plan still gives workers a stake in the financial performance of the company, but the diversification formula eliminates the extreme downside of a traditional stock-bonus plan, namely, the possibility that workers could lose up to all of their retirement accounts after long years of service. Because the DSB plan imposes about the same default risks on workers as a DB plan, workers' compensation levels with a DSB plan need not be any higher than in a traditional pension plan.

Cash Balance Pension Plan Conversions

One of the hottest issues in the pension world today involves companies replacing their traditional pension plans with cash balance plans. A cash balance plan is a pension plan that looks like a bank account or a 401(k) plan. The problem is that replacing a traditional pension plan with a cash balance plan will reduce the expected pension benefits of older workers. As a result, older workers can see their future pensions cut - in some cases deeply. Not surprisingly, many of these older workers have felt cheated, and they have filed a number of lawsuits to stop these so-called cash balance conversions. This Article considers the various legal issues that are raised by cash balance conversions. In particular, this Article considers whether these conversions violate the Employee Retirement Income Security Act (ERISA) or the Age Discrimination in Employment Act (ADEA). The Article concludes that the typical cash balance conversion will not violate these laws. As long as the conversion protects the already-accrued benefits of older workers, ERISA will be satisfied. And, as long as post-conversion benefit allocations are nondiscriminatory, ADEA should be satisfied.

Converting traditional pensions plans to cash balance plans: Should you do it?

Converting your firm's traditional pension plan to a cash balance plan will reduce pension expense. It will also help you attract younger, more mobile employees, since the plan is portable. But you'll be penalizing older employees for their loyalty to the company. Instead of receiving their traditional pensions, they'll end up with smaller ones. Some may even sue the company. So should you convert? The authors discuss the complex issues involved, and provide a checklist to help you decide. © 1999 John Wiley & Sons, Inc.

Converting traditional pensions plans to cash balance plans: Should you do it?

Converting traditional pensions plans to cash balance plans: Should you do it?

Are 401(k) Plans Replacing Other Employer-Provided Pensions? Evidence from Panel Data

This paper examines whether sponsors of traditional defined benefit (DB) plans are replacing them with 401(k) or other defined contribution (DC) plans. I compare pension plan offerings by sponsors of a DB plan in 1985 with their offerings in 1992 using Form 5500 filings from those two years. I find that 401(k) and other DC plans are substituting for terminated DB plans and that offering a DC plan of any type increases the probability of a DB termination. Thus, it appears that, at the sponsor level, many of the new 401(k) plans may not be avenues for net saving but are replacements for the more traditional pension forms. Using several specifications, I estimate that a sponsor that starts with no 401(k) or other DC plan and adds a 401(k) is predicted to reduce the number of DB plans offered by at least 0.3. That is, the estimates imply that one sponsor terminates a DB plan for about every three sponsors that offer one new 401(k) plan. The addition of a non-401(k) DC plan is estimated to reduce DB plan offerings by at least 0.4. Plan-level point estimates indicate that if a 401(k) plan is added by a sponsor, the DB termination probability increases by about 18 percentage points to 35 percent. The addition of a non-401(k) DC plan similarly increases the probability that an accompanying DB plan will be terminated.

Meeting The Communication Challenge

For the most part, account-based pension plans are not traditional long-service retirement plans. They are "when your service ends" plans, whether the employee leaves to retire or start a new job or vocation, and they are much like savings plans. They are also a new approach to helping employ-ees understand and accumulate their financial resources. Easier to explain to employees than more traditional pension plans, account-based plans still present stumbling blocks in terms of how to successfully introduce them to your orga-nization. Why the new plan is being introduced and what it is intended to do and not to do are the toughest and most important communication challenges that need to be met. Key communica-tion elements include proper naming of the bene-fit (don't call it a retirement plan) and demonstrating your organization's intended people strategy.

Traditional Pension Fund Valuation in a Stochastic Asset and Liability Environment

Using the stochastic investment model proposed by Wilkie (1995) this paper simulates the progress of a specimen final salary pension scheme over a period of 25 years. Salary experience over the projection period is also assumed to be stochastic. The specimen scheme is assumed to be stable during the projection period with respect to age, pensionable salary in real terms and past pensionable service.Regular deterministic valuations of the scheme are conducted during the projection period to determine the current level of funding of the scheme on both a discontinuance and an ongoing basis, and also to determine the future contribution rate required to meet the funding objective. The required contribution rate is calculated in accordance with the Inland Revenue surplus regulations and the Minimum Funding Requirement (MFR) introduced in the Pensions Act 1995.The effect on the level of funding (and, hence, on the size of the required contribution rate) of using different investment strategies and of varying the pace of funding, by adopting both a traditional prudent valuation basis and a more realistic valuation basis, are also explored.

New on the Pension Scene: The Cash-Balance Plan

The new cash-balance pension design may offer larger lump-sum value to younger employees than the traditional defined-benefit pension plan, while maintaining older workers' benefits and giving administrators funding flexibility and cost control.

Updating the Traditional Corporate Retirement Program, Part 2

Having decided that its traditional defined-benefit pension plan doesn't meet its current needs, the corporation might choose any of several restructuring approaches that combine a defined-benefit plan with a defined-contribution plan, or it might choose to rely strictly on a capital accumulation plan.