In August, we wrote about the decline of traditional pensions in the private sector. One of the major reasons for private companies abandoning pensions was a series of laws beginning in the 1980s and culminating in the Pension Protection Act of 2006. These laws, in various ways, increased the volatility of pension plan funding and imposed a greater regulatory burden on companies that sponsor a defined benefit pension plan. Ten years after its passage, the National Institute on Retirement Security takes a look at the Pension Protection Act and finds that it largely failed at achieving its stated goals.
The Pension Protection Act (PPA) was intended to do two things: first, to improve the funding levels of defined benefit pension plans; second, to increase participation in defined contribution 401(k)-style plans. The PPA set out to improve pension plan funding by increasing funding requirements and shifting plans to a market-based value of assets and liabilities. Unfortunately, rather than shoring up underfunded pension plans, the PPA prompted companies to close their plans altogether. Since the PPA took effect, the number of private-sector pension plans has declined more rapidly than before- from 29,000 to 22,000 plans.
Using a “market value” approach, rather than an actuarial value, involves a stricter funding requirement (100% instead of 90%) and a shorter period of time to get to full funding (2 years instead of 4-5 years). Additionally, if a company experiences a steep loss in the value of its assets or if it achieves an unusually high investment return, it has a shorter period of time over which to “smooth” the value of its assets. Unfortunately, this significantly increases the volatility of the cost of the pension plan. From year to year, companies don’t know how much it will cost them to operate the plan and what effect that cost will have on their balance sheets. Multiple surveys have shown that it is not the cost of the pension plan itself that concerns companies; it is the negative impact of this cost volatility. Congress clearly recognizes the problem here: since 2006, they have passed six different stop-gap measures, such as The Worker, Retiree, and Employer Recovery Act of 2008, to address the inconsistencies in pension plan costs.
The other major goal of the PPA was to increase participation in defined contribution 401(k) plans by making it easier for employees to enroll in a plan. The most significant way the PPA tried to do this was through increased use of auto-enrollment of employees in 401(k) plans. Unfortunately, auto-enrollment has proved to be a double-edged sword. Most auto-enrollment 401(k) plans start participants with a low contribution rate of 3 percent or less. Few workers ever go back and increase their contribution rate above 3 percent. This is a problem because that number is much too low to guarantee a secure retirement. While auto-enrollment did increase the participation of employees in plans with this feature, it also means employees are contributing a lower percentage than they might have if they had signed up for the plan on their own and chosen their contribution rate.
The Pension Protection Act sought to shore up funding for private sector pension plans and increase participation among employees in 401(k) plans. It failed to accomplish either of those goals. In fact, since 2006, the overall number of private sector workers participating in a workplace retirement plan has actually declined. The PPA has, arguably, made the problem of retirement security for working families worse. More companies are closing defined benefit plans without a corresponding increase in participation in 401(k) plans. It does not have to be this way. Rather than passing stop-gap measures every year or two, Congress could make permanent changes to the funding requirements for traditional pension plans to make funding more stable from year to year. A more consistent funding requirement means more companies would be willing to maintain or even reopen defined benefit pension plans. This is essential for working families because a traditional pension is the best way to prepare for a secure and dignified retirement.