This is an exciting and difficult time for retirement systems in the U.S. especially as the Baby Boom generation starts to move into traditional retirement ages. With an aging population and high expectations of a high standard of living, people are retiring differently and companies are changing the way they offer retirement plans.

The new plans often shift much more responsibility to the individual, and, in many cases, individuals are not handling that responsibility well. Regulations designed to improve retirement security can sometimes have the opposite effect. But U.S. experience can help Canadian companies and policymakers identify what changes are likely to have positive effects and which are not.


There has been a long-term shift in the U.S. from DB plans as the primary retirement plan to DC plans as the primary retirement vehicle. Smaller employers have mostly terminated their DB plans and many large employers have either closed plans to new entrants or have frozen benefits. The trend in the U.S. is not as pronounced as in the UK, but it is accelerating. The decline in DB plans is driven by the interaction of accounting and funding rules, globalization of business, and an economic climate that has been unfriendly in recent years.

Shifting and uncertain rules have been another major contributing factor to the decline of traditional DB plans in the U.S. For more than 30 years, the story has been one of repeated legislation, late regulations, litigation, increasing complexity, change and uncertainty.

During 2006, the 900-plus page Pension Protection Act made major changes in requirements for funding of all DB plans, clarified some open issues about cash balance plans, opened the door a crack for more formal phased retirement, bolstered the strength of the Pension Benefit Guarantee Corporation(PBGC), defined safe harbors for auto-enrollment in DC plans, made permanent early liberalizations in defined contribution limits, and authorized providing investment advice to plan participants.

The pension community waited for legislation on funding rules and cash balance plans for several years. So, one would expect that people are breathing a sigh of relief and are ready to move on. It is not that simple. Technical corrections are needed and, given the results of the 2006 Congressional elections and the controversy surrounding some of the provisions in the Act, it is likely that there will be moves to change some of its provisions.

The uncertainty marches on. And, even if there are no changes, it may be years before regulations are finalized and open questions are resolved. Experts disagree about whether the Pension Protection Act will accelerate the decline or help stabilize the environment. The Pension Protection Act is just a small part of a long saga that includes the Employee Retirement Income Security Act, the Tax Reform Act of 1986, the Tax Equity and Fiscal Responsibility Act of 1982, The Deficit Reduction Act of 1984, The Retirement Equity Act, etc. Overall this is an unhappy story.

The lesson for Canadian policy-makers is that regulators can do harm as well as good, and they should try to avoid doing harm. While regulations can serve to help protect plan participants, they can also have the opposite and unintended effect of leading to total loss of benefits. Plan sponsors will discontinue plans or move to plan designs that avoid regulation that is too onerous. Too much regulation is a deterrent to plan sponsors and if plans are voluntary, they may not be worth the price. That means that some people lose benefits rather than gaining protection.

The situation in the United States arose partly because of a lack of unified pension policy and because key stakeholders were unable to compromise and regularly provided a divided front to the Congress. Canadian policy-makers would do well to look at the inter-relationship between increasing regulation and decreasing benefits. A key lesson for employers is that it is vital to provide leadership in defining policy and to compromise where needed. At the end of the day, a lot of care is needed to do legislation well, but otherwise it can have very perverse effects.


One of the other plan design trends in the U.S. was a move over the last 15 years to new DB plan designs, cash balance and other hybrid plan designs. Cash balance plans are DB plans that define the benefit as a lump sum, and define the benefit accrual as a percentage of pay plus an amount to reflect interest or investment return. They leave investment risk with the employer and provide a benefit accrual pattern similar to a DC plan. They also offer relatively more benefit accrual early in one’s career. Cash balance was seen by employers as a very good design in light of workforce trends, but adverse court decisions and regulatory uncertainty effectively choked off the move to cash balance plans.

Some participant advocates fought against these plans, feeling that conversions were not liberal enough, and expecting that they could encourage companies to stay in traditional DB plans. However, some of the confusion surrounding cash balance plans has led companies to freeze them and has led other employers who were considering them to simply offer a DC plan instead. Ironically, the court decision(Cooper vs. IBM)that was the most troublesome has now been reversed on appeal, and the new Pension Protection Act offers clarification about conversion options, thereby reducing the regulatory uncertainly surrounding these plans.

Also, ironically, the advocates who fought against cash balance plans found that employers moved to DC plans instead of staying with traditional plans. It is not yet known if the new developments are too little and too late to rekindle interest in these plans.

The present situation can be viewed as one of turmoil, and there is a lot of uncertainty about where things will go. For employers in Canada, it is important to remember the value of DB plans and regular income. It is also important to be realistic about what DC plans can accomplish and what they can’t.

What Canadian plan sponsors can take away from the experience in the U.S. is that fighting against new designs can be counterproductive. Those who fight may find that rather than preserving the traditional, they get much less than they might otherwise get under newer alternatives. Innovation needs to be supported by accommodating regulation. Conceptually good ideas are often killed or stifled to by too much regulation.


Within the U.S., few employers have addressed the emerging patterns of retirement directly with formal phased retirement programs. Many companies offer part-time work, rehire their own retirees or the retirees of other companies, and individuals are working out their own plans. The U.S. Congress has enabled gradual retirement by making Social Security available after normal retirement age even if people continue to work.(Social Security normal retirement age is gradually being increased from 65 to 67 and it will be 67 for those people born in 1960 or later.)The recently enacted Pension Protection Act allows employers to pay benefits from plans after age 62 to phased retirees.

Retirement ages need to be increased over the long-term, but this is very difficult from both a policy and employee relations point of view. This is tragic because increasing retirement ages would solve many cost problems and help preserve plans. Long term this is a vital issue in many different Western countries, but a very difficult one for policymakers and the business community.

New employment options can help employers and employees. Many people would like to have flexible work opportunities as they move into retirement. This is an opportunity for employers to attract and retain a dedicated group of workers.


But even as people work longer, they need the fundamentals to help them navigate through their retirement needs. And retirement systems have shifted more responsibility to individuals who are not prepared to handle it well. Research from the Society of Actuaries, behavioral finance, the John Hancock Life Insurance Company, and other sources documents significant gaps in what individuals understand about retirement risk and how they deal with it.

Many people underestimate longevity and it seems that few of them have focused on the uncertainty surrounding life spans. Employees consistently have stated they feel that a diversified stock portfolio is financially less risky than the stock of their own employer. And employee sentiment did not change after the financial difficulties such as in the Enron scandal. Focus groups conducted in 2005 by the Society of Actuaries with individuals who had retired in the last few years with significant 401(k) balances explored how people had made investment decisions and whether they had decided to purchase guaranteed life income. That research showed relatively little financial planning, an intuitive process, and a short-term focus. The focus groups indicated that the individuals most likely to change investment strategies where those who had changed or added an investment advisor.

Further evidence of lack of knowledge or action to use it is the fact that many employees end up in the default options in their 401(k)plans and stay there, even though there are a variety of choices open to them. Research shows dramatically different returns in otherwise similar plans depending on the default options they include. Employers have been working to improve DC plans with auto-enrollment and good investment defaults, but much more work is needed on what defaults would work well for the payout period.

Education is viewed by some as a solution to these challenges, but it has its limits. Be realistic about what you can expect from participants and how much you can gain from education. The bottom line is that we can’t expect employees to have a good understanding of investments and retirement savings, or the discipline to save enough. The best way to provide for a secure retirement for your employees is to have plans that work without individuals having to take action to participate. DB plans are very valuable for retirement security. Where DC plans are used for basic security, plan sponsors need to structure them so that they do not depend on employees to make good choices.


The Society of Actuaries is working on a project to search for new models for retirement security. This project “Retirement 20/20” is built on the idea that traditional DB plans put a great deal of risk on employers(more than is acceptable in many situations)and traditional DC plans put too much risk on employees. This project is seeking a “Third Way” and looking for new models of risk sharing for retirement benefits.

Canadians are participating in this project. It will start by identifying stakeholders, their needs and the risks they face, and the potential methods for pooling and sharing of risks. The stakeholders referred to are society at large, employers, individuals and financial markets.

The U.S. experience has taught us that an organized retirement system is extremely important to society and to individuals and families. One of the big questions for the future is how employers will be involved in the retirement system.

Employers can pay for retirement benefits, bear risk, educate employees about savings, and provide employees good ways to save. They offer fiduciary oversight, encouragement, and a good financial deal. They play a critically important part in the retirement system, even though their role may evolve. To make this happen, it is important that they get a reasonable return on their efforts to offer benefits without too much risk and/regulatory hassle. And that is a lesson that knows no boundaries.

Anna Rappaport, F.S.A., is the founder of Anna Rappaport Consulting in Chicago.

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