Mickey Mantle, pensions, and safety nets

Published 4:51 pm Friday, December 4, 2015

Employer-provided pensions across the U.S. are changing. The old standard, the defined benefit plan, is rapidly disappearing. I suspect that this change will have significant consequences.
Pensions typically take one of two forms, defined benefit and defined contributions. A defined benefit plan guarantees annual payouts in retirement, typically based on earnings and years worked, and employer contributions plus returns on investments pay these benefits. Under a defined contributions plan, employers contribute a specified amount to an employee account, and the accumulated contributions plus investment returns, however much this happens to be, is the employee’s retirement.
The proportion of salaried, private sector employees covered by defined benefit plans fell from 38% in 1990 to 20% in 2008. Over this time, private sector workers with defined contribution plans increased from 8% to 31%. Most public sector employees currently have defined benefit plans, like the Retirement Systems of Alabama. But this is slowly changing; Michigan and Utah have switched new state employees to defined contribution plans.
The form of the plan affects who bears pension risks. One risk is that contributions and investments will fail to yield sufficient funds for retirement. This could happen because of lower than expected investment returns, or because of mistakes in pension accounting, which is described as more of an art than a science. The potential also exists for someone to outlive their retirement funds. Employers bear these risks with defined benefit plans, versus employees with defined contribution plans.
Both private and public sector defined benefit plans are often underfunded. Fewer than 10% of S&P 500 firms with defined benefit plans, for instance, have fully funded pensions. Companies must make up the shortfall from an underfunded pension out of current revenues, which can drive an otherwise successful business into bankruptcy. Defined contribution plans avoid pension-induced bankruptcy, but result in people without funds for old age. As more companies and governments shift to defined contributions plans, this problem will only worsen.
The life of baseball great Mickey Mantle illustrates the potential danger. I was in diapers when Mr. Mantle retired, but I learned early about his greatness as a player, and later about his famous carousing and drinking. Mr. Mantle often said that if he had known he was going to live so long (he passed away at age 63), he would have taken better care of himself.
The progress and prosperity of our economy have supported modern medicine and a significant extension of life. Life expectation increased by twenty years between 1930 and 2010. Based on how economists estimate the value of years of life, living an extra twenty years is equivalent to a $2 million benefit for the typical American. I hope that progress in life extension continues, and even accelerates it if possible.
We form expectations about life based on experience and available information. Mr. Mantle’s expectation was not unreasonable based on life when he was growing up in the 1930s. Before1930, men did not on average to 60, and men in the Mantle family rarely saw 50. Many Americans never reached retirement age.
Progress creates an imbalance between life plans based on yesterday’s world and a different, albeit better, future. For the lengthening of life, this imbalance takes the form of persons without funds for old age. Defined contribution pensions exacerbate this problem by placing the risk on people likely to make mistakes and possessing little ability to afford the consequences.
Millions of persons without money for old age could lead to demands for a much expanded government safety net, perhaps an expanded Social Security designed to provide full retirement income. Ironically, defined benefit pensions provide a voluntary, contractual safety net. Pensions allow the sharing of risks involved in planning for old age. These pensions reduced the potential for people to save too little and voluntarily transferred wealth to those who live unexpectedly long lives.
I do not know if defined benefit pensions will disappear. But if they disappear, I suspect that we will miss the market-based safety net they have provided for Americans as progress extended our life spans.
Daniel Sutter is the Charles G. Koch Professor of Economics with the Manuel H. Johnson Center for Political Economy at Troy University and host of Econversations on TrojanVision. Respond to him at dsutter@troy.edu and like the Johnson Center on Facebook.

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About Dan Sutter

I am the Charles G. Koch Professor of Economics with the Manuel H. Johnson Center for Political Economy at Troy University.

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