Back to the drawing board

With a Senate evenly divided for the first time in 120 years and a president who takes office with a historically thin margin, retirement reform seems a distant prospect.

With a Senate evenly divided for the first time in 120 years and a president who takes office with a historically thin margin, retirement reform seems a distant prospect.

By Justin Dini
January 2001
Institutional Investor Magazine

In his first speech as president-elect, George W. Bush talked about reconciliation. He urged Americans to pray for their country. And he spoke with passion and conviction about retirement , though not his own.

“Together we will save Social Security and renew its promise of a secure retirement for generations to come,” Bush told the nation on December 13, five weeks after the election and just one hour after Vice President Al Gore had finally conceded the race.

It’s one thing to stand in front of the American flag and pledge allegiance to Social Security. It,s another thing entirely to make meaningful repairs to a safety net sorely in need of mending. For years Republicans and Democrats have beaten each other silly over Social Security and other retirement reforms, turning voters, widespread fears of old age into blood sport and potent sound bites.

Last year it seemed as though a breakthrough might be near. Though in sharp disagreement, Bush and Gore embraced the need for Social Security reform with a passion that sent lockboxes and fuzzy math flying along the campaign trail and across debating stages. Against considerable odds and after years of inaction, the House resoundingly passed an ambitious bill for private pension reform. The proposed legislation, which would have allowed 401(k) portability and increased IRA and 401(k) contributions, looked like a sure thing when it won the endorsement of the Senate Finance Committee in early fall. But after House Republicans shoehorned the bill into their ten-year, $240 billion tax-cut package, which President Bill Clinton promptly and predictably vowed to veto, the bill was shelved for the year.

In Washington that counts as progress, but the outlook for retirement reform now appears as murky as ever. The reason, ironically enough for a race that focused so much on the issue, is the unsettled outcome of the election.

Most obviously, although Bush will be the first Republican president to control both houses of Congress in 50 years, his margin is excruciatingly narrow and his mandate uncertain. Republicans hold a shaky ten-seat majority in the House, and the Senate is split 50-50 for the first time in 120 years, with vice president,elect Dick Cheney able to break ties. Postelection calls for bipartisanship notwithstanding, both parties are already positioning themselves for the 2002 congressional elections, in which the Republicans are very much in danger of losing the Senate and possibly the House. Democrats won,t be inclined to give “Dubya” and his party any legislative accomplishments, and it’s not yet clear whether the new president will be able to rope in his own party.

Since emerging as the winner, Bush has signaled that he intends to make his controversial $1.3 trillion tax reduction plan the centerpiece of his first 100 days in office, a move that will almost certainly occupy most of his time and cost him much political capital. Democrats oppose the size of the cuts, which Gore derided as a giveaway to the rich; even some Republicans, including House Speaker Dennis Hastert, are urging Bush to adopt a more piecemeal approach.

Bush has continued to make clear in the days leading up to his inauguration that Social Security reform will be a priority for the new administration and has even gone so far as to say that partial privatization is one of several policies that will help stimulate a slowing U.S. economy. “One of the key challenges for our nation is to make sure that there is enough money in the private markets to fuel economic growth in the future,” the president-elect said in mid-December while introducing his nominee for Treasury secretary, Paul O,Neill. “A Social Security system that allows people to manage their own money in private markets will provide the fuel for economic vitality in the future.”

But Bush has already said that he will postpone Social Security reform by appointing a bipartisan commission to look at the issue, taking it off the table for several months. Moreover, the Democratic leadership of the House and Senate fiercely opposes his commitment to privatization.

“Enacting legislation is going to be a long haul, and it is a long shot at best,” says Representative James Kolbe, a Republican from Arizona who has been a strong advocate of Social Security privatization. “But if president Bush is willing to lead on this and cajole some Democrats, that will make a big difference.”

Sylvester Schieber, director of research at Washington-based consulting firm Watson Wyatt Worldwide, takes a less sanguine view. “My hunch is that the Democrats and Republicans are going to sit across the table and just look at each other.”

Politically, private pension reform is an easier exercise than a major overhaul of Social Security. Still, Congress may well ignore it while grappling with the bigger pieces of Bush’s program. Complicating matters further, Senator William Roth of Delaware, the father of the Roth IRA, who provided much of the momentum for pension reform, was defeated in his bid for reelection.

Roth’s likely successor as head of the Senate Finance Committee, Charles Grassley, an Iowa Republican, has a keen interest in retirement issues, which he cultivated as chairman of Congress’s joint special committee on aging. But he’s likely to place private pension reform behind Social Security initiatives. Confirms a spokeswoman for the senator, “Grassley thinks Social Security will be a front-burner issue.”

Certainly, other sponsors of key pension legislation remain in office. The two congressmen who co-sponsored the House version of the pension reform bill from their perches on the Ways and Means Committee, Representative Benjamin Cardin, a Maryland Democrat, and Representative Rob Portman, Republican of Ohio, are returning. A close ally of George W. Bush’s who worked in former president George Bush’s administration as director of the White House office for legislative affairs, Portman was mooted for a senior administration post. More likely, he will serve Bush’s cause on the Hill. Says an aide to the congressman: “He is not going anywhere. If anything, he,ll be a legislative point man.”

Pension reform will remain at the top of Portman,s list of things to do, but he,ll follow the new president’s priorities. Ray Sullivan, a Bush spokesman, said in December that the president-elect has not yet formulated a specific policy on the subject. Adds one Democratic congressional aide, “I don,t think this is a big priority for Bush.”

“You rarely get the opportunity we had last September,” sums up Edward Ferrigno, who oversees Washington affairs at the Chicago-based Profit Sharing/401(k) Council of America. “To think that you pick up next year where we left off this year is pure speculation. We just don,t know what will happen.”

When the 106th Congress convened in 1999, Democratic Representative Earl Pomeroy of North Dakota told this magazine that it looked like “the best Congress in 20 years” for retirement savings legislation.

He was right. In August 1997 Portman and Cardin introduced the Comprehensive Retirement Security and Pension Reform Act. Known as Portman-Cardin, the bill called for an increase in the cap on individual contributions to IRAs, from $2,000 to $5,000 a year, as well as a hike in the maximum allowable annual contributions to 401(k) accounts, from $10,500 to $15,000. The legislation, which introduced the first hikes since the creation of 401(k)s in 1978 and the IRA in 1981, enjoyed broad backing.

Portman-Cardin also eased the so-called portability regulations governing the transfer of 401(k) balances, a move that met with little resistance on either side of the aisle. But some critics charged that several measures in the bill could have rolled back existing statutes that protect the rights of moderate- and lower-income participants in pension plans.

The bill got held up in the 105th Congress because legislators, used to high deficits, treated personal savings reforms as budget busters, owing to their potential impact on tax revenues. But after Washington recorded its first surplus in years , $70 billion in fiscal 1998 , savings reform began to seem a realistic goal. Portman-Cardin was reintroduced last year, passing 401-25 in the House in July. The Senate Finance Committee approved the bill unanimously in September.

The Senate bill had included last-minute provisions tacked on by Roth’s staff that appeared to exempt cash balance plans , a controversial hybrid of defined benefit and 401(k) plans typically set up by companies to replace their traditional pension plans , from laws governing age discrimination in pension programs. That resulted in an uproar by opponents of the provisions, which were finally struck from the legislation.

As talk of a retirement crisis increasingly consumed the presidential campaign, legislators were eager to jump into the fray, looking to earn political credit of their own by voting for a popular retirement package. But under the direction of the congressional Republican leadership, House Republicans included the pension legislation in their tax-cut proposal, legislation that President Clinton had promised to veto. The House managed to pass a slightly modified version of the package in late October, but the Senate, facing Clinton’s veto threat, shelved the bill until after Election Day. Congress did not include the retirement savings legislation in the raft of budget bills it approved in its December lame-duck session.

Pension reform would seem like a political no-brainer, as both sides cry out for bipartisanship, but it’s anyone’s guess if Portman-Cardin will be resuscitated, and much will depend on whether Bush plows ahead with his massive tax cut plan.

Tacking pension reform to a big tax cut bill could doom it, since the Democrats are certain to dig in their heels. “A tax cut would be a rough beginning for an administration still trying to find its sea legs,” says Representative Pomeroy, who remains optimistic about the chances for legislative action. “The dynamic is stronger than ever for pension reform.” Pomeroy thinks reforms could go through this year, but without the protections for lower-income workers that Democrats had attempted to include in the bill when it was reintroduced in July.

Tackling Social Security, the proverbial third rail of U.S. politics, will be a mere perilous mission. The New Deal pay-as-you-go system has fallen victim to demographics, as a growing corps of retirees puts an ever-greater burden on current workers. A consensus has emerged for reform, but the details will not be easy to resolve.

Congress authorized two hikes in the payroll tax, in 1977 and 1983, to the current rate of 12.4 percent, along with a gradual increase in the retirement age from 65 to 67. These, along with a few other tweaks to the system, created a surplus that should allow it to weather the waves of boomer retirements over the next decade and a half. But experts calculate that the surplus will begin to dwindle by about 2015; by 2037, they say, the fund will go broke.

The system could be restored to solvency for the next 75 years through another hike or two in the payroll tax and a cut in benefits. Not surprisingly, though, most politicians, especially in election years, shun any notion of tax increases or benefit reductions.

Bush’s solution is to modernize the system through a partial privatization. He has proposed that some portion, most likely 2 percent of the current 12.4 percent payroll tax, should be “carved out” and shifted into a personal retirement account. The carve-out is voluntary , elected or rejected by the individual worker.

Bush argues that by investing that 2 percent in securities other than U.S. Treasuries, Social Security would save itself through higher returns from private investments. The so-called Social Security trust fund currently is credited with a rate of return equivalent to that of the special government bonds in which the funds are invested. Those bonds are projected to yield about 3 percent, over and above inflation, in the traditional 75-year projection period for Social Security. Bush argues that if one sixth to one quarter of the trust fund moved into equities, annual returns would approach 6 percent. The system would be saved, and individuals would retire with more.

The details of Bush’s plan are fuzzy, but in principle it could create quite a honeypot for the financial community. According to Social Security Administration projections, a plan similar to Bush,s, sponsored by Republican Representatives Bill Archer of Texas and Clay Shaw of Florida, would result in personal account balances of about $3 trillion by 2015. In 1999, by comparison, defined contribution plan assets reached $2.4 trillion.

Still, such numbers may never be more than daydreams for brokerages and mutual fund managers. Critics argue that to start privatizing the system, Bush would divert about $1 trillion over the next ten years into private accounts , $1 trillion that is currently earmarked to pay current retirees their benefits. On the campaign trail, Bush insisted that his plan would not divert $1 trillion but would make up for the shortfall by tapping into the projected budget surplus.

With some exceptions, like Louisiana Senator John Breaux, Democratic leaders are dead-set against privatization. House Minority Leader Richard Gephardt of Missouri and Senate Minority Leader Tom Daschle of South Dakota are vocal opponents and are sure to bang the drum of fiscal irresponsibility against Bush. After all, how can the new president make up the Social Security shortfall from the main budget surplus if he,s using that to fund his big tax cuts? “Our entire caucus is very troubled by the missing trillion dollars,” says Daschle aide Molly Rowley. “The next two years don,t look good for radical reform.”

The most prominent Democrats in Congress lean toward the Gore approach, which proposed “saving” the system through a reduction in the national debt and the creation of Retirement Savings Plus accounts. These would exist alongside traditional Social Security benefits but would not draw any money from the payroll tax; the federal government would match individual contributions with tax credits. Both plans will cost a great deal of money, but in neither case is it clear where the money would come from.

Given the gap between the two sides in the almost evenly divided Congress, it’s an open question whether Bush will be able to move Social Security to the top of the congressional agenda. “Social Security reform was prominent enough of an issue in the campaign that it will at least be on the agenda,” says Edward Lorenzen, legislative director for Representative Charles Stenholm, a Texas Democrat who co-chairs the bipartisan social security reform caucus.

Yet for all the election rhetoric, voters are not clamoring for Social Security reform. An ABC News Election Day exit poll found that 23 percent of voters think that the new administration should tackle Social Security reform, while 30 percent say education should come first. Cutting taxes is also slightly higher than Social Security on voters, wish lists.

“Clearly, the voters gave no indication that they wanted to move in a significant direction on Social Security reform,” says Thomas McInerney, chief executive and general manager of ING U.S. Worksite Financial Services and a member of the National Commission on Retirement Policy.

If Congress does wade into these choppy waters, most Republicans would likely rally around Bush’s plan for partial privatization. Grassley of Iowa has already proposed, along with fellow Republican Senator Judd Gregg of New Hampshire and Louisiana’s Breaux, a Social Security reform plan that includes carve-outs. One key difference with Bush: Grassley and other congressmen, including Arizona’s Kolbe, believe the personal retirement accounts that are carved out should be mandatory.

“The proposals put forth by Republican members in Congress are fairly consonant with the outline that president-elect Bush put forward, largely because president-elect Bush crafted his outline to be generally and broadly consistent with those plans,” says Chuck Blahous, a former aide to Gregg and now the executive director for the Alliance for Worker Retirement Security, a reform advocacy group.

Republicans expect, and fear, that the Democrats will use the reform issue for political advantage in the run-up to the 2002 elections. “The Social Security card was aggressively played one more time by the demagogues on the left during the campaign,” says Gregg, a close Bush ally and a member of the Senate leadership. “I,m not at all confident that they,re going to give that weapon up. Demagoguery works.”

Gregg says he has advised the new president that if he is to be effective, he will have to “reassemble a constituency for reform and reeducate the Congress and the public before we go forward.” Bush will also be hobbled by the departures of three Democrats on the Senate Finance Committee who were deeply involved in Social Security reform and favored something similar to the Bush approach: Nebraska’s Robert Kerrey and New York’s Daniel Patrick Moynihan, who both retired, and Charles Robb of Virginia, who lost his bid for reelection. “These are enormous losses,” says reform advocate Blahous.

Bush could get some of the momentum he needs from the bipartisan commission he plans to appoint before too much time has passed. But observers say he would be wise to do some serious early coalition building. He might recall the fate of another newly elected president who confronted his own political taboo, only to see it blow up in his face. That was Bill Clinton with health care reform, and it was not a pretty picture.

Social Security reform and pension offsets

President-elect George W. Bush says reforming Social Security is a top priority. But getting it done won,t be easy. Leading Democrats oppose the linchpin of Bush’s approach, the establishment of private individual accounts. Bush’s idea is not only to make the system more secure but to provide workers with better payouts when they retire.

To date, the details of his privatization plan remain, perhaps intentionally, rather sketchy. But Bush has spoken favorably of allowing individuals to invest up to 2 percent of their FICA payroll taxes in private accounts. Whether that would save Social Security is a matter of debate, but analysts say it could have unexpected consequences for some of the companies that still offer traditional pension plans, introducing a new element of volatility into plan management.

Why? Altogether some 13 percent of defined benefit plans explicitly take into account an employee’s Social Security benefits in calculating what the company owes to its workers. These so-called offset plans may reduce the benefits owed to an employee based on the amount that employee receives in Social Security benefits. Typically, an employee’s benefits can be reduced by no more than 50 percent of the Social Security payout.

Those benefits are completely predictable today. But any plan allowing workers to manage their own investments would alter the calculus of returns. It could force companies using these schemes to change a host of assumptions and mean greater, or lesser, liabilities, depending on their retirees, investment performance.

“The design and implementation of individual accounts will affect employer costs and could present substantial challenges in coordinating pension plans with individual accounts within the current regulatory framework for pensions,” warned a report issued by the General Accounting Office in late September.

Here’s how Sylvester Schieber, director of research at consulting firm Watson Wyatt Worldwide in Washington, calculates the difference in benefits between the Bush plan and the current system.

Start with the average wage worker who turned 35 on January 1, 2000, and who earns $33,500 beginning next year and beyond that. That worker’s monthly defined benefit from Social Security, available when he turns 65, would be roughly $1,025.

Assume that under the Bush plan the employee carves out 2 percentage points from his 12.4 percent Social Security payroll tax. Schieber calculates that his guaranteed monthly benefit upon retirement would fall to $820. Next, assume, as the Bush plan does, that this worker realizes 5 percent returns on his personal account. That would provide an additional $275 in monthly benefits, Schieber says. Adding the $275 to $820 results in a combined monthly benefit of $1,095, versus a payout of $1,025 under the current system.

Win-win? Not if he’s in a traditional offset defined benefit plan. A plan could choose to reduce the employee’s monthly pension, shrinking its own liability. On the other hand, some plans could key their offset to the $820 monthly Social Security payout, says Janice Gregory, legislative director at the ERISA Industry Committee. Under that scenario, which Gregory considers more likely, the employee might enjoy the greater monthly benefit while the company would end up paying more.

It’s unclear just how many workers would be affected. According to the Bush plan, only workers under 50 would qualify for private accounts. In addition, notes Brian Graff, executive director of the Washington-based American Society of Pension Actuaries, “most workers under 50 are not in the kinds of plans that use these kinds of formulas.”

And Congress might address the issue in formulating any new laws. Says Schieber, “I am sure that if we were to reform Social Security, lawmakers would make provisions allowing employers who have designed their pension plans around existing law to make appropriate modifications.”

They,re a skittish bunch

After a year in which the Nasdaq dropped nearly 40 percent and the Standard & Poor’s 500 index fell about 10 percent, the managers of pension plans became more than a little gun-shy about active equity investing. Their reluctance might have been more appropriate at the end of 1999, but can anyone blame them?

A year ago 80 percent of all contributors said they intended to invest in actively managed equities; as they look ahead to 2001, that number falls to 71 percent. Last year 28 percent of respondents thought actively managed equities would represent more than 50 percent of their portfolios; for 2001 that number shrinks to 15.9 percent. Twenty-two percent of respondents say they will likely have a lower allocation to domestic actively managed equities in the New Year compared with year-earlier asset allocations, while 15.8 percent say they will probably allocate more of their funds to domestic passively managed equities.

Actively managed bonds remain attractive; more than 70 percent of contributors say they will devote at least some portion of their funds to that class, versus 77 percent a year ago. At the same time, the appetite for private placements and venture capital is strengthening. Nearly 30 percent of respondents intend to invest in the category, up from 26 percent last year.

Real estate, though, remains a more exotic choice. Nearly 20 percent of respondents expect their real estate allocation to decrease in the next year, against 16.5 percent a year ago.

The overall level of contributions should not dramatically change this year. In 2001, 22.3 percent of respondents expect their sponsor to increase contributions, while nearly 20 percent expect contributions to fall. But over the next three years, 21.8 percent expect an increase in contributions, whereas only 12.6 percent expect a decrease.

Does your plan sponsor expect to make a net contribution to your plan in 2001?

Yes 46.2%

No 53.8

Did your plan sponsor contribute in 2000?

Yes 56.1%

No 43.9

If you plan a net contribution for 2001, what percentage do you expect to put into each of the following investments?

Actively managed equities:

None 28.6%

1 to 10 percent 11.1

11 to 25 percent 15.9

26 to 50 percent 28.6

More than 50 percent 15.9

Equity index or semipassive funds:

None 34.4%

1 to 10 percent 19.7

11 to 25 percent 24.6

26 to 50 percent 18.0

More than 50 percent 3.3

Actively managed bonds:

None 29.7%

1 to 10 percent 7.8

11 to 25 percent 32.8

26 to 50 percent 26.6

More than 50 percent 3.1

Bond index or semipassive funds, or dedicated or immunized bond portfolios:

None 75.4%

1 to 10 percent 18.0

11 to 25 percent 3.3

26 to 50 percent 1.6

More than 50 percent 1.6

International or global equities:

None 34.4%

1 to 5 percent 9.4

6 to 10 percent 25.0

More than 10 percent 31.3

International or global bonds:

None 84.6%

1 to 2 percent 4.6

3 to 5 percent 7.7

More than 5 percent 3.1

Real estate:

None 75.4%

1 to 5 percent 15.4

6 to 10 percent 9.2

More than 10 percent 0.0

Cash equivalents:

None 68.8%

1 to 2 percent 15.6

3 to 5 percent 6.3

More than 5 percent 9.4

Balanced accounts:

None 96.9%

1 to 10 percent 3.1

More than 10 percent 0.0

Emerging markets:

None 68.8%

1 to 2 percent 15.6

3 to 5 percent 12.5

More than 5 percent 3.1

Private placements, including venture capital:

None 70.8%

1 to 2 percent 13.8

3 to 5 percent 9.2

More than 5 percent 6.2

High-yield bonds:

None 81.5%

1 to 2 percent 10.8

3 to 5 percent 7.7

More than 5 percent 0.0

Tactical asset allocation or market timing:

None 98.5%

1 to 5 percent 0.0

More than 5 percent 1.5

Financial futures:

None 95.3%

1 to 5 percent 4.7

More than 5 percent 0.0

Commodity futures:

None 98.4%

1 to 5 percent 1.6

More than 5 percent 0.0


None 100.0%

1 to 5 percent 0.0

More than 5 percent 0.0


None 98.4%

1 to 5 percent 1.6

More than 5 percent 0.0

Oil and gas partnerships:

None 96.9%

1 to 5 percent 3.1%

More than 5 percent 0.0

Workouts and bankruptcies:

None 95.3%

1 to 5 percent 4.7

More than 5 percent 0.0

Including your expected contribution (if any), plus other shifts in allocation, how is your 2001 asset allocation likely to compare with that of a year earlier?

Domestic actively managed equities:

Higher 12.2%

Lower 22.0

About the same 65.9

Domestic passively managed equities:

Higher 15.8%

Lower 8.3

About the same 75.8

Domestic actively managed fixed income:

Higher 17.6%

Lower 11.8

About the same 70.6

Domestic passively managed fixed income:

Higher 8.0%

Lower 5.3

About the same 86.7

International equities:

Higher 24.0%

Lower 7.4%

About the same 68.6

International fixed income:

Higher 1.9%

Lower 2.9

About the same 95.2

Real estate:

Higher 7.1%

Lower 19.6

About the same 73.2

Cash equivalents:

Higher 4.2%

Lower 4.2

About the same 91.5

Balanced accounts:

Higher 1.0%

Lower 2.0

About the same 97.0

Emerging markets:

Higher 8.7%

Lower 1.9

About the same 89.4

Private placements:

Higher 13.0%

Lower 2.0

About the same 85.0

High-yield bonds:

Higher 9.5%

Lower 1.9

About the same 88.6

Futures and options:

Higher 1.0%

Lower 2.0

About the same 96.9%

What is your fund’s current allocation to U.S. equities?

None 0.0%

1 to 20 percent 0.8

21 to 30 percent 3.2

31 to 40 percent 13.6

41 to 50 percent 37.6

51 to 60 percent 33.6

61 to 70 percent 7.2

More than 70 percent 4.0

What is your fund’s current allocation to U.S. fixed income?

None 0.8%

1 to 20 percent 21.8

21 to 30 percent 38.7

31 to 40 percent 29.0

41 to 50 percent 8.9

More than 50 percent 0.9

How does the size, in dollar terms, of your sponsor’s 2001 contribution compare with the contribution a year ago?

Substantially higher 0.9%

Somewhat higher 21.4

About the same 58.0

Somewhat lower 12.5

Substantially lower 7.1

How do you expect your plan sponsor’s annual contribution, in dollar terms, to change over the next three years?

Increase 21.8%

Stay about the same 58.8

Decrease 12.6

Can,t say 6.7

The results of Pensionforum are based on quarterly surveys of a universe of 800 corporate and 250 public pension plan sponsors. Because of rounding, responses may not total 100 percent.