(Bloomberg Opinion) -- Pensions are chronically underfunded. Defined-contribution plans like 401(k)s are needlessly complicated and expensive, and many Americans can’t afford to put away even a small portion of their paychecks. It’s time to get serious about helping workers achieve a secure retirement.
General Electric Co. delivered the latest blow to workers’ retirement hopes on Monday. The company announced that it was freezing pension benefits for roughly 20,000 employees as part of a broader effort to shrink its $22.4 billion pension deficit, the largest in corporate America.
GE had little choice, as my Bloomberg Opinion colleague Brooke Sutherland pointed out, but its huge pension shortfall is entirely its own creation. As I wrote in 2017, GE made some classic blunders with its pension portfolio over the years, such as selling beaten-down risky assets around the 2008 financial crisis and chasing alternative assets at the peak of their popularity.
GE’s biggest mistake, however, is endemic to corporate pensions in general. A key assumption in every pension plan is the expected return from its portfolio — the higher the expected return, the less the company must contribute to meet future obligations. Not surprisingly, executives are cockeyed optimists about the performance of their pension portfolios. “It lets them report higher earnings,” Warren Buffett warned in Berkshire Hathaway’s 2007 annual report, and if they’re wrong, “the chickens won’t come home to roost until long after they retire.”
Those chickens are knocking on GE’s door. In 1999, the earliest year for which numbers are available, the company projected that its pension portfolio of predominantly stocks and bonds would generate a return of 9.5% a year despite obvious signs that assumption was recklessly rosy. The earnings yield on the S&P 500 Index was just 3.4% at the end of 1999, based on that year’s earnings. The yield on foreign stocks, as represented by the MSCI ACWI ex USA Index, was 2.9%. And the yield on 10-year Treasuries was 6.5%. No matter how you mix those investments, the expected return doesn’t come close to 9.5%.
As it turned out, neither did GE’s pension portfolio. It generated a return of roughly 5% a year from 2000 to 2018, leaving the pension fund woefully underfunded. Unfortunately for workers, GE’s story is the rule rather than the exception. The average expected return for pension portfolios among companies in the Russell 3000 Index was 9% a year in 1999, according to Bloomberg data, roughly in line with GE’s target. Two decades later, 83% of Russell 3000 companies that reported their pension status last year are underfunded.
Companies still don’t seem to have fully internalized the lesson. GE dropped its expected return to 6.8% last year, but that’s probably still too aggressive given that its pension fund can ill afford to fall further behind expectations. Roughly 80% of GE’s pension portfolio is allocated to stocks and bonds. Meanwhile, interest rates are at historic lows and U.S. stocks are by some measures the priciest since 1999. The same applies to the hundreds of other underfunded pensions among Russell 3000 companies. Their average expected return of 6.1% is only modestly more sober than GE’s.
Based on that tragicomic history, there’s little indication corporate executives are any better at managing money than their employees. Many companies have all but conceded as much by pivoting from traditional pensions to 401(k)s and other retirement plans that hand over responsibility for saving and investing to workers. But workers are no more likely to succeed. Many earn too little to set aside money in retirement plans, if such plans are even available to them. And those who do participate struggle to navigate the plans’ typical hodgepodge of expensive actively managed mutual funds. Retirement plans should do everything possible to optimize workers’ retirement, not exploit it.
To that end, companies and policy makers can make some simple changes. For one, companies should contribute directly to workers’ retirement accounts. I estimated that employers can give workers a secure retirement by saving $2.64 an hour on their behalf. Also, policy makers should separate retirement accounts from employment, as with individual retirement accounts. It would reduce employers’ liability and administrative burden and allow workers to take advantage of the movement toward free commissions and low-cost indexing and financial advice sweeping the money management industry.
For now, the moral of GE’s story is that companies and policy makers still have their heads in the sand when it comes to retirement saving.
To contact the author of this story: Nir Kaissar at email@example.com
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Nir Kaissar is a Bloomberg Opinion columnist covering the markets. He is the founder of Unison Advisors, an asset management firm. He has worked as a lawyer at Sullivan & Cromwell and a consultant at Ernst & Young.
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