One of the most enjoyable and enlightening conversations I’ve ever experienced was with Dallas Salisbury, president & CEO of Washington-based Employee Benefit Research Institute. For someone like me who is “hooked” on everything retirement income, listening to Salisbury’s answers caused me to reexamine many of my own strongly-held views on retirement-related issues.
Salisbury offers both a fascinating historical perspective as well as a vision for the future that contains views that may surprise some who work on contemporary retirement income solutions. He’s a font of knowledge, experience and keen judgment, a voice for change, motivation and action designed to address America’s retirement security challenges.
Macchia – Let me begin at the beginning, Dallas, and ask you if you’d be kind enough to describe to my readers the history of EBRI, as well as your present role and responsibilities in the context of heading-up the organization.
Salisbury – Well, EBRI has been functioning since December 4, 1978. That was the day that we opened the offices. If one has to say who is responsible for the creation of EBRI it’s really former President Jimmy Carter because President Jimmy Carter announced that he was appointing a Presidential Commission on Retirement Policy, which he did, which was chaired by the then Chairman and CEO of the Xerox Corporation, Peter McCullough.
The founding organizations of EBRI at that time were 13 large employee benefit consulting firms, many of whom in the 1960s had been asked by the Kennedy Commission on Retirement Policy to do studies. They, all thinking that they were the only ones that had been asked, diligently did their work and then found out that a whole lot of duplicate work had been done since they were all doing it for free. EBRI was a way for all of those firms to assist the new Commission with data and studies but only pay for it once. So, EBRI came about as an enterprise that was not to advocate, it was not to lobby, our bylaws and incorporation documents actually have a prohibition against doing either of those things, and to do data, to do basic research and education and to build databases over time that would allow anyone that had an interest in retirement programs to be able to track the effectiveness of those programs, what those programs were, what they were doing.
Initially it was principally focused on retirement, and then about 1982, after the commission had finished its work and the decision was made to definitely keep the institute going, that was the point in time when we made the commitment to extend our work to the health area and broaden our work to include employment based health benefits, general health costs and health management issues and research on the Medicare program. We’ve been doing all those things now since then and maintain two websites, www.ebri.org, where all of our research since 1978 can be found, and www.choosetosave.org, which fulfills the other piece of the original incorporation mission which was public education and worker education on what these programs were, how they could benefit from employer involvement and the ways in which individuals should be considering their own health and financial futures.
Macchia – When you mentioned Jimmy Carter, Dallas, it reminded me of my entry into financial services in 1977, through the insurance door. I can recall back then that to a great extent life insurers were the custodians of a vast amount of pension assets and that defined benefit pension plans were quite popular and typical. It occurs to me that since EBRIs formation in 1978 you’ve had a view, a consistent view, over a set of phenomenal changes that have taken place in the landscape of pensions and employee benefits, generally. You’ve seen and studied the transition from Defined Benefit to Defined Contribution, the emergence of 401k programs, all the way to today’s level of popularity, and now the effort to institute Defined Benefits into DC plans. I wonder if you see a cycle that’s emerging. How do you view this phenomenal transition that’s taken place since EBRI’s founding?
Salisbury – Well, you asked about my role in all of this. I was the first employee of EBRI and have been the Chief Staff Executive since we started. I came to EBRI from two years with the Pension Benefit Guarantee Corporation, which is principally a Defined Benefit oriented entity, and two years before that with the US Department of Labor in what is now the Employee Benefit Security Administration where I set up their first Office of Policy and Research. I’ve basically been doing on some level the same type of work since late 1974.
To your point, the original EBRI board was principally made up of people whose background was as pension actuaries. Those firms role in the retirement area was overwhelmingly related to Defined Benefit retirement plans and actuarial work for Defined Benefit retirement plans. There were obviously, in many companies, thrift savings plans and profit sharing plans on the side, but for the vast majority of what would have then been the Fortune 100 and even the Fortune 500 had a Defined Benefit plan as their primary retirement vehicle. And the only thing they did as a retirement plan was a Defined Benefit plan.
You had a handful of exceptions, Procter and Gamble stands out as a company that has always been a profit sharing and Defined Contribution company, and I mention them because if one talks about design of programs that would do what the good old fashioned DB plan did, you’d have to look at somebody like Procter and Gamble where essentially year in and year out the contribution to Defined Contribution accounts has ranged between 15% of pay and 25% of pay, as I stressed year in and year out. Procter and Gamble still does that. Procter and Gamble provides investment options in spite of a fairly heavy emphasis on Procter and Gamble stock.
There’s always been the alternative of people taking the lifetime income annuity if they did not want to take a single sum distribution. Because it was a profit sharing plan where the employer was putting money in regardless of what the employee did, that plan always basically assured 100% participation of everyone in the workplace which is one of the other traditional features of a Defined Benefit plan. So, a healthy enough contribution so that people can retire with an adequate retirement income, a set of managed investment options aimed at allowing people to build enough up over time with that substantial contribution and the opportunity for life income security protection through a pooled annuity arrangement if people did in fact want to know that they wouldn’t run out of money before they ran out of life.
If one takes that transition to what we’re seeing in the work world today as Defined Benefit plans have morphed themselves you really have to go back to the late 70s when Atlantic Richfield Company amended its traditional Defined Benefit pension plan to offer single sum distributions. That led the Internal Revenue Service to do something that in hindsight was a very significant decision. Atlantic Richfield had added single sum distributions for a participant with high income. If your pension is not more than $35,000 per year then you have to take the first $35,000 a year as an annuity. That was the late 70s and so the vast majority of people weren’t going to have that big of a pension and could not take a single sum distribution. One might say it was a balanced policy that would assure workers a base income for life on top of social security. The Internal Revenue Service went into Atlantic Richfield and said, “All get a single sum or none can have it.”
As I recall, the Chief Actuary at the IRS, at an Actuarial Society meeting said, “And we know that Atlantic Richfield will choose none, and so there will not be lump sum distributions.” They didn’t understand that CEO very well who wanted a single sum distribution and Atlantic Richfield says fine. The IRS says we have to let all of you have a single sum distribution. Now, some decades later nearly 55% of Defined Benefit plans that still exist offer a single sum distribution at the point of retirement. Essentially out of that Defined Benefits system of those 55%, generally a minimum of 80% of the participants take a single sum distribution. Generally you end up with a maximum of 20% taking a life income annuity. In many cases it’s only 4 – 5% that takes a life income annuity. In some Defined Benefit retirement plans of large employers and small employers no one takes the life income annuity.
The notion of Defined Benefit plans that I was introduced to in 1974, frankly, began to be deserted by the largest Plan Sponsors in the United States before we’d even turned the corner into the 1980s. By 1984 when Kwasha Lipton, then a consulting firm, one of the founding firms of EBRI, in a consulting relationship with Bank of America, moved Bank of America to what is popularly known today as a Cash Balanced Defined Benefit plan. A second trend moved forward because part of that transition included a standard reversion of assets to the Plan Sponsor. A process of workers seeing very small balances upon the conversion relative to what they thought they ultimately were supposed to be getting out of that pension plan, and the decisions which Congress and PPA just finally dealt with after the IBM suits.
It took until 2006 for some resolution in 2007, of essentially issues that began to be implemented in the Defined Benefit system in 1984. You then add on top of those combined actions the total restructuring, if you will of the largest enterprises in America. Microsoft didn’t exist in 1974, and today it’s one of the nation’s largest employers. Outside of the state of Arkansas Wal-Mart did not exist in 1974, and today it’s the largest single employer in the world. We have basically seen a growth of enterprises dominant in marketplaces, Starbucks didn’t exist in 1974 that have grown up as Defined Contribution only companies.
Those Defined Contribution plans have another very different mix than what the profit sharing plan than Proctor and Gamble did. In those plans the employer automatic contribution has always been de minimis. Large percentages of workers have not chosen to participate and even when they did participate the amount that the employer would contribute has generally been quite small relative to what we can describe as the Proctor and Gamble standard. If we then go to the final, if you will, today’s transition point as very large American companies, the IBMs, the Verizons, the Lockheed Martins, that were originally tradition Defined Benefit companies and have gone through a morphing process and are now at the final stages of essentially saying that we will no longer have Defined Benefit plans. In the case of IBM, no one will be in those plans post 1/1/08. For companies like Lockheed Martin and Verizon there will be continuation for some that were already there and just transitions for new workers. So, we’re seeing different varieties, but what we’re seeing when they put in the Defined Contribution plan that goes to your comment of “making them look like Defined Benefit plans”, I stress that they don’t in any way, shape or form look like traditional Defined Benefit pension plans, if you will, my father’s Defined Benefit plan.
Pop died in July months short of turning 94. He retired in 1978. He wasn’t given a single sum annuity option; it was a final pay plan, etc, etc. This transition is that we will have automatic enrollment, but you can still opt out. The result found in the data is that between 10 – 30% do opt out, even with the automatic enrollment. We might do automatic contribution escalation. So far that data is that a minority of firms will do that. We might do an automatic employer contribution. A very small percentage of firms are doing that. Those that are doing it are doing it generally with an employer based contribution of 2 – 5%. For most individuals that will not be enough, even if the employee contributes the same amount. If they started saving at 20 the needed rate would be at least10%, and if they didn’t start contributing until 35, the required annual amount would be closer to 23% per year.
So you end up having gone from a Defined Benefit and in a Proctor and Gamble case, a profit sharing plan where the employer was putting in enough money to provide a full career worker with true retirement income adequacy, to what has come to be termed a Defined Benefit/Defined Contribution system where most employers automatically put in nothing, where a large portion of employees can fail to participate and where still only about 20% even offer an annuity, life income annuity situation. Essentially none require a mandatory annuitization.
If we look at the experience of the last 30 years where Defined Benefit plans have offered the option, very few people will chose to do what my father had to do, which is take that life income annuity. It’s the morphing that changed over that 30, nearly 35 years has been dramatic and I think so dramatic that we really do need to underline that even with all of the changes that are now being talked about and undertaken for Defined Contribution plans, that even if all of those changes take place those programs, in the absence of aggressive individual savings that exceeds anything individuals have done in modern history, will never accomplish or achieve what Defined Benefit plans did, or what profit sharing plans of the Proctor and Gamble variety did. That says, even with that redesign that the principal shift of all of this is that even the best off workers will have to do far, far more for themselves than was the case under those old systems.
Macchia – You know that’s a fascinating historical perspective that explains the implications of many changes over the past 30 years. It reminds me of the countless seminars I’ve presented over the years to audiences of consumers. I can recall about 10 years ago making comments about the transition to the 401k plan that 401k essentially was one of the greatest financial foibles ever foisted on the American public. Back then I might have said that the transition away from DB was motivated by greedy corporations that wanted to improve their balance sheets and free themselves of long-term obligations. I wonder if there’s a more sophisticated answer to that, and I wonder if your dad’s own experience offers the pristine example. Where having retired in 1978 and now still receiving benefits at age 94, if that singular example crystallizes the larger phenomenon, that it’s simply impossible for those types of plans to be financially viable over the long term.
Salisbury – Well, to respond to two pieces of that. Maybe people today would stop and say the Employee Retirement Income Act of 1974 did great things without commenting on whether that’s true or not on a net-net basis. The greatest unintended consequence of that law has been the demise of Defined Benefit pension plans and the rise of Defined Contribution plans. Because one of the principal issues, and I’ve gone back and read all of the prehistory and there’s a very fine book that was published some years ago, a couple of years ago, on the history of the enactment of ERISA called “The Employee Retirement Income Security Act of 1974.” It was a history, a political history written by a guy named Jim Wooten and published by the University of California Press. It was telling in a cover quote by a guy named Dan Halperin, who was a tax staffer at the time that ERISA was passed and is now a Professor of Law at Harvard, when he said, “This book is a wonderful, detailed, intensive description of the history of an important piece of social legislation.”
The social legislation, part of that legislation was that leading up to ERISA all of the focus was on the absence of benefit portability. It was a focus on these programs doing amazingly positive things for people like my dad who did spend 30 years with one company. But there was a lot of analysis in the 60s about so-called portability losses and one of the most intense debates and also reasons for ERISA was to put into the law vesting standards and to say that these programs that only pay benefits to people that have been there for 20 or 25 or 30 years, well, that’s wrong. As you know the most recent legal changes, there are cases now that go all the way down to 3 year vesting and immediate vesting. The moment you went with that change you assured a shift in plan design as you fundamentally changed the cost equation. There is a notion and a mythology out there that in the good old days everybody used to work for one company for a full career, yet, if that had been true, you would not have needed faster vesting. You would not have had portability losses.
When my dad retired in 1978 at that point in history 16% of all workers in the private sector and going into retirement, 16% had been with one employer for 25 years of more. At the most stable, the very most stable companies, you will find of the oldest workers today, maybe 25% of the oldest cohort has been with the company for a full career, but when you look at 1952 to present median job tenure the total labor force has always been about 4 years. That’s a long way of saying that we’ve always been a very high turnover society and a long way of saying that very few of us have ever spent one career, had one long career with any employer. Put that in the sense that you’re describing.
Pre-ERISA if 12% of the people that I ever hire will retire from me and I’m doing a Defined Benefit plan and I’m promising 60% income replacement if you spend a full career with me and I fund it over time and everybody that leaves, meaning over time 80 plus percent of the people leave, every dime that I in theory contributed for all of them is going to pay the benefits of that small group that stays. ERISA comes along and says all those people that are leaving and not getting anything are losers and that’s wrong. The economists entered, bless them, and said this is a denial of deferred compensation. These plans are deferred compensation which isn’t how the companies ever thought about them in any individual worker sense, only in the aggregate. The companies thought about them as something to make sure that people that are still with us after a full career can afford to retire or we can retire them and it’s an expense and we’re paying people over here and over here on the side, if we do well with investment returns we don’t have to make any contributions, so how can there be an individualized deferred wage?
But Congress keeps bringing down the vesting period and what do you keep on doing? More and more and more of the money that’s going in is being paid out in small lump sum distributions to this huge number of people who leave between 3 years and 15 years or 20 years, the vast majority of the workers. So the majority of the money in a post-ERISA world, particularly a post-GAT amendment 1990s world, and the vast majority of the money going into a Defined Benefit plan gets allocated to short service people. It is not that my dad lives to nearly 94 or that somebody else lives to 100 that makes a Defined Benefit plan a financing, if you will, problem. If the money going in is going in to pay for those long service people the contribution cost can be low, but if I have the kind of leaking problem that fast vesting introduces, then I end up with a real challenge which requires higher contributions or a reduction in future benefits. That ends up when you think of 1984, the movement to cash balance, that the legislative decision to move the system to fast vesting, essentially imposed on an employer a career average type of contribution with a so-called final pay design. By moving to cash balance and defined contribution or lower benefit formulas cost could be kept low, the money was spread to more people, and the long service worker of the future would get a lot less.
Suddenly I say, well what’s that interpret into? For an old fashioned pension plan for somebody who’d been with me for 25 years and was approaching retirement age, if I were to actually put enough money in this year to pay for this year’s additional accrual, I’d be contributing 25-30% of their salary in their final pay formula. In this new world of equality you go to 1984 we’ll just tell everybody you’re all going to get 4.2% and you’re going to get 4.2% each and every year. Here’s the account and we’re going to tell you that’s what it is. We’ve got very fast vesting, and we need to put in money for everybody, and there’s very little redistribution of money from the leavers to the stayers, so there is not reward for tenure. Why not just do a Defined Contributions plan rather than all of the expenses and legal requirements tied to the Defined Benefits plan.
So, as opposed to the notion that this change has taken place due to greed or anything else, I look at it backward over my 33 years of involvement and say basically what we’ve done with the law is we’ve simply designed something legally that is totally and completely in conflict with what the plans were originally intended to do, which was to provide lifetime income security to the people that were still working for you at retirement age. If I was to put that in a contemporary debate, it is the equivalent to the contemporary debate that President Bush has been most vehement on which is changing part of Social Security from Defined Benefit to Defined Contribution which is the equivalent of saying we really aren’t interested in lifetime income security being achieved at the lowest possible cost thorough a group pool that redistributes across individuals depending upon life expectancy.
We’re interested in capital accumulation and at the end of the train we want to hand the individual that capital accumulation and give them individual choice and ownership and basically say you decide. This is no longer about lifetime income security in the sense that if we’re going to make you take an annuity so there is no conceivable way that you can run out of money before you run out of life. We’re saying instead we’re going to give you money and you can spend 100% of it in the next 12 months and have 30 years where you’re living off of supplemental income and Medicaid, your choice. I don’t even view it as a corporate ideology issue if I put it on the President, what we’re talking about, has been a general movement away of a theory of community and risk pooling and if you will the redistribution that is implicit in an insurance type of arrangement which is what a traditional DB plan was.
Moving to the individual fight, at this point, in that sense if the only true Defined Benefit plan to be pejorative is the traditional old Define Benefit plan that was an annuity only plan then essentially at the moment there are no Defined Contribution plans that are attempting to mimic the true Defined Benefit plan and in fact a growing proportion of the remaining Defined Benefit system is no longer made up of true Defined Benefit plans. It is made up of hybrid programs that in most cases will produce single sum distributions and will put the decision risk of whether money runs out before life or vice versa on the individual as opposed to that being institutionally protected. You then add a component to that which is what I was getting at with the new company phenomenon. If ERISA had been in effect in 1950 traditional Defined Benefit plans never would have come into existence. The huge growth of Defined Benefit plans that took place in the 50s and 60s would not have occurred because if ERISA’s funding standards, most particularly if one were to say what if PPA, the PPA amended ERISA had been in effect in 1950 there would be no Defined Benefit system.
It wouldn’t have happened because what the genesis of those Defined Benefit plans was the ability to take people who were at retirement age and give them past service credit of 10, 20, 30 years, accept a huge unfunded liability, and to be able to amortize that unfunded liability over an almost infinite time period and to be able to manage exit of a large number of people, so the people coming back from the war could take jobs, and doing all of it with borrowing against the future cash streams of the firm. Today’s PPA would say to those companies, you do that and you’ve got to fund it off within 7 years and within 7 years you’ve got to be 100% funded. The economic capacity just would not have been there…wouldn’t be there today. If you take that environment and say what started happening in post-1974 and you start looking at those enterprises now on the Fortune 100 and 500 that came into existence post 1974, and I don’t mean by renaming or merger, I mean companies that actually grew and came into being through new technology, those companies basically to overstate it, it didn’t even occur to them to put in a Defined Benefit plan because they didn’t have the primary motivation of the 50s which is a whole lot of existing older workers that we want to entice out the door with a pension.
Macchia – This is again a fascinating historical perspective which is very helpful. I’d like to go back to Social Security for a moment if I could, Dallas, because that is a Defined Benefit structure that is fraught with challenges, as you know. We’ve seen clearly in terms of President Bush’s efforts to introduce privatization and other conversations around Social Security in recent years that any talk of changing that system becomes immediately highly political and polarizing. I wonder what you feel will be the implications of politicians not being able to transcend that, continuing to arguably show a lack of political will, what happens if there isn’t the capacity to address some of Social Security’s inherent weaknesses?
Salisbury – If we limit Social Security as you’re using the words to the retirement program, totally separate and apart from Medicare and the health side of it, the reality which is recognized by the administration and is documented by the actuaries is that the social security retirement program has very little problem. The change in payroll tax that would be necessary to have the program be fine for 75 years is de minimis. The change in benefits that would be required of the change in retirement age, the changes that would be necessary to have the current program sustainable into infinity, are minor changes.
Macchia – Can I just stop you there and explore one aspect of that. If the Social Security surplus is being invested in long term treasuries isn’t there a sharp implication for the future in terms of redeeming those and potentially having to lower benefits and raise taxes?
Salisbury – You’re describing a general fiscal issue as opposed to an issue of Social Security.
Macchia – But aren’t they interlocked to some degree?
Salisbury – The degree to which I personally don’t believe that they are ultimately interlocked is that ultimately Social Security benefits being paid on a continuing basis is going to be the difference for almost every working American of whether they watch their parents or their grandparents continue to live decently. Or, they welcome their parents and their grandparents into their home and they start supporting them directly. Then adding a second component. In the last Presidential election, approaching 45% of all votes cast were cast by people over the age of 65. By the next Presidential election it will be pushing 50%. By another 2 – 3 it will be nearly 60% of all votes cast in elections will be cast by people 65 plus, unless younger voters start voting at much higher participation rates. Older voters and one looks at the polling, older people even less than their kids don’t want to be dependent upon their kids, they don’t want to move back in with their kids.
You end up with this dynamic of will there be the political will even with all of the balancing, will Social Security benefits be paid? Call me an optimist or pessimist or fatalist even with the Social Security trust fund being federal debt securities is I believe that those benefit promises will in fact be paid just given the dynamic of the population and the implications of them not being paid. Especially, and I underline the especially since relative to other issue areas, and I’ll use medical as the example, is everybody and it’s the majority, about 95%, everybody gets a Social Security check.
Listening to a Congressional hearing yesterday 6% of Medicare beneficiaries account for 50% of Medicare spending. If you end up in a dynamic, a political dynamic of the overage 65 population and their children being put up against the wall and the choice is we can continue to promise you health benefits in the event you get sick or we can continue sending you a Social Security check. Which do you want? Income or a promise of health benefits if you get sick? That’s like my trying to convince my employees to take no salary and to take health benefits. Do they want health benefits on top of salary? Absolutely, but if the choice is between income or health benefits, base income, they take income. This year 38% of the nation’s retirees have on single income source, it’s called Social Security. 64% of today’s retirees have a primary income source.
More than half of their income is called Social Security. Retirees 85 plus 62% of their income on average comes from Social Security. If one looks the old curves of health expenditures and health benefits is if you’ve put it in the terms you’re putting it in, ultimately the ultimate trade off decisions of the government, let’s assume they were going to filch on the dead, but can we filch on the benefits. If given what the options are, now defense is important to me, but is it more important to me than bread on the table. The health insurance promise is important to me, but am I willing to live in the gutter or in a box in order to have health insurance? No, I’m not, thank you very much. Putting it starkly in your push comes to shove type issue, relative to honoring the Social Security benefits promise, could Congress at some point end up saying okay, beginning 44 years from now benefits will be axed. Conceivable. We’re going to raise the retirement age, we’re going to match it to life expectancy, and we’re going to have CPI minus one. It’s what I mean by the issue that the adjustments they could make are relatively minor that would secure the program. I’ll use President Bush as the example. If President Bush wanted to secure Social Security as part of his legacy, he could get that through Congress before the end of this calendar year if he was willing to accept changes that did not include individual accounts.
Macchia – By doing what?
Salisbury – By simply going to the hill and saying no individual accounts, no fundamental restructuring of the program, here’s the list that we all agree from the Social Security actuaries are the things that we just have to basically fill a shopping cart off of in order to make the adjustments. Retirement age tied to increases in life expectancy, slight adjustment in the benefit formula for high income individuals will move the maximum wage base from roughly 100,000 to 125,000 or 150,000. Pick your level. Oh gee, we only had to do four things and the program is fine forever. Great. Done. Let’s go home. Let’s go worry about the big issue called Medicare. But because the actual Social Security problem is so small, there is not a feeling of true necessity to fix Social Security, therefore one can spend all one’s time having an ideological argument about I want Defined Contribution, I want fundamental change.
Macchia – Let me take us back into the commercial pension world where we have obviously a voluntary system. Do we need to have a universal mandate for, say, 401k?
Salisbury – It all depends on what the objective is. I was moderating a panel yesterday at a conference that looked at just that issue and what was striking from panelists from the right, the Heritage Foundation, and then the left, the Brookings Institution and Pensions Rights Center, along with the person that was there speaking from the World Bank. If you’re objective is individuals definitely having income in retirement and not being able to run out of the money before they run out of life, the consensus along that ideological spectrum was: that can only be achieved with mandates, it can only be achieved with mandatory contributions, it can only be achieved with mandatory rollovers or basically you can never borrow and spend the money, and it can only be achieved with mandatory life distribution.
I choose life distribution versus annuity because there are different ways to get there, but it’s a guaranteed payout over your lifetime. That represents a whole bunch of changes that everybody at the panel table that I was moderating agreed were the components that would be necessary if your objective was real income security in retirement. Every single one of them then said: none of those changes are politically feasible. This is the descriptive versus the normative. The descriptive is what you see happening in the private sector today in planned design decisions. It’s what defaults are all about. But it is a default rather than a mandate because of he fear of backlash. Do we know what we would have to do with these programs to have them actually achieve the objective of lifetime retirement income security? Yeah, we all know that. Are we willing to do that? No, because we don’t want to be dictatorial.
We think a lot of people would be upset with whatever the list of issues is. Everybody is trying to do it with defaults, with tricks, with incentives, you name it, but what we know at this point based on at least the 35 years that I’ve been in this field, for any bit of research that anybody’s done, regardless of their perspective, is that in the absence of that type of structure, which pejoratively speaking is the traditional Defined Benefit pension plan, the true one, or a slight modification of the Proctor and Gamble profit sharing plan, meaning the company putting in plenty of money, and then paying life income annuities indexed for inflation, to get to the objective, or in a governmental sense Social Security setting aside a method of true advance funding. Those are the things ultimately that will be needed if we want people to be able to retire and we don’t want to be back in the 1930s where most elderly Americans are in poverty.
Macchia – You recall that a couple of a minutes ago I mentioned years ago commenting in seminars on 401k plans. In another series of seminars I commented about the relatively low personal savings rate in the US. At the time about 4% in contrasting to Germany’s 8% and Japan’s 12.5%, and we’ve seen in the US that the personal savings rate has consistently come down and down and down. We also have another behavioral issue where people make poor investing decisions based upon emotions. We have seen the ascendancy Defined Contribution plans to a state where many would agree that participation levels are insufficient and deferral levels are too low. We have this confluence of facts that together, arguably, serve to substantially reduce retirement security.
In my commercial life I all the time think about the fact that the key to changing behavior and helping people make better decisions that more appropriately serve their long term financial interest is that we must to a much better job communicating around these issues in a world that’s very complex, in an industry that has its own jargon and can seem unfriendly. I often liken it to medicine where if I’m listening to a conversation between two physicians that are talking about my health or potential health problem it’s very hard for me to understand their conversation because it’s got its own unique vocabulary and I think that some of that analogy carries over to our business where we can communicate in a way that is not easy for people to understand. I’m wondering if you agree with me that communication is a big part of helping people make better decisions and ultimately strengthen their retirement security?
Salisbury – I think that communication is a key component, but I’ll then put in the caveat that we published earlier this year an issue brief on the role behavioral finance and behavioral economics. David Leibsonson from Harvard did a luncheon presentation yesterday on those topics. Most of the behavioral finance experiments that have been done to date end up documenting that at the margin, meaning with the best intended, best educated, highest income people, education and communication can be shown to have success. But all of the research that he was going over from the behavioral economist is that with the bulk of the population it’s largely lost on them no matter how much effort goes into it and how good a job an enterprise tries to do. One-on-one counseling has the best results, but that is both expensive and limited. If one uses the health field as like a case manager, if you use this field it’s then like everybody having a truly objective and independent financial manager, planner that is actually worrying about everything and doing everything and budgeting for you.
You only have to talk to the planner twice a year and we know that when an enterprise will do that, the people they do that for, it leads to a pretty high success rate. When I want to be optimistic about this and the changes that are taking place what I frankly focus on is the reality of the world that is what led to the concerns when ERISA came into being. The year that ERISA was enacted, the first year that we have good data on after that was 1977 and of everybody that was retired over the age of 65 in 1977 could come out of private sector employment less that 10% of them were getting pension income. 90% were not. 2001 was as good as it ever got coming out of the private sector.
Just under 24% of those over age 65 in 2001, the high point; just under 24% had income coming from a private pension plan. That’s now come down. By 2005 it was approaching 23%, we see it’s going to come down progressively at this point. The dynamic of the existing system, the reality of the system is that when we historically suggested everything’s okay because we have Defined Benefit plans, that system was still not doing anything for 75% of the people in the private sector, yet they all had this notion that they read in the press and they heard on TV that everybody works a full career, everybody gets a gold watch and a pension. You look at old survey data and people believed that they would eventually get a pension.
Now we know from the data, the historical stuff we do for a living at EBRI, it never really was the case and the reality of today’s world what people read about, they think, they say, well, I’ve got to worry about myself, the fact of it is that most of them always did. If you then look at it and say, okay, in the good old days 10% had pension income, meaning pre-1977 the really good old days. In the somewhat good old days, the period through 2001, coming out of the private sector less than a quarter did, three quarters didn’t. We’re morphing forward and from the existing voluntary system it looks like it’s going to stay below a quarter for some time unless we make some fundamental changes in the system that go beyond frankly what anybody right now is advocating, whether Democrat or Republican, Liberal, Conservative.
Macchia – Let me ask you this. If we know that the idealized notion of retirement of years spent lounging by the pool was never quite true, then knowing all that you know about what’s happening and how you conceive the implications of all of this for the future, at the gut level do you find yourself personally optimistic or pessimistic or perhaps vacillating between the two?
Salisbury – I guess that depends on what I’m being optimistic or pessimistic about. Take your communications point. I subscribe to anybody that says transparency is what people need. I subscribe that communications, the way where communications can be most effective is if it’s transparent communication that says to people, most people won’t get X, most people won’t get Y, most people aren’t going to have pension income, most people won’t have retiree health benefits, most people, most people, most people. The fact is that could have been said for the last 100 years, it just wasn’t being said. So, transparency and that communication is going to take everybody and put them in a mode of thinking that says, good gosh I wasn’t going to think about this until I was 50, maybe I’d actually better think about it at 25 or 30 or 35, hoping that the sooner they wake up the better.
Macchia – What you’re implying is that transparency equals candor.
Salisbury – Transparency equals candor by all parties.
Macchia – One of my big frustrations as somebody whose life’s work is in communications is that at least in the initial phases, the advertising for instance that we see from big financial services companies has framed retirement in this idealized manor. You’re 65 and now is the time to learn to parachute or snowboard. And we’re going to help you take you through this delightful, ideal, next 35 or 40 years.
Salisbury – I think to your point that the huge challenge to the degree this imaging is imaging that to use your phrase comes from the financial services industry; the financial services industry for very understandable business reasons is focusing all of that advertising on a small number of people that have money. If one looks at the population demographics and the number of people who actually have anything resembling a meaningful amount of money you’re down in the single digit millions. All of that is directed at that single digit millions of people that from whatever set of sources have reasonable assets.
All of those financial services companies are competing for the attention of that small number of people. In essence for the bulk of the people that don’t have the means and I know friends that are in the focus group business who pull people in and check this, the people that don’t have anything know that’s not going to be what they are talking about. It’s one of the reasons that the most recent date year from the Bureau of Labor Statistics is 2006 and in 2006 of those between 65 and 69, 34% still had income from earnings.
In 2006 of those 85 plus, 8% still had income from earnings. In the last 7 years for the first time we’ve seen a straight move up the percentage of individuals over 60, 65, 70, 75, the proportion of those populations continuing to work is going up. Ironically this combination of transparency in communications of what you may not have, what you need to double check maybe if you go confirm, you have it or you don’t have it. Then you see this picture from the ads and you say well, I know I’m not going to have that. What George Bush has managed to do, along with many others, over the last 20 years, is convince Americans under the age of 40 that they are not going to get Social Security.
So, in this communication they have convinced people that the floor won’t even be there. What that’s interpretation into in the surveys is more and more and more younger people saying, well, I know that I’m going to have to keep working. So where’s then the challenge? The challenge then is the number one financial problem the Social security program does have. It’s called a disability income program. It’s called the explosion of disability claims and it’s the 40% of those that retire before they wanted to that retire because of health reasons that keep them from working. That’s the component of this that is the other need for transparency in education which is he no ability to work and earn risk for people.
Macchia – I don’t even know where to begin to complement you on the insights. If I may I’d like to transition to a couple of questions that are personal in nature. Here’s the first one, Dallas. If I could somehow convey to you a magic wand, and by waving this wand you could affect any two changes, anything at all that you’d wish to change particular to the financial services industry, what two changes would you make?
Salisbury – Well, the financial services industry would end up being secondary to my two primary changes. They would, however, be dramatically affected by them. I’ve been doing what I’ve been doing for 35 years because what I believe in is the whole notion of a retirement system as a retirement system that on some level assures that people run out of life before they run out of money. It’s why I took the job; it’s why I’ve stayed with the job. That’s my normative objective and EBRI is not in the normative business, but you’re asking me a personal question. If I were King we would have a system like some have proposed in the past, the first one from the private sector was one of my founding trustees, the late Bob Paul, who at the time was running the Segal Company, and that’s a notion of a national mandatory savings requirement where there is savings where that money is in fact invested in the private sector, but it’s invested on pool basis on a very, very low fee basis, on a default diversified investment basis, but I’ll repeat, very low fee.
It would have a mandatory annuitization on a life income survivor benefit inflation index basis where the measure is not “adequacy” which for most is never achievable, where the measure is a fully prefunded supportable supplement on top of Social Security. That creates a pool that allows the entire financial services industry to go about doing what they are doing at the high end if you will, but it would for most working Americans that system would end up absorbing money that they are now putting into IRAs and frankly in many cases that they are putting in 401k plans and other places. It would be at a de minimis fee level compared to what many financial service providers now charge in that system. If what I just described happened it would have some fairly dramatic implications for the financial services industry, what they offer, the nature of how they offer it, and the nature of what they are able to charge for it. It would clearly primarily benefit the low cost provider.
Macchia – Your answer reminds me of when I entered the insurance business in the 70s, the very first thing that I was taught was the great importance of the notion of forced savings. Of course, the cost structure of the products back then was very different than what you describe.
Salisbury – My very first job was at the age of 14 and I worked for a savings and loan organization. One of the things that I went out and “marketed” by handing out brochures was their Christmas club.
Macchia – I remember Christmas clubs.
Salisbury – My grandfather was the second person in the United States to get the Certified Life Underwriter (CLU) designation, so while this is only 35 years for me, the notions of financial security, the notions of protection against risk, are something that between my dad having spent his whole career in different realms of insurance, my grandfather having spent decades in the insurance business, it’s something that I’ve had sort of water dripped into me if not genetically then by every other means my entire lifetime.
Macchia – Let me ask you another personal question. If you were not the head of EBRI but instead could have any other job in any industry or field, what would you choose to do?
Salisbury – Can I become a dictator for about 6 months? If I can become dictator for 6 months then I’ll just fix all of this stuff and then I’ll retire.
Macchia – I like your answer. Speaking of retirement, and because retirement is central to the last question, I’d like you to imagine your own retirement in its most idealized form. Where will you be and what will you be doing?
Salisbury – The thing I’ve always, and it’s advice that my family has given me since very early ages, is always try to find something that you love doing and that every single day you’re having fun. That’s why I’m still doing what I’m doing because every day I come and do this and I still have fun doing it and I still find it interesting and challenging and energizing. Whether I’m going to EBRI or “retired” or whatever, it will be just that, it will be to have fun in what I’m doing, what I’m thinking about, what I’m writing each and every day. It’s never been possession oriented, it won’t be possession oriented. It’s never been toy oriented, it won’t be toy oriented. It will be just trying to do things where I feel like I’m contributing and I’m having a good time doing it.
Macchia – I would say there’s no question that you’re contributing and you’ve certainly contributed to my understanding of the issues we’ve addressed. Dallas, is there anything that you’d like to talk about that I have neglected to mention?
Salisbury – Just the one component that we’ve only slightly touched on is I guess a closing note on the level of what people should have before they make the retirement decision and it’s just, I think, the degree to which if there was a single notation that the financial services industry could do as an extreme public service, we try to do this through our choose to save public education and public service announcement program, is just to absolutely convince people don’t sign up for Social Security benefits the day you turn 62, and don’t make the fateful decision to retire, unless you’ve sat down alone or with someone that’s an expert and worked through whether it’s the intelligent thing to do.
With life expectancy and all that it is, and as you’ve noted the long term issues of what will happen to Social Security, what will happen to Medicare, what will happen in job markets, etc. it’s a decision that most people spend almost no time thinking about. The majority of people in surveys report that the basis of the decision was, I’m eligible. A minority of Americans still ever report by the time they retire ever having done even a calculation of how much they needed in order to retire. In setting aside how much you need to save or investing or anything else if we could just manage to get people to at least not retire until they have sat down and made sure that they actually should be doing it would be the single greatest public service anybody could do.
Macchia – Here, here.
Salisbury – Good to talk to you.
Macchia – I can’t thank you enough. This conversation has been illuminating and rewarding, Dallas. Thanks a million.
Salisbury – Good to talk to you. Take care.
David Macchia runs Wealth2K, www.wealth2k.com, a financial-services media and marketing company focused on retirement income.