Legacy Risks

European and American political and private institutions have made many non-sustainable retirement promises over the last 50 years. These promises cannot be kept and that reality is forcing reform. One primary reform is a shift from defined benefit to defined contribution plans. Critics argue that would shift risks from the company or agency to the individual. But is this true?

While an individual may fail to set aside enough savings for retirement or invest poorly, that is also true for a firm or government entity. The firm or agency may have the resources to make up for a shortfall — but they may not. When firms and — increasingly — political jurisdictions go broke, they leave workers badly shortchanged. In the private sector, the federal Pension Benefit Guarantee Corporation caps benefit payouts for pensions it takes over. And around the country, financially strapped state and local governments are enacting reforms to lower their pension liabilities. In a still-struggling economy where bankruptcies are likely to increase, defined contribution plan that are independent of the resources of a larger entity may often be the less risky option.

Note that in Europe, to avoid crippling taxes during high-tax periods, part of workers’ compensation would be in kind, often in the form of a car or even an apartment. While these were nice perks, their being provided by the employer meant that to lose one’s job meant losjng not just income, but also access to critical necessities of life. The European nations that have better weathered the Great Recession are those that have liberalized their labor markets. Those reforms allowed workers in those countries to receive higher pay and gain these resources more securely themselves. Isn’t the same principle at work in the retirement area?