Can Annuities Save Multiemployer Pensions?

Northwestern professor says annuities could have helped avoid the crisis.

Earlier in March, Congress held yet another hand-wringing session about the multiemployer pension plan crisis, as a slew of experts testified before the House Subcommittee on Health, Employment, Labor, and Pensions, giving their two cents on why the plans are in trouble and how to save them.

Like Mr. McGuire espousing the virtues of plastics to Dustin Hoffman’s Benjamin Braddock in the 1967 film The Graduate, one of those experts, James Naughton, had one word for the committee: annuities.

“Multiemployer plans have not collected actuarially sound contributions and have invested the contributions they received aggressively,” Naughton, an assistant professor at Northwestern’s Kellogg School of Management, told the committee. “If these plans had chosen to collect actuarially sound contributions and purchase annuity contracts … there would be no crisis.”

Naughton criticized trustees of multiemployer pension plans who chose to take aggressive risks in order to chase higher returns, saying that the current crisis is the inevitable outcome of those risky choices.

“The movement away from the stock market may be viewed as a poor choice by some because equity investments generate higher expected returns than low-risk bonds, and these higher returns could narrow the funding gap,” said Naughton. “However, it is important to recognize the equity investments can just as easily increase the funding gap, as higher expected returns come with higher volatility and risk. One cannot generate high returns that are low in risk.”

He said that multiemployer plans are essentially similar to insurance companies in that they are an organization that manages the contributions of its members to provide retirement income. He added that they do not have the ability to respond to large fluctuations in the value of the assets in the pension because contributions are typically set over multiple years, and because contributing employers vary over time, either because of bankruptcy or because of selective exit through withdrawal.

“I am not aware of any convincing reason why multiemployer plans should invest primarily in the stock market,” said Naughton. “These plans also cannot carry a funding surplus, which is necessary to withstand the negative returns that are an inevitable component of risky investment choices.”

He added that due to the structure of multiemployer plans, certain participants have claimed that trustees’ use of risky investment choices, such as investments in private equity and emerging markets, are potential violations of a plan’s fiduciary duty.

“Moving to an annuity purchase framework is a critical first step in addressing the current crisis because it will at least freeze the amount of the total underfunding,” he said.  “Once the decision is made to adopt some form of annuity purchase model, it will be far easier to address other issues related to the amount of aid to be provided to failing plans, the amount of the PBGC guarantee, and how the PBGC should interact with failing plans.”


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