29 Pages Posted: 13 Feb 2003
The private pension market in the United States has been almost completely transformed in less then 20 years. In the early 1980s, over 80 percent of all covered workers in the private sector had a classic defined benefit plan. In the year 2001, this share has fallen to less than 40 percent. In addition, approximately one in five defined benefit plans (weighted by workers) converted to a cash balance variety, which are defacto defined contribution plans. Some of this movement is attributable to economic trends favoring the kinds of firms and industries that traditionally favored the defined contribution format, but the evidence shows a strong and persistent reduction in preferences for the defined benefit variety. I argue that the underlying reason for this trend is the adoption of a new tax policy towards terminations in the early 1980s, one that permitted terminations for reversion, which were not attributable to financial difficulty of the sponsoring firm. This change eliminated the mechanism that bonded the implicit pension contract, creating the possibility of unilateral termination by one party under conditions not originally contemplated in the contract. The more firms that either terminated their plan or converted it to the cash balance variety, the more that workers still covered by defined benefit plans discounted the likelihood that their plan would survive. Since terminations and conversions confer large capital losses on workers, workers become leery of continuing to invest in the plan (in the form of foregone wages) unless it offers an extraordinary rate of return, which in turn affects the economics of offering the plan. The growing distrust of workers for firms holding up their end of the bargain creates the conditions that are ripe for the unraveling of the industry. Following these trends, pension economics now focuses on the ability of firms to use defined contribution plans to influence productivity in the firm. Other questions arise: Absent defined benefit plans, will firms lose their ability to influence retirement ages? Will lump sums from defined contribution plans deliver comparable retirement income to future cohorts? These issues thus far remain unresolved.
JEL Classification: J32
Suggested Citation: Suggested Citation
Ippolito, Richard A., Tenuous Property Rights: The Unraveling of Defined Benefit Pension Contracts in the United States. George Mason Law & Economics Research Paper No. 03-06. Available at SSRN: https://ssrn.com/abstract=379660 or http://dx.doi.org/10.2139/ssrn.379660
By Purvi Sevak