HIDDEN PENSIONER
Simply stated, a hidden pensioner is a worker whose value to his employer has diminished and is now less than his costs to the company. Birchard Wyatt, one of the founders of Watson Wyatt Worldwide, argued that a worker’s marginal contribution eventually reaches a peak and then begins declining, eventually dropping below the compensation cost of keeping him or her on the payroll. The period of time when the value of workers’ services exceeds compensation cost is an “efficiency surplus.” Wyatt suggested that companies could use a portion of this surplus to finance a pension benefit, which could encourage workers to retire when the time was right—thus, not becoming hidden pensioners.
If businesses don’t have proper systems in place to help people retire, many of them will become hidden pensioners. This has to be a consideration when designing pension plans.
A DIFFERENT WORLD
It’s clear that helping workers retire with dignity and managing orderly exits from the workforce were key reasons employers set up pension plans in the first place. Is such sentiment antiquated?
Some would say that the world has changed and that “do-it-yourself pensions,” or defined contribution(DC) plans, will be the way of the future. The arguments are familiar—today’s worker is more mobile, can manage his or her own finances and savings, and will be able to work much longer. In addition, employers will want workers to have longer careers to stem future(and, in some cases, current)labour shortages. But is this really true? These basic assumptions are not all what they seem.
In today’s service-dominated economy, many workers are no longer subject to the physical labour of the industrial age. But workers today face technological obsolescence and cannot work as long as they want. As technology continues to rapidly advance, workers must continually improve their skill set. If they do not, the value of their services will decline. And decline they almost certainly will.
As much as our employers value certain services today, their needs and desires will change. At some point, they will not value those services at all or at a level sufficient to justify the cost. Workers can still be “worn out in service”; it is simply later in life than it used to be.
While human resource executives often talk about attracting and retaining critical skill workers, they appear to show little interest in the opposite end of the employment spectrum— managing the exit of workers. This may be because their DB pension plans have been doing this for them.
An example illustrates this case. In 1986, mandatory retirement was eliminated for most industries in the United States. However, academic institutions were granted an exemption for faculty until 1994. As 1994 approached, many colleges and universities became quite concerned about not being able to require older faculty members to retire. The large universities feared they were particularly susceptible to delayed retirement because most of them offer only DC plans, which do not include financial incentives to encourage retirement.
Many of the universities resorted to severance pay programs to encourage faculty members to retire within specified age ranges. For example, a major West Coast university’s plan offered two years of pay to 60-year-old faculty members with 20 years of service who retired immediately. For each year they deferred retirement, the payment was reduced by 20%. Many other universities established similar programs. The employers of these workers—who arguably exemplify the pinnacle of the knowledgeable worker—were willing to pay because they needed to replenish their workforces.
This story is particularly relevant given the recent elimination of mandatory retirement in Ontario. Interestingly, no exemption was given for academics. It will be interesting to see if universities in the province begin to face challenges similar to the American universities, and to what extent retirement plan design is an influence on these potential challenges. Mandatory retirement was eliminated in Quebec in the 1980s, and that has caused challenges for universities in that province.
What about labour shortages? How will they affect the employment relationship? Will it not be important to retain older workers? On the surface, these issues would seem to be in conflict with the need to “get workers out” of the workforce. They are not. Companies will need to continue attracting, retaining, developing and renewing their workforces. As a result, each employer will have to find an appropriate balance between these competing and overlapping needs. Whether the balance should be tilted toward phased retirement or early retirement is specific to each company. But the need to manage exits in an orderly way is not specific to each company.
There is also the assumption that workers can save effectively on their own, and while this may be true for some, it is likely not for most. Numerous studies indicate that people don’t save enough if left to their own devices. Based on data from Statistics Canada, the average net wealth of Canadians close to retirement was only $407,000 in 2005. While this seems like a lot, excluding the family home and employer pensions, this number drops to less than $70,000. In the United States, the accumulated wealth of the median worker close to retirement is even lower—less than US$10,000 based on recent studies, excluding the family home and retirement savings. Even those in the top 10% of lifetime earnings had less than US$40,000 of accumulated wealth.
The message is clear. In both countries, we are primarily a society of spenders, not savers. This matters less for lowincome Canadians because of C/QPP, OAS and GIS benefits. Arguably, they don’t need to save. But the rest of us do, and we will be more efficient at doing so if our employer helps us.
According to a survey on pension risk conducted by Watson Wyatt and The Conference Board, most participants believe that DB plans provide significantly more retaining power than DC plans. Specifically, 68% believe that plans with some element of DB were better at retaining employees, and only 15% believe that DC were better, a number only slightly higher than those who believe that cash compensation is best(11%).
But if it is true that today’s workers are much more mobile, then DB plans would only be effective at retaining workers relatively close to retirement. We have been hearing for 15 years that job mobility is rising. High technology makes us more mobile. The baby boomers are somehow different. We are a more mobile society because it’s an information age.
An analysis of tenure data from 1976 through 2004 by five-year age brackets shows that the general wisdom is basically false. The only age bracket in which tenure has dropped is the 55 to 64 age bracket. All other brackets are virtually flat. In point of fact, our society has been mobile primarily for one reason— because a lot more people were in the young age brackets than in the past. As the baby boomers age, average tenure on the job will increase dramatically.
MANAGING EXITS
When an organization winds up a DB plan, it eliminates one of the most effective ways to predict when workers will exit the workforce. Most organizations switch to DC plans only—and these plans do play a vital role in retirement planning and security.
But there are no built-in incentives to retire, and worse yet, they are subject to the vagaries of the market. In other words, when markets do well, pension benefits go up and employees are more likely to retire; when markets do poorly, account balances go down and employees are more likely to stay on the job. This is the opposite of what employers need—if business is booming, they often need more workers. In downturns, they typically need fewer.
It’s clear there are strong arguments that employers still need to manage their workforces and that DB plans are better at this.
Dr. Sylvester J. Schieber, a recently retired thought leader with Watson Wyatt, used data from the U.S. Health and Retirement Study, which began in 1992, as well as data from several Watson Wyatt research reports and other studies to demonstrate the impact DC and DB plans have on retirement rates.
He looked at the retirement patterns by age of those workers who are primarily covered by DB plans as compared with those covered primarily by DC plans. Retirement patterns for DB plan participants follow a more consistent path than patterns for those without these plans. Put another way, labour force withdrawal rates under DC plans have considerably more variance around retirement age than under DB plans.
The point of this analysis chart is less about when people retire than about how they retire. Undoubtedly, many DB plans used to encourage early retirement in a way that they can no longer afford and that no longer makes sense. However, even if we as a society decide that people should work somewhat longer than they used to, that doesn’t negate the value of an orderly, relatively predictable retirement path for workers. This is true even for companies that sell knowledge-based products or services.
So, while some might argue that the need for traditional pension plans is long gone, that clearly does not take workforce management into account. Organizations that choose to eliminate their DB plans(whether all at once or over time)without some thoughtful analysis in the plan design stage may well be faced with employees who cannot afford to retire. Lack of design, strategy and implementation may put employers in the position of searching for hidden pensioners within their ranks. The costs and implications of which are greater than the costs of plan redesign.
David Burke is retirement practice director for Canada, Watson Wyatt Worldwide, based in Montreal. david.burke@ watsonwyatt.com
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