Pandemic Provides Lessons to Improve Retirement System

The COVID-19 pandemic has provided some important lessons that can be used to build more resilient retirement systems using innovative pension designs for the public and private sectors, according to a recently published research paper from The Wharton School of the University of Pennsylvania.

In particular, the paper notes that the economic impact of the pandemic puts into question the wisdom of linking pensions to employers and demonstrates the need to come up with new ways to share risk.

“One lesson we have learned is that tying workers’ pensions (and in some countries, health insurance) to an employment relationship is quite risky when firms go out of business and worker mobility results,” the paper said.

Because of this, the paper suggests that in the wake of the pandemic, retirement and health insurance coverage are likely to be “de-linked” from employer-provided plans in many countries “instead of continuing what was once termed ‘industrial feudalism’ under which workers were discouraged from leaving their firms for fear of losing their benefits.”

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The paper was authored by Olivia Mitchell, a professor of business economics and insurance and risk management at The Wharton School. Mitchell is also executive director of the University of Pennsylvania’s Pension Research Council and is director of the Boettner Center on Pensions and Retirement Research.

Mitchell notes that the Setting Every Community Up for Retirement Enhancement (SECURE) Act, which was signed into law last December, allows private sector employers to establish and operate multiple employer pension plans. It also requires employers to offer part-time and part-year workers access to a company’s defined contribution plans, which the paper said could potentially benefit workers as the labor market recovers.

“Instead of pensions, health care, and insurance programs being offered though the workplace, these could be made available by associations or multiple employer programs, or indeed workplace platforms,” the paper said.

Under this format, workers would no longer need to remain tied to a single firm to retain their pensions and health insurance. The paper said the act also gave an “invaluable push” to annuitization in defined contribution plans, giving companies a safe harbor to adopt a lifetime payout component in their retirement plans. This could lead to the development of a centralized database, such as the one adopted in Israel that helps mobile workers track their pension accounts as they move to various employers.

Mitchell also writes that the financial disruption from the pandemic will likely “hasten the demise of the remaining traditional defined benefit plans around the world, unless they receive substantial financial transfers to bail them out or are dramatically altered to survive in different form.”

The paper notes that several US states, such as Illinois, have requested federal help to continue paying retiree benefits, and that “the specter of state bankruptcy” has already emerged as a potential result of states being unable to contribute enough to maintain their pension plans.

Mitchell also writes that pension models for the future will require new methods to share risk, which starts with “enhancing financial literacy in the population, helping people to save more and invest smarter and to better manage longevity.” Additionally, she wrote that plan sponsors can also do more to increase a pension’s flexibility, for instance by linking retirement ages and contributions to funding levels.

Several new models for pensions that alter how risks are shared have been introduced in recent years, the paper notes, such as a hybrid plan that can include a commitment to change benefits or discontinue benefit cost-of-living adjustments if funding levels fall. A hybrid plan could alternatively raise contributions if the plan’s financial position declined below a certain threshold. And in some cases, longevity risk in defined benefit plans may be outsourced to insurers, or funding risk could be backstopped by government entities, such as the UK’s Pension Protection Fund or the US Pension Benefit Guaranty Corporation (PBGC).

The paper also said policymakers could improve decisionmaking by providing better data to price insurance products and by formulating better forecasts and establishing plans to respond to the aging population’s needs.

“Raising retirement ages, incentivizing continued work, and helping people save more are also likely to be part of the solution,” the paper said. “Additionally, strengthening safety net programs is also likely to be critical in helping those who cannot work and lack private insurance. Taken together, these can strengthen not only retirement systems around the globe, but also the economic vitality of our economies more broadly.”