(This column first appeared in Employee Benefit News in January 2007)

Have you seen New York Life’s latest national ad campaign? Its headline, “A Promise of a Never-Ending Paycheck for All Your Retirement Days,” is great.

But the idea of guaranteed lifetime income is not exactly novel. And it completes an odd circle of sorts – bringing us back nearly a century, when the idea of retirement planning began.

A Lifetime Paycheck

The first defined benefit (DB) pensions, introduced about 90 years ago, were designed to provide precisely what New York Life touts: monthly income, for life. In fact, the earliest pensions were actually funded with life insurance, sold by companies like New York Life, as well as John Hancock and others.

But insurance is event-based. It’s ideal for producing lump sums at death, but an ineffective way to maintain streams of long-term, ongoing retirement income. Insurance-based pensions were inefficient and expensive.

It wasn’t until the 1950s, when equity investment became widespread, that DB really caught on. By using stocks, employers found they could construct dynamic, and diversified, pension portfolios. They were able to generate much higher returns than with insurance and other fixed products, and made pensions manageable and cost-efficient.

That was the “golden era” for U.S. pensions, when the number of company DB plans skyrocketed. For employees, ranging from senior managers to members of the union local, a company pension was considered the most attractive, and sought-after, fringe benefit.

Killing the Proverbial Goose

As effective as DB was, though, it wasn’t flawless. Through questionable fiscal practices, several plans squandered their assets, causing participants to lose benefits. Congress and the IRS responded with a series of regulations, such as ERISA (1974), OBRA (1987), FAS (1987 and 1988), and RPA (1994), among others, all intended to protect pension assets — and plan participants.

Though the new rules strengthened certain safeguards, they also increased employer accounting and administrative burdens. As Fred Munzenmaier, our Managing Partner and Senior Actuary, says, “I call it ‘Maximum Man-Made Complexity (MMMC).” In an effort to cover every conceivable abuse, Congress and the IRS built MMMC into all aspects of DB.”

The effects were both unanticipated and overwhelming. Layers of managerial, accounting, and administrative mandates were dumped on employers, greatly complicating plan oversight and governance. Companies had to boost contributions and ensure their plans kept pace with evolving and, in many cases, ambiguous regulations. The new requirements were both time-consuming and expensive.

It was no longer possible to view DB as the most flexible and cost-effective way to fund a golden nest egg. Legislation had “killed the goose” – turning DB into a liability that could no longer be borne.

Greener on the Other Side?

By the end of the 1990s, most companies had either cut DB commitments substantially or gotten out of employee pensions altogether. The result? A dearth of new pension plans in the U.S. – and record numbers of frozen or terminated pensions.

Today, fewer than one in four employers sponsor a DB plan. But about 90% offer defined contribution (DC) programs, such as 401(k), 403(b), and 457.

As surveys show, employees prefer these plans. They like DC's access to individual accounts and benefit portability. In addition, since each participant decides how much to contribute, and how to invest the funds, employees have more control over benefits, and the potential to generate an investment “upside.”

Employers also enjoy some advantages under DC. The plans are much easier to administer than pensions. They’re unencumbered by complex actuarial and compliance regulations; and, since participants manage their own accounts, DC plans relieve employers from investment risk. DC can also cost less – saving employers, on average, more than a third of their typical pension contribution.

But do these features make DC plans better?

DC is undeniably more attractive to job changers, active savers, and employers that want to avoid long-term commitments to their people. But these plans also have significant drawbacks.

For one, they don’t afford the same funding flexibility. Under DB rules, employers can spread contributions out over several years. DC, though, requires employers to fund the plan, with a fixed amount, on an annual basis.

Pensions provide participants with important guarantees. Each DB plan has a formula, communicated openly (if not always clearly), that defines the specific amount of monthly income to be provided at retirement. These amounts can never be less than what the formula produces. And benefits can never be outlived: they’re locked in, for the life of the pensioner and, in most cases, the spouse.

DC plans, in contrast, offer few guarantees — and what’s available at retirement can vary greatly. That’s because only the employer’s annual contribution is assured. Each participant's DC account is based largely on how much he or she decides to contribute, and the outcome (for better or worse) of his or her investment elections. Plus, at retirement, all the employee owns is the ending balance. Unlike DB, there’s no provision to provide for, let alone guarantee, income for life.

At What Price?

During the DC boom of the 1990s, few even considered the consequences of abandoning the traditional pension plan. With DB’s cumbersome, and costly, regulatory baggage – and DC’s double-digit investment returns – the idea of “lifetime income security” seemed like a relic from an outdated era.

But, in today’s post-9/11 world, investment returns have been more modest. Financial markets, personal savings, and the cost of goods we used to take for granted, have all proven vulnerable to erratic, and highly unpredictable, world events. In planning for the future, many employees long for certainty, security, and peace of mind.

The concept of guaranteed income, for life, may not be so old-fashioned after all.

Filling the Void

DC plans can produce accumulations, but can’t meet the need for savings that last a lifetime – no matter how long that might be, no matter whatever else may happen.

The near-extinction of the DB pension, and its guarantees of lifelong income, has created a void, both financial and psychological. And it is insurance companies, like New York Life, that are best positioned to fill it.

Their portfolios of fixed and variable annuity products are a convenient way to turn DC balances into lifelong income. But such security comes at a price – in the form of premiums, or loads, that cover commissions, administrative expenses, and shareholder equity. It’s not what the designers of the original DB plans had in mind.

Still, given the prevalence of DC plans, annuities do make sense.

With improvements in health care, the typical 65-year old retiree can expect to live into his or her mid-80s, or even the early 90s. In fact, the fastest-growing demographic group in the country is centenarians – those over age 100. It’s not inconceivable that the number of years employees spend in retirement will outnumber their time spent producing income. And that's not all.

Between longer life spans and the impending retirement of a generation of baby boomers, Medicare and Social Security will soon be exposed to unprecedented pressures. Many employees are unsure of what to expect from these programs when they retire.

For all these reasons, the appeal of a guaranteed, lifetime income has perhaps never been greater.

Back to the Future

New York Life is just the first of many insurers to target the growing demand for lifelong financial security. That’s not a bad thing. But it is ironic. After decades of advances that moved pensions away from insurance products, it seems inevitable that future retirement income will be delivered, in large part, through the insurance industry.

It’s unfortunate that legislation has made pensions sponsorship such an anathema. Recent innovations in DB design can incorporate such desirable features as individual accounts, flexible funding, and the comfort of a guaranteed lifetime income – at costs lower than comparable DC plans. In our pension-hostile business climate, though, few companies are open to even considering these options.

Which leaves us, as a society, with a lingering desire for the ever-elusive “Promise of a Never-Ending Paycheck for All [O]ur Retirement Days.”

At one time, this commitment was built in to the benefit itself.  But, if you want it now, it’ll cost you extra.

How’s that for progress?