Social Security Reform: Lessons from the Private Sector

By Skousen, Mark | Ideas on Liberty, March 2001 | Go to article overview

Social Security Reform: Lessons from the Private Sector


Skousen, Mark, Ideas on Liberty


"Of all social institutions, business is the only one created for the express purpose of making and managing change.... Government is a poor manager."

-PETER F. DRUCKER1

In the ongoing debate over the privatization of Social Security, one story has been overlooked: The private business sector in the United States has already faced the pensionfund problem and resolved it.

Here's what happened. After World War II, major U.S. companies added generous pension plans to their employee-benefit programs. These "defined benefit" plans largely imitated the federal government's Social Security plan. Companies matched employees' contributions; the money was pooled into a large investment trust fund managed by company officials; and a monthly retirement income was projected for all employees when they retired at 65.

Management guru Peter F. Drucker was one of the first visionaries to recognize the impact of this "unseen revolution," which he called "pension fund socialism" because this Social Security look-alike was capturing a growing share of investment capital in the United States.2 Drucker estimated that by the early 1990s, 50 percent of all stocks and bonds were controlled by pension-fund administrators.

But Drucker (who doesn't miss much) failed to foresee a new revolution in corporate pensions-the rapid shift toward individualized "defined contribution" plans, especially 401(k) plans. Corporate executives recognized serious difficulties with their traditional "defined benefit" plans, problems Social Security faces today. Corporations confronted huge unfunded liabilities as retirees lived longer and managers invested too conservatively in government bonds and blue-chip "old economy" stocks. Newer employees were also angered when they changed jobs or were laid off and didn't have the required "vested" years to receive benefits from the company pension plan. Unlike Social Security, most corporate plans were not transferable. The Employment Retirement Income Security Act (ERISA), passed in 1974, imposed regulations on the industry in an attempt to protect pension rights, but the headaches, red tape, and lawsuits grew during an era of downsizing, job mobility, and longer life expectancies.

The New Solution:

Individualized 401(k) Plans

The new corporate solution was a spinoff of another legislative invention-the Individual Retirement Account (IRA). The 401(k) rapidly became the business pension of choice, and there is no turning back. These "defined contribution" plans solve all the headaches facing traditional corporate "defined benefit" plans. Under 401(k) plans, employees, not company officials, control their own investments (by choosing among a variety of no-load mutual funds). Corporations no longer face unfunded liabilities because there is no guaranteed projected benefit. And workers and executives have complete mobility; they can move their 401(k) savings to a new employer or roll them over into an IRA.

According to recent U.S. Labor Department statistics, there are about nine times more defined-contribution plans than defined-benefit plans. …

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