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Little has been written on the subject of pension trusts, and the ways in which pension laws and trust laws interact. As academic subjects, many issues such as the purpose of a pension trust, employer duties, and the duties of directors of trustee companies, have long been under-represented. However, pension trust law is a technical area that requires more attention, and is also considered to be an exciting area of law that has been ignored in academia for too long. Author of The Law of Pension Trusts, David Pollard, explains why he decided to fill this gap and what issues he felt needed to be tackled in the law of pension trusts:

David goes on to explain why he finds pension trust law so interesting, and what the most significant pension cases were in the past 12 months. He also predicts how pension schemes might change and develop in the future:

Do you agree with David about how pension schemes might change in the future? Write your responses in the comments below.

Feature image credit: Minhas Economias, My Savings by Jeff Belmonte. CC-BY-2.0 via Flickr.

The post Why must we pay attention to the law of pension trusts? appeared first on OUPblog.

        

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By Edward Zelinsky

As the American public debated the legislation ultimately enacted into law as the American Taxpayer Relief Act of 2012, no person was more influential than the Oracle of Omaha, Warren Buffett. Much attention was given to billionaire Buffett’s complaint that his federal income tax bracket was lower than his secretary’s tax rate. President Obama invoked “the Buffett Rule” to bolster the President’s successful effort for the Act to raise income tax brackets for high income taxpayers.

In his most recent letter to the shareholders of Berkshire Hathaway, Buffett issued another oracular pronouncement about America’s fiscal health. Buffett warned that many public pension plans are dangerously underfunded:

Local and state financial problems are accelerating, in large part because public entities promised pensions they couldn’t afford….[A] gigantic financial tapeworm…was born when promises were made that conflicted with a willingness to fund them….During the next decade, you will read a lot of news –- bad news – about public pension plans.

Many of those who heeded Buffett’s call for higher tax brackets for the wealthy ignore his current warning about the parlous financial condition of public pension plans. One of the problems of being an oracle is that your listeners will pick and choose which prophecies to follow.

Attached to Buffett’s most recent shareholders’ letter was a 1975 memo on pensions Buffett sent to Katharine Graham, then chair of The Washington Post Company. Buffett’s observations in this now released memo are as compelling today as they were forty years ago. It is easy to grant pension benefits payable in the future while failing to fund that pension promise today as “making promises never quite triggers the visceral response evoked by writing a check.” Typical defined benefit formulas, which gear pensions to an employee’s final salary before retirement, are particularly expensive for the employer to finance since higher final salaries will, at the end of an employee’s career, escalate his pension entitlement. It is tempting, but futile, to assume that the underfunding of defined benefit plans can be remedied by every plan continuously earning above average returns on pension assets: “yes, Virginia, maybe every football team can have a winning season this year.”

All of this explains why many of the nation’s public pension plans are today seriously underfunded: Elected officials promise pension benefits without properly funding them and rely on unrealistic assumptions about future rates of return to deny the reality of underfunding.

Buffett’s observations resonate with particular force in Connecticut where I live. Connecticut competes with Illinois for the distinction of being ground zero in the public pensions crisis. In this election year, neither the Governor nor the legislature will acknowledge that the Nutmeg State’s public pensions are seriously underfunded.

Consider in this context Buffett’s warning that pension plans should not assume that they will earn superior investment returns. Connecticut contends that its pension plans will earn 8% annually. Most other states make similarly optimistic assumptions. The National Association of State Retirement Administrators has recently determined that the average state public pension plan currently assumes that its investments will earn an annual rate of return of 7.72%.

More realistic assumptions about rates of return would expose the underfunding of public pensions described by Buffett. Under the Internal Revenue Code, private sector pensions this month must calculate their obligations to pay retirement benefits using interest rates ranging from 1.19% (for pension benefits payable soon) to 6.76% (for pension benefits payable furthest down the road). If Connecticut or any other state with similarly underfunded pensions assumed these more sobering rates of return (as they should), Buffett’s dire assessment of pension underfunding would be dramatically confirmed.

Equally instructive is the recent contract settlement brokered by New York Governor Andrew Cuomo between the Metropolitan Transportation Authority (MTA) and Local 100 of the Transport Workers Union (TWU). With much fanfare, Governor Cuomo announced that TWU workers will receive increased wages but that the MTA will not elevate fares to cover these increased wages. Only after the cheering stopped did we learn how this alchemy is to be accomplished: by reducing the MTA’s scheduled contributions for pensions and retiree health care costs. Governor Cuomo, the MTA, and the TWU have decided to underfund pensions for MTA workers. No doubt, they will justify this underfunding by predicting superior investment returns on the pension’s investments.

The Oracle of Omaha is, unfortunately, right. Many states and localities will soon have to choose whether to pay pensions promised to retired workers, or whether to put police on the streets and teachers into classrooms, or whether to increase taxes significantly to pay pensions and maintain public services.

It is regrettable that many who marched under Buffett’s banner when he favored higher taxes on the rich ignore his message about the troubled state of public pensions.

Edward A. Zelinsky is the Morris and Annie Trachman Professor of Law at the Benjamin N. Cardozo School of Law of Yeshiva University. He is the author of The Origins of the Ownership Society: How The Defined Contribution Paradigm Changed America. His monthly column appears on the OUPblog.

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Image credit: Pension pension or retirement concept with word on business office folder index. Photo by gunnar3000, iStockphoto.

The post The Oracle of Omaha warns about public pension underfunding appeared first on OUPblog.

        

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By Edward Zelinsky

Media reports have indicated that New York Governor Andrew Cuomo has been considering the use of public pension funds to finance the replacement of the Tappan Zee Bridge and to underwrite other infrastructure investments in the Empire State. This is a bad idea, harmful both to the governmental employees of the Empire State and to New York’s taxpayers. Using public pension monies in this fashion trades the immediate benefits of public construction for the long-term cost of underfunded public retirement plans.

If investment in the new Tappan Zee Bridge yields risk-adjusted, market rate returns, then private investors will step up to the plate and invest. Resorting to special financing arrangements with public pensions signals that a proposed investment does not pass the test of the marketplace. Market rate returns attract private capital. Such investments need not be subsidized with public pension monies.

There are projects which yield social benefits beyond their financial returns to investors. In a democracy, voters (or their elected representatives) can and should be persuaded in open deliberations to finance such projects with their tax dollars.

When governmental officials (however well-intended they may be) resort to special funding arrangements with public pension plans, it indicates that the investment in question flunks both the discipline of the market and the legitimacy of voter approval.

Such projects flout the venerable fiduciary standards for pension investments, namely, prudence and diversification.

An investment shunned by private investors is imprudent. When made by a state pension plan, such a below-market investment impairs the long-term interests of both the employees who depend on the plan for their retirement incomes and of the taxpayers who ultimately finance the plan. A prudent pension investment must, at a minimum, yield a risk-adjusted, market rate return. If pensions make investments rejected by private investors, such below-market investments are imprudent.

Moreover, an investment by New York pensions in New York infrastructure fails the test of diversification. In the private sector, it flouts the rule of diversification for a private retirement plan to invest its resources in the stock of the employer sponsoring the plan. The plan is already dependent upon the economic well-being of the sponsoring employer since the employer funds the plan. Placing the plan’s resources in the employer’s stock doubles the pension’s bet on the employer and its economic condition.

Similarly, if New York’s public pensions invest in New York projects, the pensions are doubling their bets on New York’s economy. These plans already count on New York’s economy for the tax revenues funding such plans. Concentrating New York pension investments in the Empire State is the opposite of diversification; the financial fate of these plans is already tied to New York’s ability to fund them.

The budgetary pressures on Governor Cuomo and other states’ chief executives today are severe. Those pressures make it tempting to turn to public pension funds to finance infrastructure when private investment can’t be obtained and voters cannot be convinced to pay taxes for such infrastructure.

It is precisely at such moments that the sage tests of prudence and diversification play their most important role –  protecting the long-term interests of retirees and taxpayers by precluding pension trustees from making investments which flunk the criteria for sound fiduciary decisionmaking.

The most recent reports indicate that Governor Cuomo may be reassessing the desirability of using public pensions to finance in-state infrastructure investments. Let us hope so. A new Tappan Zee bridge is a great idea. It should be pursued the right way, by formulating

Edward A. Zelinsky is the Morris and Annie Trachman Professor of Law at the Benjamin N. Cardozo School of Law of Yeshiva University. He is the author of The Origins of the Ownership Society: How The Defined Contribution Paradigm Changed America. In this article, Zelinsky discusses the U.S. Supreme Court’s recent decision in MetLife v. Glenn. That decision, he concludes, unintentionally reinforces the trend from defined benefit to defined contribution plans. Under MetLife v. Glenn, employers which sponsor and administer defined benefit pensions operate under a conflict of interest which subjects their administrative decisions to greater legal scrutiny.

Wanda Glenn was an employee of Sears, Roebuck & Company (“Sears”) and, as such, was covered by the Sears long-term disability insurance plan. Metropolitan Life Insurance Company (“MetLife”) both administered and insured the Sears plan. Ms. Glenn applied for continuing disability benefits. MetLife, as plan administrator, denied Ms. Glenn’s application for benefits which, if granted, MetLife, as the plan’s insurer, would itself have paid.

Ms. Glenn sued. Her lawsuit made its way to the U.S. Supreme Court which held in MetLife v. Glenn that, in light of the discretion confided to MetLife by the Sears plan, MetLife’s denial of Ms. Glenn’s disability benefit was to be reviewed judicially under a deferential “abuse of discretion” standard. However, the Court further stated, MetLife, as plan administrator, operated under a conflict of interest since any benefits MetLife granted as such administrator MetLife itself also paid as the plan’s insurer. Hence, in assessing whether MetLife, as plan administrator, abused its discretion, the courts must, among other factors, “take account of the conflict” MetLife faced as a plan administrator which was also the plan insurer. Such conflict of interest might “act as a tie-breaker when the other factors are closely balanced.”

MetLife v. Glenn has engendered extensive discussion. However, so far, one aspect of this decision has gone unremarked: MetLife v. Glenn is one more unintended push from our legal system, nudging employers away from traditional defined benefit plans towards 401(k) plans and other similar defined contribution retirement arrangements. After MetLife v. Glenn, the administrative decisions of employers sponsoring and administering defined benefit pensions will typically be subject to greater legal scrutiny than will be the administrative decisions of employers sponsoring and administering most 401(k) and similar individual account arrangements. This greater scrutiny incents employers to shift from their defined benefit pensions to defined contribution plans.

Embedded in the traditional defined benefit pension administered by the sponsoring employer is the conflict of interest stemming from the employer’s obligation, as plan sponsor, to pay the costs of the plan — just as MetLife, as insurer, paid from its premium revenues the costs of the Sears disability plan. In the defined benefit setting, greater plan distributions to participants and beneficiaries require greater employer contributions to the plan. Consequently, any distribution denial by the employer sponsoring a traditional defined benefit pension implicates the conflict of interest in which MetLife found itself: If the employer as plan administrator denies plan benefits, it thereby reduces its costs as plan sponsor.

In contrast, an employer sponsoring and administering a typical defined contribution plan usually has no such conflict of interest since the individual accounts of such a plan belong to the participants. If, for example, an employer, as administrator of a 401(k) plan, denies a participant a hardship distribution from the plan, that denial does not decrease the employer’s costs; it merely delays the distribution to the participant of his 401(k) account until later. Since there is no conflict of interest in that setting, under MetLife v. Glenn, the employer’s decision will receive greater deference if challenged in the courts.

An important factor causing the decline of traditional defined benefit pensions and the concomitant rise of individual account arrangements like 401(k) plans has been the heavy regulatory cost imposed on defined benefit plans. MetLife v. Glenn represents the latest such cost, an unintentional cost, perhaps a small cost, but a cost nonetheless. Employers who sponsor and administer defined benefit plans are now on notice that, because of their conflicts of interest, their administrative decisions will generally receive less deference from the courts than will the comparable decisions of their competitors sponsoring and administering 401(k) plans who do not operate under such conflicts of interest. By itself, this will rarely cause an employer to terminate its defined benefit pension and shift to an individual account arrangement. But, to paraphrase the Supreme Court, this is the kind of cost which can act as a tie-breaker when the decision is close.

Consequently, Metlife v. Glenn, by reducing the deference ultimately granted to employers which sponsor and maintain defined benefit pensions, represents one more small, but unintended, push away from such pensions.

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