Allison's ode to the second moment


Welcome to the twenty-first issue of Allison’s Ode to the Second Moment, a newsletter that really likes individual pension accounts, reward travel, and trade with China (not necessarily in that order).

If liking 401(k) accounts is wrong, I don't want to be right

You may have seen this popular Wall Street Journal article that declared the 401(k) an unmitigated disaster. Andrew Biggs dismantles the argument. He explains that 401(k) accounts actually increased saving and access to pension coverage. Articles like the one in the WSJ always seem to contain two major errors:

  1. They assume causation: the creation of 401(k) accounts doomed DB pensions.

  2. They assume DB plans were risk-free.

Providing DB benefits is expensive, and any time you backload pay (for you or someone else), it is tempting to not put enough money aside. The combination of high cost and bad incentives is what killed the pension plan. Or, it was ERISA, which forced pension plans to account for the cost and fund pensions properly. It is telling that the only industry where pension are still common is the one not subject to ERISA, state and municipalities. Don’t blame the 401(k) for the fact you don’t have a DB plan!

And DB plans are risky. Risk is one reason why they are so expensive for employers. Moving a stream of income from today into the future is expensive to insure.

Moreover, contrary to the conventional wisdom, DB plans are risky for employees, too. If you change jobs, your projected pension benefit falls (or becomes worthless, if you aren’t vested). Imagine losing your job and your retirement all at once—talk about bad risk exposure. What if your pension plan underfunds and takes on too much risk to make up for it? When chickens come to roost, years of mismanagement can put your employer in terrible financial shape, and bad luck always seems to happen during a recession, when markets and other sources of revenues are down. If your employer goes bankrupt, odds are your pension benefit will take a serious haircut. Your benefit may get cut even if they don’t go bankrupt—just ask the teamsters how much they love their DB plan.

401(k) accounts may put all the risk on the employees, but at least the risk is transparent and under your control.

Now, I’ll be the first to admit 401(k) accounts have their problems, but these problems are easier to solve by:

  1. Expanding coverage

  2. Expanding auto-enrollment

  3. Having defaults that include a high enough saving rate that increases with age and salary

  4. Making the default investment fund low cost and well-diversified

  5. Including a post-retirement drawdown plan or annuity

I am not opposed to traditional pensions. In fact, I’d take a good DB plan over a mediocre 401(k) plan (assuming I planned on working for the same company until I retire). However, I am skeptical that we can create incentives to make DB plans work they way they are intended.

Health care

While we are talking about entitlements, I still not sure what repealing Obamacare even means. Will 25-year-olds be kicked off their parents’ health insurance? It seems like an iron-clad rule that once you give someone an entitlement, you can never take it away. My biggest fear, from health care reform, is we’ll end up promising even more and have no way to pay for it. It seems to me that reforming health care requires realizing two hard truths:

  1. You can’t give someone (or a group of people) more of something without someone else paying for it. It could be future taxpayers, higher earners (and some not so high earners to be realistic), or the beneficiaries. Yes, health care is an inefficient market, but you just can’t “bend the curve” enough to pay for universal coverage.

  2. If we ever have universal coverage, we must acknowledge that some health care plans are better than others. Some insurance involves narrow networks, waitlists, and limited treatments. Some coverage means any doctor you want, any time you want, and the latest, life-saving cancer drug. We often judge health-care policies by looking at the number of people “covered”-- a meaningless metric. Not all coverage is equal. If everyone gets health insurance (and we don’t go bankrupt), some coverage won’t be as good as others and people who pay more will probably get better care.

Will whatever Republicans come up with to replace Obamacare address these two facts of life? Maybe, but probably not, as these are not politically expedient truths for either party.

Long live globalization

It seems every week now, we hear about another manufacturer, who planned to open a factory abroad, and changed their mind. “Buy American” is once again in fashion.

I don’t care what anyone else says, I am still a globalist and always will be. I am not minimizing how terrible it is to lose your job to trade with China. But trade still makes lives better, on net. Besides, China may be a rare case. Even the best trade models don’t work all the time. A country that large entering the market that fast was a one-time event and the extent of the shock may already be reversing itself.

Trade with China probably only accelerated a process that had already started. Technology is changing the nature of work and how we think about jobs. The sort of people who go to Davos (not I, this Pension Geek seems more likely to find herself in the company of prostitutes and criminals than the illuminati) call it the 4th Industrial Revolution.

Trade sped up and exacerbated a painful process, but it also brings in the jobs of the future. Trade ensures you use the latest technology and it forces the labor market to adapt faster. Trying to slow or control the process risks exposing another generation the same insecurity their parents faced. Protectionism only prolongs the pain.

Speaking of global risk management

Like many citizens of the world, I am a rewards point fanatic. The New Year is a good time to assess your investment strategy and that includes your point strategy. My resolution is to get serious about building credit card point wealth. It saves me the hassle of flying for points. Soon, I will be one of those people who have a specific credit card for every transaction. Then I will be one of those people whose life is a series of free perks and upgrades. Or I won’t bother and, instead, will find a new, more socially useful hobby. I’ll see how it goes.

Until next time, Pension Geeks!