Back in late May, we posted an item on the story of almost 8 in 10 West Virginia teachers choosing to abandon their 401(k)-style defined contribution plan in favor of rejoining the state's defined-benefit pension system.
In Monday's Wall Street Journal, Jennifer Levitz added more detail to this fascinating case study. Here's part of her opening salvo:
[O]n July 1, after a vote authorized by the state legislature, 14,871 school employees, or 78%, switched to the old-fashioned pension plan.
After the vote, teachers were "jumping up and down and crying in the halls," [union president Judy] Hale says.
The school employees put their mistakes behind them, but their experience stands as a cautionary tale for employers and employees across the country. As large numbers of workers are starting to retire with 401(k) or 401(k)-like plans to support them, what happened in West Virginia is a window into exactly how things can fall apart for workers, and it serves as a wake-up call for figuring out how to avoid having plans go as badly off track as this one did.
As we wrote in May, this story is stuffed with themes applicable to the bigger picture in the American system: "underfunded pensions, employers' cost-conscious transition from DB to DC plans, expensive/under-performing insurance-focused products, poor decision-making by participants, and, as a consequence of all of that and more, grossly inadequate outcomes for rank-and-file participants." The Levitz piece is very much worth reading, but as usual, we ran across a couple of items worth quibbling over.
Here's one (emphasis added in bold):
Many workers with retirement accounts have built nest eggs far bigger than they ever imagined possible. But unknowledgeable ones often are far short of comfortable retirements -- and they don't have the option the West Virginia teachers did of appealing to state legislators to get them out of their investing mistakes.
Knowledge is important, and ignorance generally doesn't help plan participants achieve the best possible long-term outcomes. But it isn't just a matter of knowledge; it's also a matter of psychological and behavioral capacity to avoid making big mistakes. The problem for some participants is their sense that they have too much knowledge, and thus that they can outsmart the markets. The picture we see isn't the sophisticated elite among plan participants on one side and the clueless masses of rubes on the other. It's participants of widely varying "sophistication" encountering very much the same set of problems: excessively expensive, under-performing investment choices; emotional whipsaws; and inertia.
One of the dominant themes in the Levitz piece is the role of annuity-based products in the West Virginia defined-contribution plan. This is ugly stuff:
From the start, most employees favored the annuity. Some say they were swayed by [AIG unit]Valic's sales force, which included former educators and school employees who went into the schools during the workday to talk about the option. "These people came during your lunch or during your planning period basically to sell the program," says Debra Elmore, a third-grade teacher in Ansted, W.Va.
Ms. Elmore acknowledges knowing little about investing. "Oh, Lord no," she says. "I had no idea." She set up her account so that 85% of her contributions would go into the fixed-rate annuity. "I just thought, 'Well, these are safe. Let's stay there.' "
"Safe" being a decidedly relative term, apparently. Later in the story, Levitz notes that at one point, more than two-thirds(!) of plan assets were invested in a fixed-rate annuity. But wait. There's more:
AIG spokesman John Pluhowski says the insurance company hires former school employees to sell its products to schools "because the education market is important to us; educators know the needs and concerns of educators." He says the representatives were "not authorized or directed to give investment advice; they were only authorized to sell a fixed-annuity contract."
In other words, some former teachers know how to play to the fears--"concerns" is a classic Orwellian euphemism--of their former colleagues. Beyond that, here's Pluhowski uttering one of the industry's sorriest canards, that "selling" can be separated in any moral, ethical, or practical sense from the giving of "investment advice." Now, we're fully aware that that distinction has had the force of law for many years (in the distinction between brokers and agents who sell and investment advisors who advise). But let's leave the fine artificial regulatory distinctions aside for a moment, shall we? The fact of the matter is that some degree of investment advice is always and forever inseparable from selling. Does Mr. Pluhowski really think--do you think?--that his agents descended on Ms. Elmore and her colleagues and didn't utter a word of advice? "I think you should buy this because it's in your interests; just look at all these features and benefits." Isn't that a form of advice by definition? What's the alternative? "I want you to buy this because it's the only way my boss will pay me." That isn't advice, but it isn't plausible either. Not in this universe, anyway.
Later in the story, Mr. Pluhowski returns:
AIG denies wrongdoing. Mr. Pluhowski declined to specifically discuss the lawsuit or the current state investigation, but says, "We are confident we met the obligations we were contracted to provide." He declined to say how much employees were paid for sales of the annuities, but says that "no plan contributions were used to pay commissions." West Virginia's insurance commissioner investigated Valic's sales practices in 2002 and cleared the company, saying it had found no misrepresentations by Valic agents.
How many disingenuous arguments can one man make in a single Wall Street Journal story? We may be testing the limits here. "No plan contributions were used to pay commissions." Yes indeed. What that means is that when Ms. Elmore deferred $100 into her Valic annuity, she saw $100 appear on her statement. But...but, but, but...the super-generous commissions paid to AIG's sales force have to come from somewhere, right? And where would that be? From Ms. Elmore, of course, over time, as an implicit deduction from her potential returns. The consequence:
Ms. Elmore, 46, says she realized her disappointment in the defined-contribution plan when she received a letter from the state's retirement board in April projecting that, at age 60, she would have a big-enough nest egg to provide her with $1,571 per month for her life. By contrast, the letter projected, if she voted to go back to the defined-benefit plan, she would receive a projected monthly payment between $2,656 and as much as $3,050.
This form of deadweight loss, a consequence of near-monopoly power and consumer ignorance, is especially ugly because it's so enormously consequential and so easily avoidable. As ever, the moral burden is broadly shared: Plan sponsors, participants, and providers simply must do better.
Jennifer Levitz, "When 401(k) Investing Goes Bad," Wall Street Journal, August 4, 2008