“What is truly distinctive about American social provision,” political scientist Jacob Hacker once noted, “is not the level of U.S. spending, but that so many social welfare duties are handled by the private sector, rather than by government.” One reason this is so: the Employee Retirement Income Security Act of 1974, which has been remarkably successful at enshrining private responsibility for America’s corporate pension and health-care benefits. ERISA ensures that employer-benefit plans are robustly and transparently funded, that firms are liable for the cost of promises they incur, that workers’ rights to benefits extend beyond the whims of administrators, and that state laws cannot erode benefits due to employees. But the law has come under increasing attack from politicians who see it as an impediment to the establishment of single-payer health care, as well as from those who want federal taxpayers to subsidize overextended union pension schemes.
Employer-sponsored benefits have been a tax-deductible business expense since Congress established the corporate income tax. When World War II broadened the reach of personal-income taxation (from 6 percent to 69 percent of the U.S. population) and hiked top marginal rates (up to 94 percent in 1944), health insurance became appealing as a tax-exempt method of compensation. Meantime, pensions enabled workers to defer income to retirement, when they would be in a lower tax bracket. From 1940 to 1970, private pension coverage surged from 4 million to 26 million workers, while health-insurance enrollment soared from 12 million to 175 million. After the war, unions made employer-sponsored benefits the focus of their collective-bargaining efforts, and employers were happy to defer worker compensation into retirement.
But defined-benefit pensions—which make regular payments in retirement at pre-determined levels—held individual workers hostage to the whims of plan administrators, left them without legal rights to protect their benefits from misallocation, and meant that they lacked vested rights to benefits when they left the firm. This led to scandal: Teamsters Union leader Jimmy Hoffa used pension contributions as a slush fund, distributing loans to friends and associates, allowing them to claim exorbitant administration fees, and steering illicit payments to politicians, journalists, judges, and mobsters.
Defined-benefit plans were also typically underfunded. Though federal tax law required businesses to fund pension liabilities associated with current employment, it failed to credit them for fully funding pensions associated with past service. Unfunded liabilities became particularly problematic for firms struggling economically, as maturing pension obligations loomed large relative to declining revenues and workforce contributions. In a well-publicized incident, the collapse of auto manufacturer Studebaker left 7,000 newly redundant workers to learn that the pensions promised to them had largely been wiped out.
Confronting the prospect of widespread pension shortfalls as the 1973 oil crisis caused stock values to plummet, Congress enacted ERISA in 1974. While it doesn’t require firms to provide pension or health-care benefits to workers, it establishes rights and duties for all tax-preferred “employee benefit plans.”
The legislation set minimum funding standards for employer-sponsored pension plans, established fiduciary duties for plan sponsors, and regulated their investment decisions. It gave workers a right to participate and to receive information about plan finances and specified the conditions under which they may retain benefits after switching employers. Furthermore, ERISA required defined-benefit pension plans to purchase “plan termination insurance” from the Pension Benefit Guaranty Corporation (PBGC), a federal agency that becomes responsible for paying insured benefits (up to an insured cap) if the plan’s sponsor runs into financial distress. As a result, the share of defined-benefit plans with assets exceeding liabilities rose from 25 percent in 1978 to 84 percent in 1987.
By requiring firms more fully to bear the costs and risks associated with defined-benefit plans, ERISA gave defined-contribution pensions—whereby benefit levels depend on the value of funds invested—a competitive chance. The legislation also established Individual Retirement Arrangements, which let individuals contribute up to $6,500 tax-free per year into a retirement account and laid the groundwork for the development of 401(k) plans, which now allow up to $22,500 to be deposited into tax-deferred accounts annually.
Defined-contribution plans are inherently fully funded and transparent. They can provide control of investment choices to the employees who stand to gain or lose from them. Accrued balances in defined-contribution accounts follow workers from job to job, don’t bind them to employers for whom they no longer wish to work, and don’t push them out of employment before they want to retire. They have also proved popular with newer businesses that want to avoid overhanging pension liabilities. From 1975 to 2020, while defined-benefit enrollment fell from 33 million to 32 million, participation in defined-contribution pension plans rose nearly tenfold—from 12 million to 110 million.
Yet fewer than half as many state and local government employees have defined-contribution plans as have defined-benefit plans. Exempt from ERISA’s funding regulations and accounting standards, state and local governments have incurred unfunded pension liabilities of $6.5 trillion in 2021—with funds covering only 44 percent of the benefits promised to their workers. It is likely only a matter of time until this becomes a major crisis.
Defined-benefit plans established in collective bargaining with multiple employers have run into similar trouble. Organized labor secured lower funding requirements and PBGC premiums for multiemployer plans (typically a single fund managed by a union for workers across several businesses in an industry), claiming that these were less subject to termination risk due to the bankruptcy of individual firms. But multiemployer plans are no less vulnerable to declines in the overall profitability and size of an industry. From 1975 to 2020, 59 percent of PBGC claims were for airline, primary metal, and auto workers—even though these represented only 1.5 percent of U.S. employment in 2021. Whereas assets of single-employer defined-benefit plans covered 83 percent of liabilities in 2019, those for multiemployer plans covered only 44 percent of benefits promised.
Current Teamsters Union president James Hoffa Jr. made a federal bailout for multiemployer pensions his main priority in the 2020 election. Following a Democratic sweep, the American Rescue Plan Act provided an estimated $94 billion in general revenue funds for the purpose. Yet, establishing such open-ended assistance without governance or funding reforms will only encourage multiemployer defined-benefit plans to make increasingly risky investments to inflate benefit promises, while reducing the need to fund liabilities fully in case investments don’t work out.
Though ERISA was originally viewed primarily as reforming pensions for retirees, it has also had a major impact on health insurance for current workers. Section 514 of ERISA declares that it “shall supersede any and all state laws insofar as they may now or hereafter relate to any employee benefit plan.” Subsequent Supreme Court rulings have held this clause to preempt any state laws that alter the shape and administration of self-insured, employer-sponsored health-care benefits.
Unions had originally pushed for ERISA’s strong preemption of state legislation, due to concerns that state taxes may chip away at negotiated benefits. But businesses quickly embraced the legislation: it gave them control over benefits and eliminated the need to craft different benefit systems in every state in which they operate.
Often motivated by hospital protectionism, most states have enacted laws restricting the sale of cost-effective health insurance while forcing coverage for hospital and physician services to pay for visits to chiropractors, dentists, psychologists, and optometrists. ERISA allows large employers to avoid these strictures, enabling them to develop newer, more efficient methods of procuring medical care. Walmart and Lowe’s have set up national centers that provide joint-replacement surgeries to their employees without out-of-pocket charges, and other businesses have used ERISA to fund on-site medical clinics for their staff.
Three-quarters of Americans with private insurance (135 million) were covered by ERISA health plans in 2017. For decades, governors have been frustrated by the impediment ERISA poses to their ability to tax health-care benefits. Indeed, by preventing states from diverting employer funds into their own coffers or commandeering plans through regulatory micromanagement, ERISA has served as a key obstacle to the establishment of single-payer healthcare.
Might all this change? In 2020, the Supreme Court chipped away at preemption by upholding an Arkansas law that established a floor on reimbursements which their Pharmacy Benefit Manager (PBM) contractors were required to pay to pharmacists—essentially mandating a broader network of providers. This has encouraged 39 states to enact new laws regulating PBMs since 2020. Some argue that further eroding ERISA’s preemption of state health-care law could constrain health-care costs. But lobbyists for medical providers, who dominate state capitals, would likely use additional regulatory power to increase their revenues.
As with pensions, the segments of the health-insurance industry uncovered by ERISA fare poorly—especially the small-group and individual markets, both currently subject to unlimited regulation by states as well as the regulations of the Affordable Care Act. But ERISA’s principles offer a solution: employer-provided healthcare funds should be placed under individual control, as with defined-contribution pensions. And those individuals should be free to purchase insurance that remains, as ERISA plans do, exempt from their home state’s costly regulations.
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