Carrying the Risk

Risk is a big issue in careers.

It enters into labor negotiations as each party attempts to move the risk to the other party. Public sector unions in North America were successful during the late 20th century in assigning pension risk to the employer, but the pendulum of the 21st century appears to be swinging the other way.

The two competing models are defined Benefits and defined Contributions.

Defined Benefits plans assigned the risk to the employer. If the pension plan fails to generate enough money, the employer has to make up the difference. What this means is that employers must pay a large amount of money out of their operating funds into the pension plan to make up for the shortfall in earnings. These payments are an unplanned increase in the organizations’ labor costs.

Defined Contribution plans put the risk onto the employees. Employers are not responsible for addressing this variation; the risk is carried by the employees who must adjust their post-retirement standard of living to fit the money available.

In Canada during June 2011 two large-scale strikes are underway: Air Canada and Canada Post. A major issue in these negotiations is identifying which party carries the risk for pensions. Each party wants the other to carry that risk.

Across the USA, many states are redefining their contracts with public sector employees. A major theme in these negotiations or legislated contracts is moving the pension risk away from the employer and to the employees.

As with many financial questions, debate on these issues cites standards of fairness.

  • Are employees deserving of a defined benefit when it imposes a burden on employers?
  • Does it make sense for organizations to devote much of their operating budgets to support retired employees?

One party often absent from the discussion is the investment managers. The shortfalls in defined benefit pensions generally signal a shortfall in investment performance. The concept of a defined benefit plan is that the math should work to produce sufficient funds to provide the pensions. A shortfall in a pension plan means that the investment managers were wrong about the necessary level of contribution or the investment strategy.

Too often the problem is described in terms of employees’ unreasonable expectations rather than investment managers’ underperformance.

Whatever your values or perspective on fairness, an important long term career issue is managing risk.

A few key points:

  1. Nothing is free of risk: your defined benefit pension plan could go insolvent, converting it by default into a defined contribution plan in which people share whatever remains.
  2. Individuals and organizations have a limited amount of control over the amount of risk they will carry. Pensions are defined through negotiations among parties. Neither side fully controls the agenda. Individuals have to go along with what is negotiated.
  3. Creativity and flexibility matter. Maintaining a lifestyle that allows some breathing room is a lot more relaxing than living at the limit.
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