June 2012

Fundamentals of Private Pensions Roundtable Interview

Fundamentals of Private Pensions was first published in 1955. Since then it has been utilized on the exam syllabus and as a helpful resource for pension related issues. The SOA recently spoke with Mark Warshawsky, Olivia Mitchell and Bob Sanford about the history of the book, its usage and the upcoming tenth edition.
Download a copy of the interview.

Mark: I’m Mark Warshawsky, director of Retirement Research at Towers Watson. My involvement in the book project is that I am one of the co-authors of the ninth edition. I led the effort for Towers Watson in terms of bringing together the authors and other resources, setting the new outline for the book, and establishing the timetable so that we could get the ninth edition, which is the current edition, out in a timely manner.

Olivia: I am Olivia S. Mitchell, director of the Pension Research Council. The council is a research center at the Wharton School of the University of Pennsylvania that was founded by Dr. Dan McGill in 1953. With a great deal of help from others, we have spearheaded the process of keeping Fundamentals of Private Pensions up to date, collaborating with wonderful people such as Mark and his colleagues.

Bob: I am Bob Sanford. In terms of my relationship to the book, I'm the curriculum chairperson of the SOA education system and a past chair of the curriculum committee for the SOA’s retirement track. We've used the text heavily within the retirement track over the years. Also, I've been in this business 30 years, so I have studied this book as a student; I've used it as a practitioner; and I've seen many updates of the book on SOA curricula for actuarial exams that have been given over the years. That is my familiarity with the book.

Kathryn: Please tell us about the history of the book, Fundamentals of Private Pensions. We understand the first edition was published in 1955.

Olivia: Let’s turn the clock back to remember what the U.S. economy looked like back in the 1950s, a time of substantial growth in corporate pensions. During World War II, pensions had spread rapidly because of Supreme Court rulings and also because benefits were introduced as a key component of compensation during the wage price control period. Yet, though pension coverage and expenditures had become widespread in the American economy, there was very little written about them. Professor Dan McGill, my predecessor at the Wharton School, was prescient in taking on the task of writing one of the first books about American pensions.

In putting together the first edition of Fundamentals of Private Pensions, McGill recognized that many different stakeholders in the retirement security world would benefit from understanding the history, actuarial and legal structure, and economics of corporate pensions. Moreover, he wanted to teach the next generation about the fact that pensions are a microcosm of everything finance, economics, and human resource management. After he wrote the first edition and it proved popular, the book was then updated and revised whenever a major piece of pension legislation was passed. The goal was to provide students, actuaries, plan sponsors and policymakers a chance for “one-stop shopping” for everything pension-related. That takes us to where Mark Warshawsky came into the picture for the 9th edition.

Mark: Well, actually I’ll take it back a couple of editions even before that, based on my knowledge of what occurred. In the sixth edition, McGill added a co-author, Don Grubbs, a well-known actuary. This was important because the actuarial material in the book is very significant, in terms of the funding rules and some of the legal issues, like the qualification rules. Then, in the seventh edition, Towers Watson (or actually our predecessor company, Watson Wyatt) became very heavily involved, and there were several co-authors added: John Haley, an actuary; Syl Scheiber, an economist; and Kyle Brown, an attorney—all at the tops of their respective professions in the pension area. They did both the seventh and eighth editions, and, as Olivia indicated, they personally represented the eclectic nature of the book, and contributed to the growth in the book.

Scheiber added the economic dimension. Brown covered a lot of developments on the legal side, and Haley followed up on the developments in the actuarial field and actuarial rules. That takes us to the ninth edition. I was brought on, with my economics and government background, including the development of the Pension Protection Act of 2006, to join the co-authors. I feel very proud to be a part of the book project.

When I was starting out as a young economist interested in pensions, I relied heavily on this book, not only as a textbook, but as a reference book. I think a lot of people use it for that purpose as well. If you want a fairly quick or a fairly understandable description of, let’s say, how the non-discrimination rules, which are very complex, work or how the basic funding rules work, Fundamentals serves that purpose very well.

Olivia: I would also point out that this book is widely read, not only in the United States, but also elsewhere. Our Canadian counterparts find it of interest, as do colleagues in Latin America and Asia. This is because when anyone needs to understand what it means to have a funded pension and how to design it, the fundamental notions and structures are the same the world over. Naturally, one must adapt pensions to the local legal environment. But the book has been translated into Japanese and Portuguese; I hope to see the day that we can also translate into Chinese.

Bob: Building on what Mark said, one quality of this textbook that I think makes it stand out is that it strikes a wonderful balance between technical content and content that can easily be understood by a non-practitioner. I've even used it and seen it used by others in situations when you're working with a client, an HR manager or a finance manager, who just wants to study up on why things are the way they are. If you want to go into the details of the regulations, you can do that with the book, but the book also gives you a nice layman’s context for a lot of the things we deal with as pension professionals. I've seen the book used a lot in that regard.

Kathryn: That leads us into question number two: What is the involvement and use of Fundamentals by the actuarial profession?

Mark: I’ll begin, but I think it would be great for Bob to add his thoughts here as well. There are several purely actuarial chapters, and they have changed over time in line with the legislative and regulatory changes. The actuaries have made sure that those chapters are technically correct and also give the motivations behind the rules, particularly focused on the funding rules. So there's a discussion of actuarial cost factors, funding rules for both single and multiemployer plans, and then really a very nice chapter recording of the historical development of the financial accounting for pensions. This latter chapter is a great resource for understanding how, over time, from the ’50s through the present, financial accounting for pensions has developed; this is another actuarial chapter.

Bob: There are two core retirement practice area SOA exams that candidates must get through to attain the FSA designation, and the McGill Fundamentals book is used heavily on both of those exams. In prior years, it has also been used in the SOA’s e-learning modules where we want to give student actuaries, who may end up in any one of the tracks that are offered, a flavor of what's going on with pensions. The book has been used extensively throughout the education system.

One thing that was very notable to our committee in 2011 was that we undertook the task of having an outside expert look at our retirement track syllabus. We engaged the services of an economics professor from Williams College to get someone from the outside to see if he thought our syllabus was manageable, relevant and in accordance with current economic principles. He did review the economic content of the syllabus, but, in addition, he looked at our syllabus from the perspective of a professor and an educator. He commented on how well the material is (or is not) organized, the amount of material covered, etc. The result of his review was that he recommended replacing a number of articles and short study notes that we had on the exams with chapters from the Fundamentals book. It was his opinion that the text does a better job of presenting the material to candidates, particularly with respect to the investment material on the syllabus. He was a real fan of this book.

Mark: That's good to know.

Kathryn: Olivia, I know you mentioned that the book has been translated into some other languages, and it is great that it’s being used globally and internationally. I know Bob mentioned using it with HR managers, but are there other people outside of the actuarial professional who use this book?

Olivia: Indeed. I have assigned chapters to my benefits classes, and to my doctoral students needing to know about pension design and structure. Several other college professors use it in teaching as well. These students need to understand the role of retirement plans, why employers find them attractive, how employees benefit from them, and how policy can make them work or harm them. Many of the younger students I meet today have only ever seen a 401(k) plan, and yet when the MBAs find employment in firms with defined-benefit plans, they will need to understand how to manage the risks and benefits from such plans.

Mark: One other sector that I'm aware of—admittedly not a very large group, but an important group—is folks on Capitol Hill and in the Washington policy environs, both in the regulatory agencies and in the legislative branch. Very few people come in as experts on pensions, but there are a lot of people—maybe staffers for a committee—who need to know about pensions because legislation is being considered and they're thrown into the mix suddenly. This is a nice text if they need to get up to speed very quickly. I know it’s been used in that context as well, over the years.

Bob: This is really a question instead of a comment, but maybe Olivia or Mark would know. Obviously lawyers have to have some knowledge of ERISA law, and accountants have to have some knowledge of pension accounting. I would be curious to know whether Fundamentals is part of the syllabus for the CPA or bar exams.

Mark: The one thing that's somewhat related to that is Kyle Brown, who has been one of the authors now for the last three editions, has taught ERISA in law school as an adjunct professor. I know he has used the text in his course.

Kathryn: What's new in the ninth edition?

Mark: As Olivia indicated, one of the emphases of each new edition is the passage of a new piece of major legislation. In this edition that certainly is true: the Pension Protection Act (PPA) of 2006 was passed. It was indeed a very major piece of legislation, not just in regard to the funding rules, which were totally revised, but there were a lot of provisions relating to hybrid and defined-contribution plans, particularly the automatic enrollment movement I think got a big boost. Qualified default investment arrangements also got a big boost through PPA. There were also a lot of changes in the multiemployer plan rules. All of those changes were reflected in the text, so it was a major rewrite on everything in terms of the legal environment and the funding rules, as well as an explanation of the economic motivation for the changes.

I'm very gratified to hear about the approval of the professor from Williams College on the investment chapters, because those were also completely rewritten. Not really a criticism of the past chapters, but they needed significant updating in the sense that there had been a lot of developments in the reality of investments and strategies for retirement plans, both for defined-contribution and defined-benefit plans, as well as in the theory of investing for retirement plans, which had grown enormously in the professional literature. We basically added three chapters.

Another change is that we added a lot of material to the chapter of the book that focuses on the question of how defined-contribution plans should operate in terms of paying out benefits and how participants might face that choice in terms of the question of distributing retirement account assets. In the academic literature, it’s called the annuity puzzle: why people don't purchase annuities or if they should.

Overall, all the data and statistics were updated through the year before the publication. We edited, sliced and diced, removed some material that had gotten a little old, and added new material. Kyle Brown, who is the author of the legal sections, did major revisions, particularly discussing the hybrid plan issues that have been very active in the last several years.

Olivia: I would add that the last chapter offered a look ahead at the future of pensions, including the outlook for baby boomers. In new editions, we may try to expand more on these themes.

Kathryn: That leads us into the next question: What are the plans for the 10th edition—the who, what, when and where?

Mark: We haven't exactly finalized plans for the 10th edition, but Towers Watson has committed to continuing its support. We're having some internal discussions among authors—John Haley; Olivia, replacing Syl Scheiber; Bill Belanger, replacing Kyle Brown; and me—as to how we might change it; therefore, what I say here is quite tentative.

But one major change, again reflecting the underlying changes in the retirement system, would be a further reflection of the movement away from defined-benefit plans to defined-contribution plans, as defined-contribution plans themselves have developed over the years. I think that would be a shift in the book but without taking away the essentials of the defined-benefit part, which are still very valid and relevant, and serve as a very important function of the book. So this is just a change in emphasis to reflect the reality of what's going on there in the field.

Olivia: The tension has always been between wanting to be encyclopedic, versus wanting to make sure that somebody can pick the book up. McGill’s first edition was only about 200 pages, and now its north of 800 pages. We must also recognize that students today are different: they're somewhat less likely to pick up a book, and they are more likely to go online or download a text to their e-reader. For this reason, we're pondering how to reconfigure the book, perhaps divide it into two volumes, or perhaps structure it in an electronic format. Bob, do you think the people that you come across would be amenable to an e-book version?

Bob: Yes, I think that people would be very much amenable to e-books. In terms of SOA candidates, there is already syllabus material for the exams that is available by links to online sources. We even have links to media such as webcasts and podcasts that are becoming part of syllabus material; thus the movement away from the printed page is definitely happening.

Olivia: Of course we must also discuss the options with our publisher, Oxford University Press. I would also like to see more discussion on international pensions and pensions for multinational firms, as our readership grows more international. Moreover, there are some very interesting pension models that our stakeholders could be appropriately exposed to, so they have an informed view of some of these alternatives.

Bob: The need for good international material is actually a current need of the syllabus committees. We're always trying to include that content on the exams, and mostly what we find as syllabus sources are consultant articles that are likely written based on a project that a consultant did. Some international content that is a bit more pedagogical would be very helpful.

Mark: I think that would be a great addition. In fact, as Olivia mentioned, we did add in this edition a chapter on the future of pensions. If we were to develop that further, in particular to have that background of what's going on around the world, that represents a great learning laboratory as to what other countries and other systems have done.

Olivia: I would also like to point out that Mark’s firm, Towers Watson, is global in scope.

Kathryn: The final question that we have here is that there's been a lot of controversy, particularly in public pension plans as of late, and we're just wondering how you address an issue like that when the industry is still trying to come to a consensus on these issues.

Mark: Directly answering your question about public pension plans: The book is consciously devoted to private plans. We mention Social Security as a relevant part of the system—for example, many private plans are integrated with Social Security so you need to have a very good understanding of Social Security; that's Chapter 2 in the book. I believe in that context we very briefly mention public plans, but we do not really take them on; they're a subject in their own right.

But I will say with regard to your broader question of how we deal with controversial issues and the question of consensus: If there's a sense in the profession and in the literature that there is a tendency toward a primary viewpoint or a consensus, that's what we’ll include in the book. I think the authors have had a good sense of that over the years. The book is reviewed by outside practitioners and scholars, and so they keep us on the straight and narrow. If there's an area where there is still controversy, we’ll reflect that; for example, there is still controversy within the actuarial profession about the appropriate discount rate to use in valuing a pension, and so we mention both sides of the issue. I'm sure Olivia and Bob would have more to say.

Olivia: Indeed, one area where there is substantial controversy is regarding how to do pension accounting. The Europeans do it one way; we do it a different way in the U.S. corporate environment; and state/local governments do it a third way. Accordingly, this is an area where we will have to scope out the key similarities and identify some of the differences. This will provide a strong foundation if someone were going to work in Europe on a corporate pension regime; in any event, they would still need to pay attention to not only the accounting rules in that country but also the tax issues and other conventions. So we are not global in scope, but the book does have a lot to teach the rest of the world.

Bob: In terms of how we address controversial issues in the syllabus material and the exams themselves, we actually welcome taking on these issues. People who are writing questions for the exams are always trying to come up with new question ideas. Current, relevant issues within the profession can provide a nice context for good exam questions. Mark mentioned the discount rate issues; these issues have been discussed as they relate to private plans for longer than they have for public plans. The issue of how or if the asset structure supporting the plan should affect the selection of a discount rate is an argument that continues to churn within the actuarial profession. There definitely have been past exam questions that ask the students to think about these issues and evaluate the arguments around them. We generally provide material in our syllabi that gives both sides of the issue. Similarly to what Mark indicated, if there's a primary school of thought within the profession as it relates to a specific issue, we will emphasize that conclusion in the syllabus. Where there is brisk dialogue around both sides of an issue, we find it very instructive to include it and think that exposure to a variety of viewpoints will make our candidates think critically and ultimately be better professionals.

Kathryn: Those are all the questions that we had. Is there anything that anyone else wanted to add, something that we didn’t ask or that you think is important to note about the book or to include?

Olivia: One last thing I would like to note is that my research has shown a widespread dearth of financial literacy around the world, a particularly critical gap in the wake of the financial crisis. In the 10th edition I hope we provide much-needed help to fill the gap in terms of making sure the next generation can understand the value of pensions in a very uncertain world where we will all be living a very long time in old age!