Rani Issac's "The Philanthropist": An Odd Little Text

Isaac’s concern is the concentration of wealth to top earners (and the preservation of generational wealth passed down through families). In this book, she takes on this issue by fictionalizing the future and making a story through the eyes of a member of one of the richest families. In the book, the representative character of the rich has second thoughts about the economic system and her place in it. She secretly attends school and through the teachings of a mentor who knows the past better than she does, she is able to see through the edifice that was built by her family and class for their own self-perpetuation, and see that instead her high status means lower status for so many.

Through some machinations, the main character is able to make some changes and release funds out to the world - basically she dissolves her wealth and the family foundation that was part of how she controlled so much capital.

I’m sympathetic to Isaac’s position. The concentration of wealth at the top is a real issue these days, as explained by both the authors of the “Spirit Level” and more recently by Thomas Piketty in his widely-purchased but little read magnum opus “Capital”. What strikes me as unworkable is that the vision of the future finds that this issue will not be resolved until those who have made the accumulations decide that it is in everyone’s best interest to do what is against their short term self-interest. So despite heroes of capitalism like Gates and Buffett pledging to give away their wealth, there are those who are fighting tooth and nail to eliminate estate and gift taxes. If the problems of capitalism are dependent on the beneficiaries of capitalism to solve them, then the issue will not be solved.

A further issue is the format that Isaac takes. I’m not sure if the fictio format is the best angle for her argument, The book is short and tries to pack a lot in its few pages, but it is lacking in character development. The narrative voice doesn’t help, it’s a close third person past, so it has this weird clinical detachment where we are told and not shown things. The author shows her familiarity with stringing together a proper sentence, but lacks in the verve necessary to tell a compelling story.

Kunkel's "Utopia or Bust": Made Me Want to Read and Write More

When I first heard that Jacobin and Verso were teaming up, I was super-jazzed.

They offered six books for fifty bucks around the Christmas of 2013.

I was like that meme of Fry where he’s saying “Take My Money!”

Basically, I have achieved a level of material success where I still have revolutionary desires and our household income is a bit more than the US household median income. So I have a need and a desire to give the money to the revolutionary presses that I can fulfill. My favorite thing is to sit on my couch and read and drink beer. I often read of revolution, and I can help create a future where the workers of the world, who once united, can lose their chains and drink beer and do their own reading. Verso and Jacobin will help facilitate that.

So I bought the books through the publishers, and ended up with the first batch. I read the other two books right quick, but for some reason I let this one sit. I think I had tried to read it once, but I was sad at the the structure of <add introduction + previous essays = book>. I put it down and on my shelf, even though I had not read any of the essays previously.

But last weekend, I picked it back up. The essays in the book are about writers, for the most part, that I admire or have read. There are a couple of ones about unfamiliar writers to me, so I can’t make a judgement on them, since I only know them through Kunkel’s lense. But the ones that we cross over the things I’ve read and he’s read, show the writers I like in a new light and made me think more and broader and deeper about them. His essay on David Harvey illustrates this - it just helps put my own reading of Harvey in context of other thinkers.

Here’s the best thing about the book. It broadens my horizon, in that I want to read more about the people who he talks about but am only tangentially familiar with. I guess it’s time for me to put Fredric Jameson on my reading list. But the real best thing is that it makes me want to write more just by engaging in the ideas that the author engages with. Kunkel is a clear and exact writer that holds the attention even when writing about  unfamiliar subjects.

The Making of a Manager

I sometimes think of essays I want to write, and bounce them around in my head a bit, but I never actually get down to writing them, because who has the time to write an essay for fun with no possibility of compensation.

One of the prompts I wrote to myself was “manager”.

I’m not sure of the basis for it. I think it was part of my MBA program. We have been taking in various classes about leadership and people that you want to follow and how you become that person. It might boil down to who you want to work for, so this is all subjective. For me, it is hard to look at the good qualities that you want. Like a movie or a book you like, it is hard to say why some people are easier to work with and for, but it is easy to think of bad examples. I had a boss that was petty and capricious and incapable of doing any of the jobs that he nominally supervised without getting in the way. When I think of bad bosses, he fits the bill.

It is harder to think of the opposite. I want to work for someone who is not those things I listed. I have been fortunate to work for some good supervisors in my career, so to really say there is one best is hard. Luckily, my first boss was someone who I was glad I worked for, even though the job itself was something that is often denigrated. My first real job was at Burger King, Well, I’m sure it was technically for some franchise, but I forget the name on my checks and told people the name on my uniform.

My first boss was Mike Devericks. He was young and enthusiastic. There were open interviews for the new Burger King that was opening up at what was then a blank space on the map but turned into a busy shopping area once the new Walmart went in. As I remember, the interviews started at 8:30 on a Saturday, and I had nothing to do and family that was strongly encouraging me to get a job. I made it a point to be there as early as possible, and I think I was the first one interviewed.  What I am certain of is that Mike was the first person to offer me a job where he stood up and shook my hand.

In the scheme of things, it was a summer job, but I tried to have pride in what I did, making those Chicken Sandwiches and BK Big Fishes, and making sure the fries were always on supply, and that the chicken tenders were not to old to be served to the customers. I liked the people I worked with, and I learned to smoke at least three cigarettes in the thirty minute lunch break while eating food. They key was remembering which hand was for drinks and which for the smokes.

But the thing is that though I could work by myself or with the other fry cooks, there were times when there was no way we could keep up. The orders would go up on the screen with a timer on it to tell you how long they had been on the screen and they would start blinking if they were too old. I have a memory where Mike stepped in right as panic began, and looked at the screen and knew how many buns to drop and how many fries and just took over. I had thought I was good at the position, but he rocked it.

And that is what I want in a manager. I want the person above me to allow me to have the autonomy to learn my job and work it to the best of my abilities, but be able to jump in and help me (and my team) when I need help. Additionally a key trait is to know when that is, because sometimes people don’t realize how far they are in over their head. It may have been a summer job, but on reflection, it was an important lesson on leadership.

Goldbugs: Occam's Razor and Value

So, it looks like gold is trending down. Even the Journal published an article calling gold a pet rock.

This makes me think about my father, who over Christmas made me feel his ingots of silver, and who listens to a lot of Fox News in his free time. I have to tell you, holding that silver gave me some very strange feelings. It was shiny, yes, but the thing is that it was very heavy – much more than I would have guessed just by looking at it. There’s a very atavistic feeling satiated by holding that density that is hard to replicate.

But that doesn’t really speak to value. It is shiny and heavy, but what is it worth? There’s no future cash flows to discount. There’s the well-known issue that there are no dividends and a carrying cost. Basically it is a hedge for when the world crashes. Right now, what is it worth? Whatever the next guy will pay you, since it at least has some use value. Looking at the CME, what the next guy will pay is around twelve hundred bucks an ounce. That’s off from what it was at the height of the last time everyone was buying in gold by like a third. That’s a lot.

Hold on. That’s a lot if you’re buying and selling it, hoping holding it as part of your portfolio.

What’s gold worth now is assuming that its continued use value and the speculative part will hold forever, with no major changes in demand or supply. But what if demand changes? That means the gold held will increase in value if it goes up. What can make demand change? A change in the financial climate. It can be held as a hedge against what the preppers et al call “When the shit hits the fan”. Now, I am skeptical of all the collapse scenarios that I have seen on “Doomsday Preppers,” but here’s the thing – what do we know of the chances of total societal collapse and ultimate valuelessness of the dollar? There’s not much to go on. I would say it’s a one in whatever chance, where the goldbugs and the preppers and etc would say that I was off by a factor of ten or a hundred. The problem is that neither of us have much to go on. The sample size of societal collapse is small, and not very good for making predictions.

So here’s the thing. No matter who’s right, they still have something that they can trade for things as itself or if converted to the coin of the realm first. But there’s a huge payoff if they are right. (This ignores the whole weird fantasy thing where it seems some people want society to collapse just for their vindication.) I’m not willing to make the bet, but I shouldn’t judge others who are. Heck, I still play the lottery when the jackpots get big – someone’s gotta win it. It just goes to show that consistent rationality is hard to enact, especially when it comes to long odds and big numbers.

Johnathan Crary's "24/7"

Twice while reading this book, I was asked how I was liking it.

The first time, I told the teller at the bank that it was a little theory heavy. I’m not sure if she knew what I was talking about, since she didn’t respond.

Then my wife asked, and then my narrative was already set in place.  I told her the same thing.

And I’m telling it here a third time. I was expecting a little hotter and brighter, but there are references to postmodern theorists that I am familiar with but haven’t read and other texts I’ve heard about and haven’t experienced. So it wasn’t what I was looking for, so I cannot detract from it too much for that. It is just another nail in the coffin of capitalism if we can ever get that squirmy beast to stay down.

You have nothing to lose but your chains, and a whole world to gain.

Price Setting with Inelastic Demand: An Ethical Approach

Introduction - Overview of a Global Business

The modern pharmaceutical industry came of age with the growth of chemistry as a science. Though healing compounds can be traced back millennia to various civilizations in Europe, the middle east, the Indus valley and China, there was no formal or systematic approach to developing new healing compounds until the rise of capitalism and the industrial revolution. The industry as we know it rose out of the german dye manufacturing companies in the late nineteenth century. With the development of compounds to treat a variety of symptoms and diseases, along with new imaging technology in the x-ray and the germ theory of disease, the science of pharmacology is a rather new science in the scope of human existence.

Though it is relatively new, it is very large. The World Health Organization explains how large it is on their website: “The global pharmaceuticals market is worth US$300 billion a year, a figure expected to rise to US$400 billion within three years. The 10 largest drugs companies control over one-third of this market, several with sales of more than US$10 billion a year and profit margins of about 30%.”  These large companies are largely American or European, and they sell many of their drugs to americans and europeans and the Japanese. In fact, the same site notes that the companies spend roughly one third of their sales revenue on sales and marketing - more than double the amount they spend on research and development.

This paper will focus on the decisions that just one of these companies has to make. Gilead science is a biotechnology drug firm located in Foster City California. In 2014, the company enjoyed revenue of almost twenty five billion dollars compared to just over eleven billion the previous year.  (financials 10-k).  What drove this increase? It was the release of a new treatment for hepatitis C, called Sovaldi. This drug is a breakthrough in treatment, and it is priced as such. Sovaldi is available as a twelve week treatment that is a daily pill. It is effective in treating 90% of Hepatitis cases. It also costs whoever is paying for the treatment a thousand dollars a pill. That means it cost the payer $84,000 in the United States. That price is the process of a deliberate set of choices in the decision making process.

Problem Statement - What Challenges in Organizational Design Exist in This Business

Though a thousand dollars a pill sounds as if it was an arbitrarily chosen price that is not true. Internally, the company should have to balance a lot of factors with their pricing decision, if they were using a rational model of decision making. A firm will look at the costs and the potential market of the drug to set pricing. In terms of Hepatitis C, the centers for disease control estimate that there are 2.7 million people living with chronic Hepatitis C in the United States. Most are unaware that they have the disease, Many of these people will develop chronic liver disease, and be in need of a new liver at some point down the line, if they can get one (CDC). This means that there is a ready market for a pill that can essentially cure Hepatitis C. With the advent of wiser health coverage under the Affordable Care act, many if not most of the people affected by the disease will have coverage that in theory should be able to pay for it. So in terms of a product, the demand side is solid The other side to look at is the supply side. The government grants patent protection to companies who make new products. This patent is a temporary monopoly on a product, meaning that there is no other company that can legally make and sell the drug. That means the price setting decision in theory is internal. Again, the company should look at the costs here. This is easier said than done, as accountants can look at costs in several different ways and they all can be correct. In one sense of the term, the cost of the drug is just the raw materials cost. How much do the constituent parts of that drug cost, and there is the cost of the drug. The problem with this view is that there may be subsumed costs. The company has to run itself and sell the drugs. This cost Gilead almost three billion dollars last year (10K). The company has to do research on new drugs, the line item for Gilead’s R&D last year was just at three billion (10K). How do you allocate these costs? Are they part of the cost of Sovaldi, or are these the costs of future drugs? A recent study by the Tufts Center for the Study of Drug Development puts the average cost of the development of a new drug that makes it to market at almost 2.6 billion dollars. Gilead is right to recoup these costs, but finding the right cost for the drugs should go through the evidence based decision making process as described in Kinicki and Fugate’s “Organizational Behavior” First, the problem is identified, then internal evidence is gathered, then external evidence is gathered, then the views of the stakeholders, then all the views and data are integrated, and then a decision is made. This model  is will inform the basic outline of the rest of this investigation.

Causes  - A look at Stakeholders

The drug pricing decision does not happen in a vacuum. The medical delivery industry in the United States is enormously complex, with many stakeholders. It is also where a lot of the GDP is funneled to. Of the large economies in the world, the United States spends the most in terms of its economy on health care. The World bank estimates that as a nation over 17% of GDP was from health spending, only bested by tiny Tuvalu (World Bank).  Overall, there are five separate players in the drug pricing scheme that all can be looked at in terms of why the pricing is so high and informs Gilead’s decision on how to price the drug.

The first stakeholder is the Gilead itself. It is the one that sets the prices, and they are the easiest to look at and say they should do things differently. There is the fact though that they did go through the research and development and clinical trials (or bought a company that did), so they should be able to reap the profits from that work. The counter argument is that they have patent protection, and we don’t know what the marginal cost is of one pill. It is most likely less than a thousand dollars.

The second stakeholder  is the government, which plays a couple of roles in the medical infrastructure of the nation. First, it helps keep prices high as a regulator, making the company have to jump through numerous hoops just to gain regulation to sell the drug from the FDA. Then if a secondary use is found for the drug, the company has to go through more trials to prove that the drug that was already proved safe and effective for one treatment is safe and effective for another. These are the so-called “off-label” uses of the drug. There are a couple of notable examples of this. The drug known as Rogaine was first used as a blood pressure medication before it was found to be a hair rejuvenator (Our History). The drug Viagra was first used as a heart medication before it was found to have its more well-known properties (The Little Blue Pill that Could). The government makes the companies show that the new use is safe, and by putting up those walls, it increases the price of bringing a drug to market (Downsides).  Governments at all levels are also one of the biggest buyers of a lot of drugs. Theoretically, they could use that market power to bargain with the drug companies to lower their prices, but unfortunately through custom and statute, they often fail to fully bargain on price where they might be able to in a sad case of regulatory capture. The government also covers a disproportionate number of patients, because many people who suffer from Hepatitis C are poor. Many are also drug users. There is a perception that some victims may have gotten the disease from tattoos or sexual intercorse. This means from a political standpoint, these patients covered by the government are not sympathetic victims. They may somehow be perceived to have deserved their disease. That lowers the government incentive to treat them, especially at such a high rate.

The third stakeholder is are the insured people, particularly the ones who have the disease. Hepatitis C, especially the chronic and acute versions of the disease do not sound like enjoyable things to have.  The current treatments are more long term, and the even then the result of managing the disease for years is liver failure and the need for a new liver. Donor livers can be found, since a live donor can give up part of their liver and there is not 100% reliance on cadaver livers. Even then, the patient will still be at risk for rejection and will have to remain under treatment for the rest of their life. So it makes sense if the patient sees Sovaldi and its success and short time frame of treatment and they decide, “I want that treatment.” and through the structure of the healthcare market, they don’t know anything about how much things cost because there is no transparency in the market about prices. This is the demand side looked at earlier.

The demand would not exist without the mediators between the drug companies and the people with the disease. These are the doctors and hospitals, who prescribe the treatment. It is their job to match the patient with the proper treatment. Is Sovaldi for every patient, or are the maintenance drugs for even chronic Hepatitis a worthwhile treatment if and until it gets worse? This is a decision for a trained medical profession to make and for the medical infrastructure to enact. By connecting patients to Sovaldi, they help mediate between the supply and demand for the drug. If no physicians prescribed the treatment, then there would be no demand, and thus the price would not matter. So that even though it is much more effective than other treatments, the ones that have been out there longer are less expensive so might be more affordable and covered by the insurance companies.

It is these insurance companies are the final stakeholder to look at. These companies do not want to pay that sort of money because Hepatitis C, as seen earlier, is relatively common. If they paid the full list price for even half of the current Hepatitis C victims out there, they would have to pay $126,000,000,000. Which is a lot of zeros. The counter to paying the cost of the treatment now is that as a long term, chronic disease, the cost for treatment over time adds up. Further, many of these patients will eventually face liver failure and the cost of a liver and transplant and after care is over half a million dollars. There are other, more expensive drugs than Sovaldi, but most of the diseases they treat have relatively few victims.  This means that there is less outcry over the price by the insurance companies and the general public. There are fewer economies of scale, so a cancer with a multisyllabic name is anticipated to cost a lot to treat. Someone with a less sympathetic disease that is actually fairly common could be seen as less of a priority, especially if there are management drugs in existence. The bottom line for the insurance companies is the bottom line. They do not want to pay for any treatment that they determine to be in excess. With the price of Sovaldi,  this has already come into play. One example in the Washington Post was a patient whose physician had prescribed the drug on three separate occasions only to be told by the insurance company that they were not sick enough yet to receive the treatment (Who gets what). The patient’s very goal was to get the available treatment and to not get sicker, but the insurance company exists to pay for needed treatment. The only catch is that they get to decide what treatments are needed.

Ethical Considerations - What What possible solutions are available for the organization?

Within the organization, with all the stakeholders just looked at, the question is what price should be priced at. This is a hard decision to make because their product is one that can greatly enhance the quality of life for people who suffer from Hepatitis C. It can also save their life. Thus it is no ordinary product. In fact, it is a special case. In terms of drugs that can cure Hepatitis C, from an economic standpoint,  they are the sole supplier. There are other similar compounds on from other companies, so the time that Gilead is the sole provider will be short. This means that Gilead comes into a special  market with a lot of power. The market is special because there is a set amount of people who want the cure. Most students of economics should be familiar with the crossing supply and demand curves. The supply curve slopes up, where companies will supply more goods when the price rises. This meets the downward sloping demand curve, where as the price rises, some customers will drop out of the market. This is a special market case. Where most demand curves are upward sloping, like water in a desert, cures for fatal diseases have an almost unchanging demand. This means that the demand curve is a nearly vertical line in a situation known as “inelastic” demand. With inelastic demand, the three million people in the United States who want a cure for their Hepatitis C will continue wanting that cure no matter how much Gilead will charge them, and they will pay as much as possible. This gives Gilead a lot of power over those other stakeholders on their pricing, and it becomes an ethical decision that they have to make through the evidence-based decision making model taking into consideration all aspects of the variou stakeholders to make an equitable pricing decision that benefits all parties.

Alternative Evaluation

Gilead can take several different tracks when it looks at its pricing. One look would be to go with the pure logic of the market. This is where the company could set the price at a point to maximize profits at the expense of the stakeholders. Looking at the data, what Sovaldi prevents at the most drastic case is a liver transplant. Seeing that the transplant and the after care cost almost half a million dollars, the company could price Sovaldi at that price and show that not only does the drug save the transplant cost, it also improves the patient’s quality of life and eliminates costly after care and lowers the chance of rejection so even at half a million dollars for a course treatment, Sovaldi is in fact a good deal. Some insurers and the the government might balk at such a pricing level. At a true market price, there would be fewer payers willing to pay even though there would be patients who wanted the treatment. It just shows the disconnect between supply and demand in our medical economy.

On the other end of the spectrum, Gilead could offer up the treatment for cost. Looking at the cost of bringing a new drug to market averaging over two and a half billion dollars seems like a lot of money. But remember that Gilead covered that average cost over four times in 2014. Based on their current pricing, everything above the materials, manufacture, and overhead for each new pill of Sovaldi is pure profit. Gilead could give away the drug as part of a lasting legacy towards the health of the planet, effectively eliminating Hepatitis C as a cause of death of the peoples of the world. There is precedent for such an action. Jonas Salk famously did not take royalties for his polio vaccine, an action that made him a much less rich man than he could have been, but cementing his legacy as a scientist and an ambassador of goodwill (How Much). Estimates for cost of manufacture of a run of Sovaldi run to about $130 (Sovaldi Tax), so the minimum price could be just that much.

The final option lies somewhere in the middle. Companies under capitalism are hard pressed not to be secular saints like Salk, but the realities of the market is that they are not the cold, hard, calculating markets of a simplified version of Econ 101. There are other issues at play and other stakeholders. Looking at the government as regulator, patents protect companies and provide a temporary monopoly so that the company can reap the benefit of its investment. The United States government has proven itself to be strong supporter of these property rights. But other countries may not be so forgiving. If Gilead takes too much license with its property, the government may expropriate it from the company and license or manufacture itself. Gilead also has to participate in the court of public opinion. This drug will soon have competitors, and there is always goodwill to be built or destroyed. Even in America, profit over and above some unspecified level is unseemly. Yes, the citizens can applaud someone for making innovative strides in medical research, but economic rent-taking is too much. The outcry over the pricing of Sovaldi proves that Gilead crossed this line. There is reaction not just from the pundits, but also the potential payees of the treatment. Though it may cost more over time, insurance companies do not want to pay the piper if they feel the benefit is not in balance with the cost.

Recommendation - what are the solutions and state the benefit of this course of action

Gilead did try the middle ground, but they aimed too high. The evidence should be reappraised and what should be examined is greater flexibility by the company. It is in drug pricing the gulf between costs to the company and price to the consumer are sometimes the most evident. Gilead has actually already shown flexibility on their pricing globally. The price for Sovaldi in some developing countries is as low as $900, such as in Egypt and India. Even in some countries that have comparable levels of development to the United States, the drug is sold at a discount to the sticker price. Gilead charges $55,000 in the UK. The difference is that there is less regulatory capture in the UK of policy makers (Unacceptable). These differences and flexibility are good in terms of being able to treat patients with a dreadful disease, but it only serves to highlight what subjectively feels like too high a price the United States. This is where Gilead should refigure all the data that they have received and make a new decision. At this point they could lower the pricing of Sovaldi even to the prices seen in the UK and they would benefit on two fronts. First, they would get credit for cutting their price almost in half - many outlets have rounded up to $100,000 for the treatment costs. Secondly, there would be greater access in terms of patients successfully treated for Hepatitis C.  The patient whose insurance company thrice rejected the treatment might be more open to paying for the treatment for patients who are only a little sick.

References

http://www.forbes.com/sites/theapothecary/2014/06/17/the-sovaldi-tax-gilead-cant-justify-the-price-its-asking-americans-to-pay/

http://www.forbes.com/sites/quora/2012/08/09/how-much-money-did-jonas-salk-potentially-forfeit-by-not-patenting-the-polio-vaccine/

http://www.forbes.com/sites/johnlamattina/2014/08/08/even-at-900-per-cure-sovaldis-cost-could-be-unacceptable-in-india/

http://www.rogaine.com/category/facts/our+history.do

Working Bibliography: “Price Setting with Inelastic Demand: An Ethical Approach”

Kinicki and Fugate Organizational Behavior

World Bank http://data.worldbank.org/indicator/SH.XPD.TOTL.ZS?order=wbapi_data_value_2013+wbapi_data_value+wbapi_data_value-last&sort=desc

http://www.cdc.gov/hepatitis/hcv/cfaq.htm#cFAQ21

file:///home/chronos/u-97582656d28a10e66f11e8d2a8a68a34398f53fd/Downloads/GileadSciences_10K_2014.pdf

http://www.who.int/trade/glossary/story073/en/

High prices for Drugs Criticized at Meetings; Joseph Walker June 1 2015 Wall Street Journal

http://www.wsj.com/articles/high-prices-for-drugs-attacked-at-meeting-1433119411

Drug Shortages Plague U.S. Medical System. Peter Loftus. Wall Street Journal June 1, 2015

http://www.wsj.com/articles/u-s-drug-shortages-frustrate-doctors-patients-1433125793

Speeding up Drug-Approval Process Could Have Downsides. May 29. Wall street Journal.

http://www.wsj.com/articles/speeding-up-drug-approval-process-could-have-downside-

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Appleby, J. (2014, May 2). New hepatitis C Drugs’ Price Prompts an Ethical Debate: Who

Deserves to Get Them? Washington Post. Retrieved from

http://www.washingtonpost.com/business/new-hepatitis-c-drugs-price-prompts-an-

ethical-debate-who-deserves-to-get-them/2014/05/01/73582abc-cfac-11e3-937f-

d3026234b51c_story.html

Pollack, A. (2015, Feb 3). Sales of Sovaldi, New Gilead Hepatitis C Drug, Soar to $10.3 Billion.

The New York Times. Retrieved from http://www.nytimes.com/2015/02/04/business/sales-of-sovaldi-new-gilead-hepatitis-c-

drug-soar-to-10-3-billion.html

Wilson, J. (2013, March 27). Viagra: The Little Blue Pill That Could. CNN. Retrieved from

http://www.cnn.com/2013/03/27/health/viagra-anniversary-timeline/index.html

Kinicki, A., & Fugate, M. (2012). Organizational Behavior: Key Concepts, Skills, and Best

         Practices (5th ed.). New York: McGraw-Hill Irwin

Filling The Gap: 401(k) / 403(b) Architecture to Enhance Savings

Introduction

Early in a career, an employee can often be laissez-faire about the benefits that a company offers. The various add-ons are not really noted. These benefits are wide ranging, ands provide both extra compensation and protection for the employee. The top line number on the salary is easy to focus on, but health insurance, paid leave, long-term and short term disability, and life insurance are all part of a comprehensive benefit plan. These are not entirely benefits for the employee. The employer benefits by having a present and healthy workforce. The various benefits aid in that manner. They also can be used as positives. In their textbook “Human Resources Management,” Robert Mathis and John Jackson point out that these benefits are not just costs, but that they can help keep an organization competitive in recruitment and as a competitive advantage in competition, as employees with better benefits have been found to have higher job satisfaction and thus better outcomes (p. 427). As strong and varied benefit package also help the organization by keeping the best employees around, even if they do not necessarily use them. The authors further note that benefits have the advantage of often being untaxed as income to employees (p. 429). So that the marginal return in terms of utility is enjoyed more on a dollar spent on more salary.  

Problem Statement - What Challenges in Organizational Design Exist in This Business

Politicians from both sides of the aisle have been raising alarm bells about the coming insolvency crisis of the Social Security trust fund for a long time. The last major changes in the program came thirty years ago, and it has been a political football ever since. The Social Security Administration estimates that at current rates, the trust fund will be depleted by 2037. At that point the funds for social security will no longer be paid out of the trust fund, but will come from incoming taxation. The inflows are expected to be lower than the outflows, so this means that payments after that date will be at 76% of the expected amount. Thus the SSA is calling for either slightly lower benefits now or a raise in taxes to plug that shortfall (Future financial status). If this doomsday scenario happens or not, Social Security was not fully formulated to replace all of a household’s income. The exact amount of income social security replaces varies, but for the median family, it is just a little over a half of the last year’s income (income replacement). The good news is that there are costs associated with with work that can be avoided by being retired. A worker has added food and transportation costs. In retirement many people after long careers should have reduced housing costs as well. When all the costs are considered, only eighty percent of the previous income is calculated as necessary for retirement. Eighty percent needed with fifty percent filled by Social Security creates a gap of thirty percent of the former take home pay. The question then becomes how do you fill that gap.

Traditionally, one way to fill that gap has been through private pensions. At their height, thirty-five percent of private sector Americans were working under a defined benefit pension plan. For better or worse, that number has almost halved in the last two decades, where now only eighteen percent of private workers have some defined benefit coverage. Because of traditional working patterns where one spouse worked outside of the home in the workforce, while another stayed home in domestic toil, there are still thirty one percent of households that are covered by pensions (pension coverage). There are still sectors where pensions are still extant, but they face pressures of their own. Currently pensions are found amongst government workers at a much higher rate with seventy-eight percent of government workers covered. This has created  a disconnect between government workers who are funded by the taxpayers. The taxpayers see the government workers enjoying a benefit that the private workers do not get to enjoy, so the easy response is that they government workers should not continue to enjoy those benefits. The reasons that the private sector scaled back on pensions is complicated and has political and social correlates with the decline of unions and the rise of globalization, but the bottom line is that from a business perspective pensions are long term, open-ended liabilities. For a business to be competitive currently, it needs to operate leaner, and that means having long term, open-ended liabilities on the books is not optimal. Though proper benefit design is a competitive advantage in attracting and retaining talented staff, there are other competitive pressures that predominate, and the general trend is to do away with private defined benefit pensions.

With Social Security perhaps dropping what it pays the average retiree along with the diminishing of defined benefit pensions, what has to replace the thirty percent gap between what Social Security replaces and what is needed to live a comfortable life then has to come from the employee's own savings. Thankfully, the federal government has created ways so that employees can save money and be incentivized with tax favors. 401(k)’s and related plans for nonprofits were set up so that savings could be put into various funds and then grow tax free until they were pulled out of the funds for use in retirement. This means that taxes can be deferred, and taxes will be paid at a lower rate as it is assumed that the tax rate when the monies are pulled out will be lower than the rate that exists when the employee is working. There is a secondary benefit in adding money to a 401(k) in that employee contributions lower taxable income, so the employee has lower taxes. There are limits to how much can be contributed. In 2015, the limit is $18,000, which is almost a third of the median household income (Tax Information). 401(k)’s as of right now are the most efficient vehicle for employees to use to save their money to make up that gap. There exist other retirement plans, such as a Roth IRA which uses taxed funds and are allowed to grow untaxed. These are also subject to limits, and are not an option at upper income levels. For the majority of the middle class, the 401(k) is where it is at.

The problem is that not enough people are saving enough money to fill that gap in retirement. If a saver took that $18,000 limit and put that much away every year for a thirty-year career, they would have put away a nominal $540,000, which would appreciate nicely barring some untimely rift in the global economy and markets. If that was just put in a money market fund with no growth, it would allow an income stream of $21,600 a year if withdrawn at the commonly accepted rule of thumb to withdraw only four percent of your savings a year. This is more than the gap, and an employee who saved along these lines would be in line for a comfortable retirement

The problem is that most people are not saving for retirement at anywhere the rate that would allow a comfortable retirement. Younger workers see retirement as far off, and there are always bills that need to be paid first, from student loans to housing costs to bringing children into the world and all of those associated cost. What young are missing out on is the potential for great growth in whatever money is out aside. To retire with half a million dollars which will be needed to make up the gap between what is needed and what Social Security can provide, it is much cheaper in dollars to start early than it is when older. Using the shorthand of the rule of 72, where you divide 72 by the assumed fixed growth to see how fast it will take for the money to double, any saving done by the time a worker hits thirty will double three times before their retirement using the long term trend in the S&P index of 6.5% growth (real returns). The reality is that very few people are making contributions to their retirement plans that will allow them to take advantage of the seeming magic of compounding growth. The reality is much more grim. Social Security will be around in some form, but with the decline of pensions, personal savings is what will support people in their retirement, a period of life that is increasing with every generation with better medical care to enhance longevity. The General Accounting Office (GAO) of the federal government did a recent survey that shows just how unprepared most people are for retirement. The GAO looked specifically at people who are close to retirement and how ready they were for the coming life change. They found that 29 percent of people in the cohort of people from 55 to 65 had exactly no retirement savings. For those that did, the median amount was just $104,000 (Retirement Crisis). As seen earlier, this will not be enough to fill the gap between social security and the amount needed. That is why the GAO also looked at other studies about future retirement insecurity, and determined that somewhere between a third and two thirds of retirees will not have the resources to live a comfortable life (Retirement Crisis). Many people further infer that that they will be able to work past the traditional retirement age to shield themselves from this crisis on a personal level, but these plans are often thwarted because people end up having to drop out of the workforce for a myriad of issues that were not foreseen.

Literature Review

If the problem is that the average person will not have enough resources in retirement, then the answer is that more resources should be allocated to the worker in retirement. There are three possible sources. First is the government, which could allocate more resources to the retired, through raising the taxes for Social Security, or raising the cap on money that is taxable for Social Security purposes, currently at $118,500. With the gridlock in Washington, the SSA will advocate for some of these changes, but their implementation remains an unknown. The second source would be from the employer of the retiree, but as seen earlier, these defined benefit plans are receding from common use, not increasing. So that leaves the retiree as the source of the retiree’s resources that will fill in the gap.

The question is how do you get people to save money when it is clearly in their long term interest, but it is still something that does not happen. Here is where insights from behavioral economics can come into play. The field looks at how people interact economically in real world situations. This approach runs counter to a more traditional view of economics where the economic actor is a self-maximizing, rational character. Behavioral economics asks the question “What if people aren’t rational”. It is still contentious in some circles, but it has had some useful applications at the micro level. Richard Thaler is one of the founders of the field, and in his new book “Misbehaving,” he talks of the application of behavioral economics to making people save money. His view is that signing up is complicated, and most people will not sign up for something that is complicated. Evert friction put in place makes people less likely to do something, even if that thing is in their best interest (Thaler 312). So one of the big insight of behavioral economics is about setting the defaults so that people are forced into the choice that is best for them, this choice architecture has entered the language by the title of one of Thaler’s previously co-written books. It is a nudge. Through nudging, whoever is making the default can make it so that the default is the best option. As Thaler puts it: “Why not make joining the plan the default and tell people that if they do not opt out, they will be enrolled in the plan at some default savings rate and in some default investment product?” (312). The opt out is important because it still allows the employee choice in the matter. If they really do not want to save any money for retirement for whatever reason, they have the choice to do so. There are critics of nudging who say that nudging is paternalism and limits options, but the opt out clause leaves saving up to the individual.

Causes

The lack of savings is just not an issue to look at at the higher levels. Each organization in their human resource departments have to make choices about benefit design that will balance the available resources and what is necessary to attract and retain talent. Making sure that their people do what is best for them is in the long term interest of every organization. My organization is no different. We have health and life insurance and disability and worker’s comp, we have twelve holidays and more vacation and sick days than you can use accumulate. The problem is that as an organization, we are not saving enough. CSS provides services to the developmentally disabled in the western suburbs of Chicago. There are approximately 150 hourly staff who provide front-line services for the individuals we serve. We also have 56 benefits-eligible employees who work in our administrative offices and other full time workers.

There are two proximate causes to our own lack of savings. First of all, we work in the nonprofit sector, which offers fewer extrinsic rewards to employees in the sector, which are balanced in part by the intrinsic reward of doing well in the community. More bluntly, the pay is not what it is in the private sector. Paychecks are stretched The second cause is that we have to opt into the retirement plan, here a 403(b) because of our nonprofit status. The default is structured so that you have to fill in these forms and there are enough people who end up not putting anything aside in spite of the tax-sheltered nature of the plan, and also in spite of the matching, which is half of what the employee puts aside up to four percent. This default means that of the 56 eligible employees who could put their money aside, only 30 do so. Of that thirty, only 12 people save more than what they need to do to get full matching, which is four percent. That means that as a whole, we are not saving enough.

Solutions

A couple of ways exist to improve the amount of money we save as individuals at the agency. First, there could be better outreach and education from the HR and Finance Departments to individual employees about the need for retirement savings and a recommended level of savings. This could work so that every employee would make an educated choice about their savings rate and their plans that they allocate their money too, which is a separate discussion to be had once you just get people putting money back for retirement. A related option would be to seperate the retirement discussion from where it is now. Currently, we now have to make decisions about all the various benefits that we have options for at one meeting in October. It is overwhelming, and when people have too much cognitive load they will reach for the safe and easy choice to make. Isolating the decisions so that they can be focused on would allow the individual decision to be the center of the employee’s attention, and thus would be able to benefit from deep concentrated thought from the employee. From an organizational perspective, however, doing everything all at once is more efficient in that you do not have to pull all the employees away from their productive duties for administrative tasks, no matter how important. The third option would be changing the defaults. If currently only about half of the employees are taking advantage of the retirement plan and two thirds of those people are sticking right at the default, then the defaults are off.

Recommendation - what are the solutions and state the benefit of this course of action

The current structure of the retirement benefit at CSS is that for eligible employees, the company will match fifty percent of your first four percent of savings if you opt-in. These defaults have resulted in under-saving by our employees, and they need to be changed. The easy thing to say is that there should be greater maching, so that it was dollar-for-dollar up the a set amount. Unfortunately, we operate in an industry that generates a lot of its funding from governmental bodies, and governmental bodies are at the point in the political cycle where they are not freeing up extra funds for their partner agencies. There is a marked constraint on the agency’s resources, but still the need exists to incentivize employee savings. The thing to do is change the defaults. First off, change the enrollment from an opt-in to an opt-out structure. That means that the half of the people who are not enrolled would now be part of the plan, barring disenrollment. Secondly, change the matching. It may sound less generous, but matching a smaller percentage of the employee contribution would mean that employees would have to contribute more to themselves in the future to ensure that they received the full match from the organization. A simple proposal would be to match only twenty five percent of the employee contribution up to eight percent of the employee’s salary. That means that in real terms the agency would not have to contribute any more to the employee than they already are, but instead of the sum of savings being six percent of the employees’s salary, it would be ten percent. Set that as the default and then you would help the employees have a more secure. There is also the added benefit that humans love nice round numbers. One final consideration exists in designing this nudge. People do not like seeing their take-home pay decreased, so to make sure the most people take this up as possible, it has to be phased in gradually. The increased withholding should be timed to pay increases, so that the employee will see their take home increase at the same time they are increasing their own contribution. Otherwise, people would see their pay decrease in the here and now, and might take the opt-out option to stiff their future selves.

References

Thaler, R. (2015). Misbehaving. New York, New York: Norton

Mathis, R., & Jackson, J. (2011). Human resource management (13th ed.). Mason, OH: Thomson/South-western.

Social Security Crisis: http://www.ssa.gov/policy/docs/ssb/v70n3/v70n3p111.html

People Have No Savings:

http://www.nbcnews.com/business/personal-finance/retirement-crisis-29-percent-older-americans-have-no-savings-gao-n369241

Fall of Defined Benefit Plans:

http://www.epi.org/blog/private-sector-pension-coverage-decline/

Income Replacement:

http://www.ssa.gov/policy/docs/ssb/v72n3/v72n3p37.html

IRS Tax Information:

http://www.irs.gov/Retirement-Plans

Equity returns:

http://www.pragcap.com/u-s-equities-long-term-real-returns