Characteristics of Survivors
Given those financial imperatives, companies that
continue to offer defined benefit plans also tend to be
financially strong, with well-funded plans that reflect
the sponsor's financial health. GuideOne's $90
million plan covering approximately 1,700 participants,
for example, has assets that exceed its accumulated
benefit obligation, according to John Roberts, the
company's senior vice president for human resources. So
does Gorton's plan covering about 200 salaried employees,
according to Paul Coz, vice president of human
resources.
However, more than the mere availability of funding
distinguishes healthy plans from their underfunded cousins.
Equally important, say pension consultants, is the
sponsor's commitment to funding the plan during good times
as well as bad. Consider what happened during the latter
half of the 1990s, when stock market returns were so
strong—and interest rates manageable enough—that many
employers were not obliged to contribute anything to their
plans to maintain the minimum funding levels required by
pension law. Many took that funding holiday (in fairness,
some were precluded by existing law from putting aside as
much as they otherwise might have
been inclined to do), then paid a steep price when
the equity markets tanked at the turn of the decade and
interest rates began tumbling. The combination of rapidly
declining asset values at the same time that falling
interest rates were boosting the present value of plan
liabilities, and at a time when a surge in early
retirements put additional strain on funding, pushed many
defined benefit programs to the brink—and beyond. According
to a top US Treasury official, underfunded, single-employer
private pension plans were short $7 billion in 2000. By
2005, that figure had risen to $450 billion (a figure that
is expected to shrink this year, courtesy of rising
interest rates and rebounding asset values). "Those
employers that were putting in the bare minimum year after
year felt the full
brunt of falling interest rates and, at the same
time, falling assets," says Tom O'Connor, a vice
president and actuary with MassMutual Retirement
Services. "Companies that continued to make
Âcontributions during years they were fully funded, even
though they were not required, put themselves in a
comfortable position, cash-wise, to weather this
storm."
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Tweaking Versus Freezing
Of course, even financially sound companies with
well-funded plans are not immune to the threat of a
business downturn, or the consequences that could have
for their retirement plan sometime in the future.
In a recent survey of senior financial executives
by the consulting firm Towers Perrin, 60% of respondents
said their companies likely would freeze their
plans—either deny pensions to new workers, stop adding
benefits for current employees, or both—if those plans
began to make inordinate demands on their cash flow, and
48% said they probably would implement a freeze
if their plan cut into corporate earnings.
"Any responsible employers are making sure they
evaluate all their options," says Hammond.
"We're doing a lot of work with clients to help them
understand the range of options available to them:
continuing the plan as it is, changing the plan, freezing
the plan, even terminating the plan.
However, they need to understand the way their plans
operate and what their objectives are, and not just buy
into the herd mentality and freeze their plans because they
see some of the big guys doing it. Defined benefit plans
still can be a very powerful, valuable tool for recruitment
and retention, and simply for taking care of
employees."
One alternative to freezing or terminating a plan,
says Jennifer Cummings, vice president of defined benefit
services for MassMutual Retirement Services, is to tinker
with the payout formula. Some companies have switched to
a formula based on career average earnings rather than
peak-year earnings; that can reduce liabilities now,
while leaving the door open to future benefit increases
if and when business conditions permit. "A relatively
small decrease in benefit accruals often can provide
enough decrease in cost to keep programs at affordable
levels," O'Connor says. Sylvester Schieber, director of
US benefits consulting for Watson Wyatt, adds that
companies also might restructure their plans to express
the benefit as a lump-sum payout rather than an annuity.
This can eliminate some of the funding volatility
associated with changing interest rates.
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The Longer-Term Outlook
Unfortunately, it is not just internal factors—the
financial health of the company, the ratio of active to
inactive plan participants—that have an impact on the
viability of defined benefit plans. Congress is working
on pension legislation that, if passed, could make
funding requirements even more volatile than they are
now. Likewise, the Financial Accounting Standards Board
has put forth new proposals that likely will have a
dramatic impact—subjecting corporate balance sheets to
even more volatility. Moreover, if the growing propensity
of workers to change jobs frequently continues, employers
may face greater demands from their employees to shift
their funding focus to 401(k)s and other defined
contribution plans, where the benefits are more
portable.
Still, Hammond does not see the traditional pension
plan disappearing entirely. "My personal view is there
are still a few unpredictable years to come as some of
these new funding rules are sorted out," he says, "but I
believe the plans are an important part of financial
security and, over time, Congress and regulators and
employers will find a way to make them workable. I think
they'll remain a cornerstone for governmental entities,
and that's a pretty good model for private
employers."
"I think some situations may begin to evolve five or
10 years down the road when some plans being closed now
will be reopened," adds Schieber. "Part of the reason is
the fundamental economics for why the plans were set up in
the first place, and the fact that alternatives will not
meet the same economic purposes these plans have served
over the decades. That doesn't mean future plans won't be
somewhat restructured from what we have come to know, but I
think the basic elements of the defined benefit plan will
continue to exist."
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