EBRI: DB System In Jeopardy

May 5, 2004 (PLANSPONSOR.com) - Workers new to the labor market and their families are about to face a tremendous loss of retirement income unless the decline in use of defined benefit plans is reversed, the Employee Benefit Research Institute (EBRI) has said.

In its analysis, contained in the May EBRI Issue Brief, “ERISA At 30: The Decline of Private-Sector Defined Benefit Promises and Annuity Payments? What Will It Mean?” EBRI attributes the decline in defined benefit plans to factors such as:

  • new economy firms not adopting defined benefit plans;
  • smaller companies favoring defined contribution plans;
  • a decline in the number of people employed by manufacturing companies;
  • bankruptcy and insolvency leading to defined benefit plan terminations;
  • preferences of the workforce when Baby Boomers began entering the labor market;
  • changes in the domestic and global marketplace;
  • changes in relative program costs.

Further, the decline of the defined benefit plan is being hastened by current reform proposals in the works. As evidence of the potential for a reduction in the use of defined benefit plans, EBRI cites a survey finding half of corporations are likely to seriously consider reducing pension benefits if these initiatives are adopted.

Thus, EBRI President and CEO Dallas Salisbury said policymakers need to take action to create greater regulatory certainty for pension plan sponsors. In particular, Salisbury says decisions are needed on the status of:

  • cash balance pension plans;
  • permanent funding rules and interest rates to be used in plan calculations;
  • accounting treatment related to how investment returns and interest rates affect pension plan assets;
  • rules and premiums paid by plan sponsors to the Pension Benefit Guaranty Corporation (PBGC).

“Until these kinds of policy decisions are made, further erosion of the defined benefit system can be expected to continue,” Salisbury said. “While the decisions made could either slow or speed that erosion, they would at least create an environment in which individuals could better assess what they are likely to have as retirement assets and income, and plan to continue working, or to exit the work force, accordingly. A demographic time bomb is ticking, and the time to act is now.”

If regulatory action is not taken, EBRI provided examples of other alternatives plan sponsors may turn to. For example, freezing all defined benefit accruals starting in 2005 would reduce the expected average real dollar first year surplus – beyond basic expenses – of families between age 39 and 43 by almost $4,900 a year. For single males, the loss would be more than $2,750 a year and for single females the loss would be almost $1,700 a year. Additionally, t erminating all cash balance retirement plans would reduce the expected average real dollar first year surplus of many high-income couples born since 1945 by more than $1,000.

Participant Payments

Outside of regulatory pressures, plan sponsors are also struggling with participants about the value of annuitization. To help reverse the trend for current defined benefit plan participants, education is necessary about the perils of lump sum distribution. Under the assumption that all defined benefit plan participants would take a lump sum distribution at retirement, the study found there would need to be an average annual increase to savings of 14.9%. Assuming plan participants elect for an annuitization of their defined benefit plan assets at retirement, a 30% decrease in annual savings is needed, the study found.

The annuitization of retirement benefits is not the current trend, though, a movement EBRI attributes the to factors such as:

  • early departing executives and worker preferences;
  • competition with defined contribution plans;
  • IRS ruling on equal treatment;
  • Interest rate and rate of return environment;
  • Desire to shift longevity risk;
  • Relative marketing emphasis of financial services organizations and planners.

The report was written by Temple University Professor and EBRI Fellow Jack VanDerhei and EBRI Senior Research Associate Craig Copeland. A copy of the report is available at http://www.ebri.org/policyforums/may2004/ .