Study Warns Companies Against Being Too Quick to Freeze DB Plans

June 5, 2006 ( - Since October 2003, 20 companies have frozen their DB plans, but in an analysis issued this month, Merrill Lynch advised companies to wait and see what the pension landscape will look like in the future, rather than simply following the lead of other companies.

According to the report, freezing DB plans is not a new trend and does not necessarily mean underfunded plans forced companies to freeze their pension assets. According to the report, 168,725 companies terminated their DB plans from 1975 to 2004, which, Merrill Lynch contends, marks the “extended decline” of the DB plan. About 98% of these companies, 165,256, had enough assets to pay their contributions.

The past two decades showed DC plan assets increasing and DB plans leveling off, the Merrill report found.

The report defined the three types of freezes: hard plan freezes, in which every participant stops receiving benefits in the DB plan on an effective date; partial plan freezes, in which a segment of the active participants stop accruing benefits; and soft plan freezes, similar to hard freezes in that service stops receiving benefits on a certain date but employers still consider future pay increases when they calculate participants’ projected pensions.

In hard plan freezes, companies usually increase contributions to another benefit plan after the freeze, according to the report. In partial plan freezes, participants may have a choice whether to continue accruing benefits in their DB plans or begin accruing benefits in another plan, such as 401(k) plans.

According to the report, companies in the past froze their DB plans for reasons such as the high interest rates of the 1980s and the introduction of pension accounting standards. Today, though there are low interest rates, there are also high premiums that are charged for close-out annuities.

The report included a Mercer Human Resource Consulting survey of plan sponsors, who said the top two reasons that they decided to change or freeze their plans was to ensure long-term cost savings and reduce cost volatility.

According to the report, the government could pass permanent Employee Retirement Income Security Act (ERISA) funding legislation by the end of July. Merrill predicted that the government will extend the time table for airlines to pay back their plan defectives to a period of more than 20 years, rather than seven years.

Northwest Airlines asked the government in May to help fund its three underfunded pension plans, which have a $3.7 billion shortfall altogether (See  Pension Bill Likely to Save Northwest Pension Plans ). If its proposal is accepted, the airline will have two decades to pay contributions to its plans. If Northwest’s proposal is declined, executives say the airline will be forced to terminate the pension plans.

In January, Northwest’s pilots union agreed to take a 29.9% pay cut as well as for the company to freeze its DB plan and switch to a DC plan (See  Northwest Pilots OK DB Plan Freeze ). The agreement is expected to save the airline $358 million per year. General Motors announced in February that it would freeze its DB plan in favor of a retirement savings program and a retiree health coverage cap (See   GM DB to DC Pension Move among Belt-Tightening Steps).

The Royal Bank of Scotland decided in May to go the way of other UK and US companies that have decided to freeze their plans for new hires (See UK Pensions Follow US Trend), but it will offer salary increases for current workers and new employees to compensate (See   RBS To Close DB To New Participants ).

But if age discrimination issues facing cash balance plans are resolved in the House and Senate, the Merrill report said, airlines may not have to freeze or terminate their plans because new types of DB plans could reverse the trend.

The theory behind freezing a plan is that it will allow employers to keep cash on their balance sheets rather than locked in pension plans; however, it does not always make sense for a company to freeze its DB plan, (See The Bottom Line: Back to the Drawing Board ).