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  Time to Retire Defined Benefit Plans?
Time to Retire Defined Benefit Plans?
Time to Retire Defined Benefit Plans?
Defined Benefit Pension Plans have played a very important part in the past for tens of millions of American workers’ retirement plans. The “three legged stool” of retirement has historically been Social Security, company pension plans and individual savings. However, the news is filled with companies shutting down their Defined Benefit Pension Plans because they cannot afford them and the Pension Benefit Guaranty Corp. (PBGC) is in a growing deficit position of $22.8 billion as of Sept. 30, 2005 (only approximately 29,000 Defined Benefit Pension Plans remain in effect now in the United States).

These Defined Benefit Pension Plans were designed historically as part of an employer’s employee benefits strategy to help recruit, reward and retain employees. The longer you worked for an organization, the more benefits you received from the Defined Benefit Pension Plan. The formula is typically a percentage of salary times years of service (see above graph).

The workforce has become more transient over the past two decades. Changing jobs multiple times no longer has as negative a career connotation as it may have had in years past. Defined Benefit Pension Plans turn out to be not much value, especially to employees under age 50.

The job market continues to be competitive for talent. Whether a traditional Defined Benefit Pension Plan helps to attract this talent needs to be seriously evaluated. Some organizations have both Defined Benefit and Defined Contribution (401k) plans. Ultimately, a benefits and cost analysis needs to determine their cost effectiveness.

In a survey recently conducted by Wells Fargo Institutional Trust Services, it was noted that sponsors of Defined Benefit Pension Plans will be making changes. More than one-third of the companies surveyed had a Defined Benefit Pension Plan in effect. According to the survey, 14 percent of these Plan sponsors intend to replace their Defined Benefit Pension Plans with Defined Contribution Plans immediately and 13 percent intend to either “soft-” or “hard-freeze” their Plans.

When making these changes, careful consideration must be given to those employees who will be most affected – the longer tenured and more highly compensated. Being able to provide a benefit restoration to those individuals becomes critical. Effectively communicating these changes is important. There are innovative solutions available to accomplish benefit restoration in an enhanced formula Defined Contribution Plan and a separate Restoration Program (hybrid) or both. Employees should be made “whole” in the process.

Actually terminating a Defined Benefit Pension Plan provides certainty and takes the organization out of the administration business. Freezing a Defined Benefit Pension Plan does not solve the problem in itself, since all of the costs to keep the Plan running (on life support) continue (i.e., actuarial, custodial/trustee, administration, PBGC premiums, funding costs and investment costs). Cash Balance Plans do not solve the problem. For those Plans that are under-funded, the Pension Protection Act of 2006 and FASB Statement #158 (announced on Sept. 29) require the recognition of this liability directly on the Balance Sheet under a new seven year time frame.

What are the ramifications of these changes?
•           Increased concern by analysts and rating agencies
•           Plan Sponsors are impacted by:
                        -           ERISA additional cash flow requirements (now seven years)

                       -           Higher PBGC premiums

                       -          Liability that now appears directly on the Balance Sheet

Those Plan sponsors who would prefer to terminate their Defined Benefit Pension Plan, but discover liabilities to do so (i.e. the present value to terminate the Plan exceeds the value of the assets on hand) may be forced to “freeze” the Plan. Unfortunately, Plan costs continue along with the variable cost of investment returns.

There are, however, innovative solutions to transfer a Defined Benefit Pension Plan’s liabilities to a guarantor of these Plan liabilities over seven years, in conjunction with a Plan termination. By doing so, it provides the Plan Sponsor with immediate transfer of liabilities, predictable cash flows and eliminates exposure to Plan volatility. It also eliminates all the costs associated with keeping a frozen Plan alive. The issue is over in seven years.

Each plan Sponsor will need to carefully assess whether or not it is time to actually retire their Defined Benefit Pension Plan, based on the effectiveness of the Plan weighed against the cost to both contributions and the cost to operate. Each situation is unique. Knowing what non-qualified hybrid alternative options are available, coupled with effective communication with Associates, is critical. Restoring lost future benefits, and retaining loyal senior and long-service management with enhanced executive “flex plans” is a viable solution.          

Executive Resource Partners is a privately held consulting firm assisting banks and others in designing custom plans and services that attract, retain and reward executives and long-service employees. For more information, contact Ben Morril at Ben@neretirementconsultants.com

Posted on Sunday, December 31, 2006 (Archive on Saturday, March 31, 2007)
Posted by kdroney  Contributed by kdroney


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