By Pat Parks

Until recently, pension plans were rarely front-page news. Now, it is difficult to avoid headlines with the words “pension crisis,” the “perfect storm” and, even, “the imperfect storm” in them.

The importance of pensions and their fragility is evident in the Boeing strike. According to The Seattle Times, Boeing offered the machinists’ union a 10% increase in the monthly pension benefit. The machinists dismissed the offer as the smallest percentage increase ever and went on strike.

The Times, with the help of an actuary, estimated that Boeing’s offer to the 16,500 Puget Sound-area machinists would require $200 million in additional funding. Because of post-bubble shortfalls in stock and bond returns, Boeing has been making huge pension contributions in the last few years, including nearly $4.4 billion last year. The article ended on the sobering note that Boeing workers are among a dwindling number of Americans who even have pension plans. Today, only 20% of workers are covered by such plans versus 40% some 30 years ago.

Similarly, weeks before the Boeing strike, the local newspapers reported on picketing by the Service Employees International Union against Swedish Hospital for its proposal to freeze its traditional pension plan in favor of another plan. According to an article in The Boston Globe, 11% of Fortune 1000 companies terminated or froze their plans in 2004. In addition, 4% of the companies closed pension plans to new employees in 2004.

Pensions Losing Favor
Traditional single-employer, defined-benefit pension plans pay employees a retirement benefit that is typically based on years of service and pay. The pension is paid in the form of an annuity, with monthly payments over the employee’s life or over the life of the employee and the employee’s spouse. Lump sum payment options also are usually offered.

Why are these plans going out of favor? One reason is that the benefit is less valuable to today’s mobile workers than to workers of past generations. Pension plans began when workers spent 20 to 30 years with one company. Pension benefits accrue at a lower rate in the early years of employment and accelerate in later years. Consequently, today’s more mobile worker will accumulate a considerably smaller pension benefit than a worker who stays at one company.

The consulting firm Watson Wyatt, in its August 2005 publication “Insider,” gives an example of a worker who begins work at age 22 earning $30,000 and has annual salary increases of 4%. Under a given formula, she would have a pension of approximately $51,500 per year if she retired at age 60. But if she changes jobs at ages 32, 41 and 49, under an identical formula she would receive only $32,500 per year.

Also contributing to the current “crisis” is the fact that, although there are many healthy, well-funded pension plans, many others are underfunded. The “perfect storm” of asset value decimation and low interest rates inflates the present value of the plan’s liabilities and increases funding requirements. Lower rates require employers to make larger contributions to make up for the lower expected returns.

Statistics bear out the precarious financial health of many plans. According to the Pension Benefit Guaranty Corporation, defined-benefit pension plans are underfunded by $450 billion. For plans terminating in 2005, the PBGC guaranties pension payments up to a maximum of $45,614 a year for employees retiring at age 65.

Even more troubling, the PBGC is in not much better shape than the plans it guaranties. In 2004, the PBGC had $62.3 billion in long-term obligations, but only $39 billion in assets. The $23.3-billion shortfall was double the previous year’s. Without major changes in funding and premium increases, the PBGC will have a $78 billion deficit in 16 years, according to the Center on Federal Financial Institutions, a Washington think tank. Many believe a taxpayer bailout will be necessary unless pension plan funding materially improves.

In an effort to shore up pension plan funding and avert a bailout, the Bush administration has issued a proposal to fund benefits over a shorter period of time and increase PBGC premiums from the current $19 to $30 per participant. Legislation with provisions similar to the President’s proposal is pending in Congress, including the Pension Protection Act of 2005 and the National Employee Savings and Trust Equity Guarantee Act of 2005 (NESTEG). Critics of these proposals say they will only worsen underfunding problems and cause underfunded plans to terminate, thereby increasing PBGC liabilities.

Uncertain Future
At this point, it is fair to ask, “Is there a future for pension plans?” Recent articles and commentary take the position that 401(k) plans are failing to provide employees with adequate retirement benefits because they lack certain features of pension plans. For a 401(k) plan to provide an adequate retirement, the employee needs to: 1) start contributing at a relatively young age; 2) contribute an adequate amount; and 3) invest wisely. Upon retirement, the funds also must be managed to last over an increasingly long life span. Many participants fall short in at least one of these areas.

Pension plans, on the other hand, meet all these requirements. Employees are enrolled automatically in the plan. Employers typically make all or most of the contributions to the plan. The assets are invested by professional money managers with lower investment fees. Finally, a monthly pension plan annuity eliminates the chance that a retiree may outlive his or her nestegg.

More than one-fourth of large employers have met the challenge of the future by converting their traditional pension plans into a “hybrid plan.” The most prevalent hybrid plan is the cash balance plan. It has the look and feel of a defined-contribution plan, yet maintains the positive aspects of pension plans: automatic enrollment, employer contributions, professional asset management and investment risk remaining on the employer. The cash balance plan eliminates the problem of benefit accruals increasing at a faster rate as retirement nears. Rather, benefits accrue ratably as they would in a 401(k) plan. There have been legal challenges to these plans based on age discrimination against older workers. Pending pension legislation specifically approves hybrid plans, provided they meet certain requirements.

The positive aspects of pension plans are likely to ensure their existence for the foreseeable future. However, those plans most probably will not look exactly like the pension plans of today. n