Current Issues With Pension Plans: Even as traditional defined benefit pension plans become increasingly rare, the problems faced by those still in existence are mounting rapidly. In a vicious circle, these problems then accelerate the demise of such plans. In short, these pressures fall into three main categories:
- Rapidly increasing longevity of beneficiaries
- Depressed bond yields
- Increased federal insurance premiums
According to the American Institute for Economic Research, over 60 million Americans are covered by traditional defined benefit pension plans. This number includes both people who are now retired and drawing benefits, and people who will be eligible to do so at some time in the future.
Mercer LLC, a major player in human resources consulting, including compensation consulting and pension consulting, estimates that, as of the end of 2013, total corporate pension liabilities in the U.S. tallied up to roughly $2 trillion. Meanwhile, as treated in considerable detail in our discussion of the pension gap, the actual funds presently set aside to meet these projected obligations fall considerably short of that total.
Current estimates indicate that the pension gap has grown by about another $150 billion since the recent studies cited in the aforementioned article, due to surges in life expectancy. Meanwhile, increased federal insurance premiums are due to raise pension costs by yet another $20 billion, according to a study by Morgan Stanley.
The Shifting Pension Landscape: According to the Employment Benefit Reseach Institute, in 2011 only 14% of people working in the private sector were covered by traditional defined benefit pension plans. The comparable figure in 1979 was 38%.
Meanwhile, participation in defined contribution retirement plans, such as 401(k) plans, was 42% in 2011. The 1979 percentage was less than half this amount.
Increased Longevity: On average, the projected remaining life span for Americans who reach age 65 in 2014 is roughly 4 years greater than it was for those who hit 65 in the year 2000. This means the average new retiree in 2014 will cost the average pension plan 4 more years of benefit payouts than did the average person who retired in the year 2000. This is a significant change in a short amount of time.
In 2014, the American Society of Actuaries updated its mortality tables for the first time since 2000. The average man who turns 65 in 2014 is projected to live to 86.6, compared to 82.6 (an increase of 4.0 years) for those who hit 65 in 2000. For the average woman, the change is from 85.2 to 88.8 (an improvement of 3.6 years).
Another leading benefits consulting firm, Aon Hewitt, projects that the effect of these revised actuarial tables will be to increase the pension liabilities recorded on corporate balance sheets by 7% on average. Hence the above cited figure of $150 billion (just over 7% of $2 trillion).
Depressed Fixed Income Yields: As explained in more detail in our above cited article about the pension gap, the continued policy of The Federal Reserve Board to keep interest rates low in hopes of stimulating the economy has had a disastrous impact on traditional defined benefit pension funds. Constrained by law, regulation and custom to pursue conservative investing practices focused on bonds and other fixed income instruments, pension plans have seen their income fall dramatically while their actuarially-determined liabilities have soared.
Increased Federal Insurance Premiums: The Pension Benefit Guaranty Corporation (PBGC) is an agency founded in 1974 under the Employee Retirement Income Security Act (ERISA). Playing a role somewhat analogous to the FDIC and SIPC, the PBGC is supposed to protect retirees by stepping in to pay out defined benefit obligations (subject to an annual cap per retiree) in the case of companies and pension plans that become insolvent. Nonetheless, PBGC currently pays benefits to only a relatively small number of retirees, and lacks the resources to cover many more.
One of the PBGC's principal sources of funding is a premium assessed on each employee that it covers. The flat rate premium per each participant in a single employer plan will rise to $64 in 2016, up 52% from $42 in 2013 and up 106% from $31 in 2007.
There also is a variable rate premium assessed on unfunded vested benefits (UVBs) in single employer plans. This rate has risen even more rapidly, from $9 per $1,000 of UVBs in 2007 to $24 in 2013 to $29 in 2016. In fact, the 2016 rate may be even higher, because it is indexed to a measure of wage inflation computed by the Bureau of Labor Statistics. For 2017 and beyond, all premiums will be indexed in this manner.
The variable rate premiums, by the way, were capped at $400 per participant in 2013 and rise 25% to $500 in 2017.
For multi-employer plans, just a flat rate premium is assessed. At $8 in 2007, it rose to $12 in 2013 and will be $13 in 2016, but subject to adjustment per that wage index cited above.
As an example of how these costs can add up, Xerox, which closed its defined benefit plan to new participants in 2005 and froze benefits in 2012, nonetheless expects to spend $9 million more on PBGC fees in 2014 than in 2013.
Corporate Responses: Many of the remaining defined benefit pension plans are closed to new employees. They also tend to be much more common in unionized companies.
Some companies are offering, or considering offering, new retirees the option of taking a lump sum payout instead of a monthly check for life.
In 2014, Boeing froze benefits for over 68,000 nonunion employees and transferred the assets to a 401(k) plan.
Other companies are closing down their plans and shifting the assets and risk to insurance companies. In 2012, Prudential Financial received $27 billion from General Motors and $7.5 billion from Verizon Communications in this manner. In the process, the latter firms removed these pension liabilities from their balance sheets.
A class action suit on behalf of 41,000 nonunion Verizon employees is challenging the move, claiming that this diminishes their protections under ERISA and the PBGC. Verizon counters that this move should inspire more confidence because annuity contracts are a core business for major insurers, whose expertise in the field is thus far beyond that of a non-financial company like Verizon.
Merrill Lynch was far ahead of this trend, shutting down its own defined benefit pension plan in early 1988, and using the assets to purchase annuities from MetLife for eligible employees.
Principal Sources:The Wall Street Journal, "Pension Plans Brace For a One-Two Punch," March 25, 2014. The PBGC website, www.pbgc.gov, was consulted for more detail on premium rates, including past rates and future scheduled increases.