Kjellquist Blog

Interesting article today on the next economic shoe to drop – defined benefit pension fund under funding! One cynical comment before my thoughts on pension plans

What has happened to the concept of capitalism and markets? With the way EVERYBODY is running to Washington I should have invested in DC hotel rooms and be selling DC-bound airline tickets on eBay! From this story and every other one I have read in the past many weeks, it is easy to see our economy is really run by Washington! Ok, I know your reaction is “Duh, where you been dude?”!

On with my pension plan prediction. In principle I understand the problem. Defined benefit pension plans take company contributions (and in some cases employee contributions) and invest the contributions for the future pension payments. The amount required to be contributed is based on employee age (time to expected retirement), investment performance and payout provisions (defined benefit). Obviously, with the latest developments in the equity markets, pension fund values have been hit badly. Thus, companies need to contribute more and these dollars come from current revenues.
So much for the simple stuff.
Wouldn’t you expect that with an obligation to pay your pensioners a defined benefit in the future a prudent company would invest the fund assets in a conservative manner? Not necessarily according to the NYT article

“…so they [our congressman] wrote the law to encourage conservative investing. The law does not specifically ban volatile pension investments,….”.

Interesting; so companies can gamble on the market thus reducing the amount of their contributions! Thus, if a company assumes an 8% return it can halve the contributions compared to a more conservative 4%.
But, and this is a big BUT. If they lose the gamble to bring their pension to full funding and it

“… suffers losses big enough to throw it off the seven-year path to full funding, then it no longer gets seven years — it has to achieve 100 percent funding right away.”

Here comes the part I love and boy, wouldn’t I like Las Vegas or Atlantic City to work this way. The companies knew the rules, took the gamble i.e. made the bet and are now facing big loses. So what do they want to do. CHANGE THE RULES OF THE GAME!!
That’s right

“Many of the companies now calling for relief have sprawling, mature pension funds with obligations so big they can dominate the companies’ own financial performance. Mr. Zion has identified nine big companies whose pension obligations are more than five times the size of their single largest liability on their balance sheets; six have signed the letter: the NCR Corporation, I.B.M., Rockwell Collins, the ITT Corporation, Northrop Grumman and the Pactiv Corporation.”

It continues to be even more complex because many of these companies have frozen pensions also. Frozen pensions (not be confused with closed pensions) are pensions where obiligations are NOT continuing to grow! BTW, they are seeking relieve for these pensions also! Why not, XMAS is just around the corner especially in Washington!
BTW, closed pensions are pensions accepting no new members but as long as the current population continues to work fund obligations grow.
So, what will be the reaction by industry to this experience whether they get relief or not. Obviously, shift the risk to employee and make the pension costs definable! Enter the defined contribution pension. Already a national trend.
In a speech to the US Chamber of Commerce in 2004 Bradley D. Belt (Executive Director, Pension Benefit Guaranty Corporation) described it this way.

“Traditional defined benefit pension plans, based on years of service and either final salary or a specified benefit formula, at one time covered a significant portion of the workforce, providing a stable source of income to supplement Social Security. The number of private sector defined benefit plans grew through the 1960s and ’70s before reaching a peak of 112,000 in the mid-1980s. At that time, some 40 percent of Americans workers were covered by defined benefit plans.
Since then, there has been steady erosion. Over the past two decades, the number of defined benefit plans has fallen by 75 percent to just over 31,000 plans today. Moreover, just 1 in 5 workers—20 percent of the workforce—now participates in a private sector defined benefit plan. Notably, no new plans of significant size have been established in recent years.”

Defined contribution pensions (401k-based and others) are plans where the employer puts in a fixed amount based on salary usually matching a portion of employee contributions. The ENTIRE risk for the value (payout) at retirement is borne by the employee! Thus, my prediction – the COMPLETE demise of defined benefit plans.
Based on yesterday’s S&P 500 performance this type of plan (employee) would lose 45% this year. Looked at your 401k recently? And the company, NOTHING except maybe an e-mail expressing concern and advise to take a long term view!

Welcome to the future!