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Pensions Are Losing Popularity
The traditional corporate pension, which gives workers a guaranteed paycheck in retirement, has rarely looked more attractive--or been more endangered, pension experts say.
The Enron Corp. scandal and losses in 401(k) accounts have raised questions about the wisdom of shifting the responsibility for retirement saving to workers.
But far from enjoying a renaissance, traditional corporate pension plans are falling even further out of favor with employers. For the first time in years, many companies will have to contribute money this year to pension funds that until recently had been bursting with returns from a booming stock market.
At the same time, the recession has increased pressure on companies to cut costs.
Pension experts believe this double squeeze will persuade more companies to shut down their pensions and discourage others from starting new plans.
"We'll see more plan freezes and plan closures," said pension expert Steve Vernon of consultant Watson Wyatt. "Some of the companies that are already cash-strapped won't be able to tolerate these [contribution] increases."
No one is predicting the extinction of traditional pensions, which cover some 36 million workers nationwide. The big, unionized industrial companies are unlikely to abandon their plans, pension experts said. But smaller plans are on the endangered list. And workers without pensions aren't likely to get them in the future.
The decline of the corporate pension could mean more workers reaching retirement age without enough money to retire, consumer advocates warn.
They point to disasters such as that at Enron--where workers lost $1 billion in 401(k) accounts heavily invested in the company's stock--as evidence that workers may not be the best stewards of retirement money.
"Ideally, the 401(k) should be a supplement to a traditional pension plan, not a substitute," said Karen Friedman, director of policy strategy for the Pension Rights Center.
Traditional pensions enjoyed a heyday after World War II and the Korean War, when wage controls forced employers to add benefits to compete for scarce workers.
But pensions lost ground with the decline of the manufacturing sector, where defined benefit plans typically are part of union-negotiated compensation packages, said Alicia Munnell, director of the Center for Retirement Research at Boston College. Traditional pensions also were pushed out, Munnell said, by employers' rush to 401(k) plans.
In 1975, 43% of corporate employees were covered by a traditional pension, according to the Employee Benefit Research Institute. By 2000, that proportion had dropped to 20%.
In contrast to 401(k)s, in which workers invest their own money (often with some match from the company) and bear all the investment risk, traditional pensions are entirely funded by the employer, who is required to make up for any shortfalls if the plan doesn't have enough money to pay promised retirement benefits.
Those promises also are backed by the Pension Benefit Guaranty Corp., a quasi-government agency that steps in if employers go bankrupt, default or fail to adequately fund their plans. The agency collects premiums from companies to cover this risk and sets guidelines for how much money employers must contribute to their plans.
The contribution amount varies from year to year, depending partly on how well the plans' investments perform. In good years, such as the late 1990s, companies might not make any contributions.
Earnings at companies in the Standard & Poor's 500 were boosted by an average of 5% to 7% during the stock market boom of the late '90s, said Ronald Ryan of pension tracker Ryan Lab Inc. At IBM Corp., for example, pension fund profit since 1986 exceeded expectations by more than $5 billion.
But two years of poor stock returns have "ravaged" pension plan finances, which will force companies to pony up more money to keep their pensions fully funded, Ryan said. Ryan, like many other analysts, thinks hefty pension contributions will lead to reduced corporate earnings, lower credit ratings for companies and increased Pension Benefit Guaranty Corp. insurance premiums in coming years.
Some companies already have reported that their pension earnings have dropped sharply, including General Electric Co., General Motors Corp., IBM and tractor maker Deere & Co., which said its pension plan lost $1 billion last year. While these companies don't expect to have to contribute to their pension plans in the near future, J.C. Penney Co. said last month that pension expenses would cost the company 25 cents a share in 2003. That compares with earnings of 85 cents to 95 cents that the retailer expects this year.
Congress provided companies some relief from the pension crunch earlier this month when lawmakers, as part of the economic stimulus bill, loosened minimum funding requirements for the plans. Employers had complained that the requirements, which tie pension funding to the 30-year Treasury bond, had been unfairly inflated as the government bond hit record lows.
Even with the relief, though, most of the nation's biggest companies will still have to contribute to their plans, pension consultants said.
"It's really the plan assets that drive the swings in funding," said pension expert Lee Straate of Milliman USA, "and obviously we've seen some pretty significant decreases in assets in the past few years" because of stock market losses.
Many companies will be forced to make contributions equaling 3% to 5% of their payrolls this year, said Vernon of Watson Wyatt. Those facing the biggest contributions, he said, are companies that have contributed nothing to their plans for years--in some cases more than a decade. "It's going to be a jolt," Vernon said.
Some companies could freeze or close their plans rather than bear the increased costs, said Ron O'Hanley, president of Mellon Institutional Asset Management. In a plan freeze, current workers keep whatever pension benefit they've accrued, but they don't earn additional benefits, and new employees aren't allowed into the plan. In a plan closure, new hires are excluded from joining the plan but current workers continue to accrue benefits.
Few employers are likely to shut down their plans completely, pension experts said, because such terminations are costly and require paying out accrued benefits to workers.
Most plan closures and freezes in recent years have been because employers were trying to avoid future costs, rather than deal with current expenses, pension experts said. For example, Frontier Corp., then the fifth-largest long-distance provider, froze its plan in 1996 because it was concerned about future liabilities. The plan was later transferred to Citizen Communications Co., which bought parts of Frontier from Global Crossing Ltd.
Cost isn't the only factor in employers' decisions to close pension plans or their failure to start new ones, said pension attorney Dianne Bennett, author of a book on pension plan taxation. Many employers are convinced that workers don't appreciate the plans.
Employers complain that employees--particularly younger workers--don't understand the benefits of a traditional pension or don't believe they'll be at one job long enough to benefit.
Workers typically begin to accrue pension benefits after five years, but they often must stay at their employer for 15 years or more to get full benefits.
Only 6% of workers surveyed by the Employee Benefit Research Institute in 1997 and 1999 ranked traditional pension plans as a vital benefit, compared with 25% who called 401(k) plans essential.
"A defined benefit plan doesn't mean as much to employees as a 401(k), [even though the 401(k)] might be worth less in the long run," Bennett said. "If you're an employer and your employees don't appreciate [the pension], it's hard to justify the expense."