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Is It Time To Retire Your Defined Benefit Plan?
Glenn Jensen, Healthcare Retirement Strategist
Defined benefit plans have played and do play a very important part in tens of millions of American workers retirement plans. The three legged stool of retirement historically was Social Security, company pension plan and individual savings. However, the news is filled with companies shutting their defined benefit plans because they cannot afford them and the Pension Benefit Guaranty Corporation (PBGC) was in a deficit position of $22.8 billion as of September 30, 2005.
Defined benefit plans were designed as part of an employer's employee benefit program to help recruit, reward and retain employees. The longer you worked for an organization translated into more benefits from the defined benefit plan. The attached graph illustrates that most of the accrual of benefits takes place after 20 years of service and does the job of rewarding the longer term employee.
The workforce has become more transient over the past two decades and changing jobs multiple times does not have a negative connotation as it may have had in years past. As a recruitment and retention tool, are defined benefit plans of much value, especially to employees under the age of 45 or 50? The answer that is voiced by many involved in human resource recruitment is, "not really." Attached is a sample defined benefit plan of a hospital where the age demographics show the vast majority of employees being under the age of 50.
As the job market continues to be competitive for talent, questioning to see if having a traditional defined benefit plan helps to attract talent needs to be evaluated. An organization may be have both a defined benefit and defined contribution (401k/403b) plans which together can accomplish this goal. Ultimately, a benefits and cost analysis should be done to determine the cost effectiveness and competitive advantage in the marketplace.
In a survey that was recently conducted by Wells Fargo Institutional Trust Services, it was noted that sponsors of defined benefit plans will be making changes. More than one third of the 450 companies surveyed had a defined benefit plan but reported that it will be declining. According to the survey 14% of plan sponsors plan to replace their DB plan with a defined contribution plan, 13% plan to freeze their plans and 5% plan to terminate their defined benefit plan within the next 12 months.
When making any changes, careful consideration should 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 as well as effectively communicating any changes. There are innovative solutions to be able to accomplish benefit restoration in the defined contribution plan, a separate restoration program or both.
Terminating a defined benefit plan provides certainty and takes the organization out of the administration business. When you freeze a DB plan, you stop adding on additional liabilities (accrual of benefits) but all the other costs to keep the plan on life support continues; actuarial, custodial/trustee, administration, PBGC premiums, funding costs and investment costs. For those plans that are under funded, not only will they have to accelerate getting out of their being under funded in 7 years as a result of the Pension Protection Act of 2006 but the FASB Statement 158 that was announced on September 29, 2006 requires the amount of the under funding be placed directly on the balance sheet.
What are the challenges of under funded plans?
- Increased concern by analysts and rating agencies
- Plan sponsors are impacted by:
--ERISA threshold requires additional cash flow
--PBGC threshold leads to higher premiums
--Affects of being on balance sheet
For those plans sponsors that would prefer to terminate their DB plan but because the present value to terminate plan exceeds the value of the assets (under funded) the amount required to make up the difference is too costly and they opt to freeze the plan. As mentioned earlier, there are several costs just to keep the plan alive until it can be terminated. These costs go on every year and the variable cost of investment returns is still ongoing.
There are innovative solutions to transfer a defined benefit plan's liabilities to a guarantor of DB liabilities 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" to keep a frozen plan alive. For under funded plans, they would be required to pay the amount of the under funded assets plus interest over a seven year period.
Each plan sponsor will need to personally assess whether or not it is time to retire their defined benefit plan based on their goals and the effectiveness of the plan weighted against the cost (both contributions and cost to operate). Each situation is unique and any change requires unique solutions. Knowing what alternatives are available and then carefully analyzing those options will need to be followed up with effective communication to announce any changes.
Communication is critical to ensure a positive outcome.
Constant Change and Ambiguity in our Federal Employment Legislation……
David Ryan, LLER Committee co-Chair
My father-in-law used to tell me "... David, the only constant in life is change!" He said it constantly, without any change whatsoever, contrary to his point I think(?). One of his many well intentioned "father-knows-best" sayings, it actually applies to laws and regulations governing employment.
In a December 18, 2006 decision, the 1st Circuit Court of Appeals rendered a decision that expands the rights of employees to a leave of absence under the FMLA, and further adds to the already substantial burden on HR practitioners. The case is Rucker vs. Lee Holding Co. In a case of first impression (which means that it is the first time the Court had considered the specific legal issue), the Court ruled that Mr. Rucker could combine 2 separate employment periods with Lee Holdings Co. to satisfy the requirement that he work for at least 12 months and 1250 hours to be eligible for a protected leave under the FMLA. Rucker had previously worked for Lee Holdings Co. as a car salesman for 5 years, left the company for 5 years, then was re-hired, injured his back, took intermittent leave and was fired for excessive absenteeism. The 1st Circuit ruled that the definition of "12 months" in the statute was ambiguous (oh boy, here we go), and decided to expand the traditional interpretation to include prior service with the same employer. Unhelpfully, the Court did not place any limit on how far back this new "prior service" standard would go, leaving employers with a significant question about how long to retain the records of ex-employees. The decision raises many questions for employers.
I worked at a Coca-Cola plant during summers while I was a college student - about 25 years ago (ouch). If I am ever re-employed with Coca-Cola (and could that be anywhere in the US?), would my summer job from 1980 be considered as "prior service" and included in calculating my 12 month period? Imagine being the poor guy/gal at Coca Cola in charge of FMLA administration!
So, what is in HR's future? Constant change and ambiguity in federal employment legislation, for one thing.
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