The public sector isn’t the only realm struggling to meet pension commitments. According to Mercer, a financial consulting firm, the private sector is hurting, too.
Mercer reported that 1,500 U.S. companies of various sizes had compiled a $400 billion funding deficit for their pensions at the end of 2008, and those firms represented about 85 percent of the companies listed on the stock market.
With April 15 as the deadline for employers to make quarterly pension contributions, the American Benefits Council noted that this year’s payment is more than double the one that was due in the first quarter of 2008 — shortly before the financial market crashed.
ABC said having to meet these obligations by next week could force companies to cut jobs and delay making investments in their businesses, actions that would slow the nation’s economic recovery. A diverse coalition of employers, including Navistar International Corp., NCR Corp. and the Girl Scouts of the USA, recently asked Congress for funding relief.
“The longer we wait, the more jobs will be lost,” said ABC President James Klein in a statement.
A pension is a defined benefit plan that guarantees a company’s employees a set annual retirement payment based on a formula that incorporates compensation and years of service. Employers are then required by law to set aside money, which is invested, to pay for those benefits.
“At any given time, the employer is on the hook for those benefits regardless of the investment success they have in trying to meet those obligations. So, in a sense, the assets to fund that retirement obligation are the responsibility of the employer. The management of those funds is the responsibility of the employer and, therefore, are on the balance sheet of the employer,” said David Hoogendoorn, the managing partner of the West Michigan office of Ernst & Young LLP.
The popularity of these plans has been in decline for decades. The Employee Benefit Research Institute reported that the number of single-employer defined benefit pension plans has dropped by 75 percent over the past 20 years to 30,000. In 1988, there were more than 112,000. Roughly 16 million employees are currently covered by the plans, mostly non-unionized workers. That number is down by 27 percent from the 22 million workers who had a pension in 1988.
Guaranteed pensions began fading when defined contribution plans were introduced. These plans have typically taken the form of a 401(k) plan, which relies on employee rather than employer contributions. Hoogendoorn said an employer can push this plan along with a match of some sort but isn’t required to do so. In a defined contribution plan, employees are individually responsible for how their money is invested.
“These are not on the books of the employer. At the end of the day, the key difference between a defined contribution and a defined benefit plan is, in a defined benefit plan (a retiree) is going to get a stream of payments over time. In a 401(k) plan, (an employee) has a choice to receive it in a series of payments or in a lump sum. The other difference is, unlike a pension, an employee can roll over a defined contribution plan from employer to employer,” said Hoogendoorn.
There are other types of defined contribution plans. One, a money purchase plan, requires employer contributions, usually a percentage of an employee’s salary. Others include profit sharing, stock bonuses and owning company stock.
Hoogendoorn said in today’s market most companies with defined benefit plans have set cut-off dates for pension enrollments and have offered new hires defined contribution plans as a way to control the cost of long-term benefits. But those aren’t the only choices. There is also a hybrid plan.
“A hybrid plan has attributes of both a defined benefit and a defined contribution plan. So like the defined benefit pension plan, a hybrid plan’s benefits are determined by a formula with contribution requirements by the employer and the assets managed by the employer. So it sounds a lot like a pension plan,” said Hoogendoorn. “But like a defined contribution plan, the formula in a hybrid plan is based on wages and earnings of the assets, not length of service. Not only that, it’s reported as an individual account and not an account in total like a pension plan. It can be paid in a lump sum at retirement or rolled over. So it has attributes of both,” he added.
These plans are usually treated as defined benefit plans for tax, accounting and regulatory purposes, and the investment risk normally belongs to the plan’s sponsor. Being treated as an individual account pleases employers, as they’re not as financially on the hook as with a pension plan.
The Pension Benefit Guaranty Corp., which insures pension plans, reported last September that its loss exposure to underfunded plans sponsored by companies with credit ratings below investment grade reached $168 billion. The previous September the figure was $47 billion. PBGC also said multi-employer plans, which are much fewer in number, may need financial assistance of $326 million.
PBGC reported it is protecting the pensions of about 1.5 million Michigan retirees and workers. State-based companies sponsor 1,065 defined benefit plans that are insured by the PBGC, and the insurer has taken financial responsibility for 307 failed plans that were sponsored by Michigan businesses. In 2008, the most recent data year, PBGC paid more than $150 million in retirement benefits to over 26,400 retirees and beneficiaries living in Michigan.