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For many years, employer sponsorship of defined benefit pension plans has been declining. The past ten years in particular has seen a rapid fall in the number of traditional plans being offered to new salaried employees. In a recent interview with Editor-at-Large Jerry Geisel, Kevin Wagner, a senior consulting actuary with Willis Towers Watson P.L.C. in Southfield, Michigan, discussed the decline of defined benefit plans, the broad implications of that decrease and whether the plans will stage a comeback.
Q: The number of defined benefit pension plans offered by employers has been declining for many years. Your data shows that just under 20% of Fortune 500 companies offered the pension plans in 2015, down 30 points from 10 years earlier. How do you explain the dramatic decline?
A: The reasons for the decrease are several. First of all, the aging of the population. Pension plans are more expensive when they cover more older people.
In addition, the government loosened funding rules. That boosted federal revenue because with companies making smaller contributions, that reduced their tax deductions. That meant companies underfunded their pension plans and had to make higher plan contributions later on.
Furthermore, with the feds moving interest rates to essentially zero, that means higher liabilities and higher cost of future pension plan payments.
Q: But there are industries in which defined benefit plans still are common. How do you explain that?
A: There are industries with a relatively high prevalence of defined benefit plans. You see that in the utility industry, in financial organizations and in the oil and gas industry. The main reason you still see a higher prevalence in those industries is that those industries have fundamental differences compared to the average organization.
Take utilities. Typically, the cost of their pension plans is part of the rate-making process. So, plan sponsors in the utility industry typically keep their pension plans well-funded because those costs are included in the bills we pay every month.
With respect to the oil and gas industry, companies in that industry feel the same financial pressures as other plan sponsors, but their balance sheets are tremendously different.
If you take a look at an oil and gas organization, the risks posed by their pension plans to them are substantially smaller than, say, the risk of drilling a dry hole.
So plan sponsors in those industries focus on other things. They have bigger risks in other areas. The risks inherent in their pension plans are considered more manageable.
Q: Did Congress contribute to the decline of defined benefit plans?
A: I believe that Congress, the Executive Branch and the federal regulatory agencies are all to blame, as well as perhaps the short-term views of plan sponsors. They are all to blame. Take Congress. They want plan sponsors to minimize contributions to plans because that maximizes revenue for the federal government.
In addition, look at what happened to cash balance plans. Many of us saw cash balance plans as a panacea. But it has taken regulators decades to figure out the regulatory requirements the plans would have to meet.
Employers can't really wait 20 years for legal rules that support the structure of these plans.
So, even though we may have once thought cash balance plans would be the savior of the defined benefit plan system, they really have not been because many employers' unanswered questions are only now beginning to be answered by regulators.
Q: Is it too late for the defined benefit plans?
A: I believe it is probably too late for defined benefit plans to come back in response to what government could do.
That said, just in the last couple of weeks, I have talked to a couple of major organizations who are quite frankly coming to the conclusion that 401(k) plans are not meeting the joint financial needs of employers and employees.
Q: Where do such defined contribution plans fall short?
A: They fall short in a number of areas. I think many of us are aware that many employees have not used 401(k) plans to the extent they could to provide the same level of income that one might have received out of a defined benefit plan. Secondly, we are seeing a much more diverse workforce than what we had years ago. Take my son-in-law. He is in dental school. He will have a good career as a dentist, but he will come out with a substantial amount of debt. So, the expectations we have that employees can reasonably save early and save long, that is really questionable. We need to have some kind of program that better meets the financial needs of all of our employees.
If defined benefit plans ever come back, it will be because plan sponsors realize that other alternatives have not been working. I think the only way (defined benefit plans) will come back is when plan sponsors figure out how they will add value.
Q: Are you optimistic that defined benefit plans will come back?
A: I think they could, but I doubt that will ever happen. The reason I say that (is because) I am not sure plan sponsors feel that it is their obligation to make sure that people have good retirement incomes. Employers have not reached the point where they feel it is their obligation to do that.
Q: Will employers continue to slim down their defined benefit plans, for example, by letting employees convert their annuity benefit to a cash lump sum or selling the liabilities to insurers?
A: There is not a single monolithic answer for every employee. Some employees might be better off taking a lump sum with them. From a plan sponsor perspective, they might like to pay a lump sum because it really reduces risk by removing pension liabilities from their balance sheets.
I do think plan sponsors want to make their pension plans smaller by giving certain participants the option to take a lump sum. I think we will continue to see that.
Q: Where does this downsizing trend leave the Pension Benefit Guaranty Corp., the federal agency that takes over the pension obligations of failed or financially troubled companies? Premiums have soared in recent years. Soon, they will be $80 per pension plan participant, up from $1 when the PBGC was formed in 1974. How important are rising premiums in employer decisions to slim down their pension plans?
A: The move of employers away from defined benefit plans initially was not driven by higher PBGC premiums. However, over the last few years, the mass increases in the flat-rate and variable-rate PBGC premium has led employers to make financial decisions to reduce the cost of their pension plans. The cost of keeping participants in their pension plans is substantially higher than it was five years ago. That is one of the reasons you are seeing plan sponsors offer lump sums to plan participants, such as vested former employees, so they don't have to keep paying those escalating premiums. You also are seeing employers slash PBGC premiums by shifting liabilities to insurers through the purchase of group annuities. Because of higher PBGC premiums, there is more urgency to do this sooner rather than later. It is a way of saving dollars.
Q: Will lawmakers come to recognize that what is going on will shrink the PBGC premium base so much that the agency won't be able to meet its legal mandate to guarantee participants' benefits?
A: That could happen. But even when you take into account all the transactions plan sponsors have taken over the last few years to reduce PBGC premium payments, that is still a small dent in the number of employers paying PBGC premiums. To be sure, the administration has said that it essentially believes that premium rates for the single-employer pension plan system should remain at current levels. The thing, though, that scares plan sponsors is when we talk about the 300-pound gorilla: multiemployer pension plans. Many are very scared whether there is sufficient money in the PBGC multiemployer pension insurance program. Congress might say why don't we aggregate the PBGC's single- and multiemployer pension insurance programs? That would cause single-employer plan sponsors to pay an enormous amount in premium dollars.